Essex Property Trust Q3 2022 Earnings Call Transcript

Quartr
Provided by Quartr
October 27, 2022

Key Takeaways

  • Essex announced a planned CEO transition: Michael Schall will retire in March 2023 and Angela Kleiman, a 13-year veteran, will succeed him after being appointed to the Board.
  • In Q3 the company delivered its fourth consecutive quarter of improved core FFO per share, reporting 18.3% year-over-year FFO growth and 15.4% NOI growth, beating guidance by $0.04 per share.
  • For 2023, Essex forecasts 2% market-level rent growth, driven by modest job growth (0.4%) versus limited supply gains (0.6% of stock), with California markets expected to slightly outperform Seattle.
  • Operational initiatives are driving efficiency: phase 1 of the “collections” operating model is fully rolled out with administrative expenses up just 1.4% year-to-date, a maintenance rollout begins mid-2023, and a new software platform is on track to cut transaction tasks by 35%.
  • The balance sheet remains strong with net debt/EBITDA at 5.8x, over $1.1 billion liquidity, virtually no near-term funding needs, and an ability to pursue opportunistic, accretive investments as markets recover.
AI Generated. May Contain Errors.
Earnings Conference Call
Essex Property Trust Q3 2022
00:00 / 00:00

There are 16 speakers on the call.

Operator

Good day, and welcome to the Essex Property Trust Third Quarter 2022 Earnings Conference Call. As a reminder, today's conference 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.

Operator

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 Schall, President and Chief Executive Officer for Exis Property Trust. Thank you. Mr.

Operator

Schall, you may begin.

Speaker 1

Thank you for joining us today, and welcome to our 3rd I will begin by congratulating Angela for her appointment to the Essex Board and for being chosen as the next CEO of the company following my planned retirement In March 2023, I have known Angela for almost 2 decades and we have worked closely together Since she joined the company 13 years ago, Angela embraces and exemplifies Essex's strategy and core values and is a dedicated, thoughtful leader as well as an excellent negotiator. Our recent leadership announcement was the culmination of a multiyear session plan administered by the Essex Board, and I appreciate each participant's commitment to the plan that resulted in its success. It has been an honor to lead this awesome company made possible by my great leadership team and the coordinated effort of every Essex associate. My thanks to all of you. Today, I will touch on our Q3 results, introduce our initial market level rent Consecutive quarter of improving core FFO per share.

Speaker 1

On a year over year basis, we reported core FFO per share and NOI growth of 18.3% 15.4%, respectively, with core FFO exceeding the midpoint of our guidance by $0.04 per share. The positive results are reflective of the team's execution and the continued recovery throughout our markets, Largely driven by the ongoing rebound in Northern California and Seattle with Southern California remaining a consistent and strong performer. Year to date, the economy on the West Coast has shown resiliency with job growth as of September 2022 Of 4.3% in Southern California and significantly higher in the tech markets of Northern California and Seattle. The positive job growth is partly attributable to the recovery of workers lost amid the significant shutdowns early in the pandemic, especially leisure, hospitality and service jobs that were added throughout the summer. As a result, it is not surprising that the unemployment rate at each Essex market with the exception of Los Angeles is under 4%, including San Francisco and San Jose in the mid-two percent range.

Speaker 1

The unemployment rate in Los Angeles is higher at 4.5%, Likely related to the ongoing eviction moratorium in the City of Los Angeles, which is expected to run to end in February 2023. Job openings at the large tech companies have declined from record levels during the pandemic, although they remain with approximately 20,000 jobs available, roughly consistent with the number of job openings they reported between 2016 early 2020. Thus, while we recognize that tech job growth is slowing, the large tech companies are well capitalized and continue to expand and hire in our markets. As in previous years, we have included our initial forecast for 2023 Market level rent growth on Page S-seventeen of the supplemental. Our forecast begins with the consensus estimates of 3rd party economists For the national economy with respect to GDP and job growth indicated at the top left of Page S-seventeen.

Speaker 1

Based on these estimates, our data analytics team estimates job growth in each Essex metro. On the supply side, we use our ground up fundamental research if the key assumptions prove inaccurate. In summary, housing supply across the Essex markets Is expected to grow at 0.6 percent of existing housing stock with the greatest increase occurring in Seattle with a 1.1% increase. Job growth is expected to be new next year, growing at 0.4% overall in the Essex markets with the best job growth expected to be In San Francisco, at just under 1 just over 1%. As a result of these demand and supply assumptions, We expect net effective new lease rents to increase 2% in 2023 with our California markets expected to marginally outperform Seattle.

Speaker 1

On a year over year basis, we expect apartment supply to decline about 10% in 2023 with Northern California having the largest expected reduction, down 45%. We also expect 2023 single family deliveries to be similar to 2022 even with permits growing modestly Given much higher mortgage rates. With respect to for sale housing, declining housing production And reduced affordability are tailwinds for apartments in the Essex markets, representing a small positive factor contributing to our rent outlook next year. Given economists' expectations for a modest recession in 2023, I'd like to summarize our historical experience about operating our portfolio in previous economic downturns. Generally, in each significant past recession, our weakest market has been Seattle, which is due to the confluence of negative job growth And higher levels of housing supply deliveries.

Speaker 1

Northern California follows a similar pattern to Seattle with respect to job losses during recessions, Although with significantly less supply that results in outperformance relative to Seattle. Finally, Southern California is our best performer during recessions given its diverse economy and minimal supply. That being said, Each recession is unique and there are several factors that could lead to a different outcome. First, most of the previous recessions followed a long economic expansion where rents grew substantially. And it's those higher rents that pressures affordability It fosters higher level of apartment supply.

Speaker 1

On the West Coast, rents plummeted in the early part of the pandemic And our recovery was much delayed compared to the rest of the country with Southern California's recovery beginning in mid-twenty 21 Northern California and Seattle in early 2022. As a result, the West Coast is still in the early stages of its In addition, with many offices closed during the pandemic, it was common to hire remotely with the expectation that workers would need to relocate Closer to offices upon reopenings, which is now occurring. The relocation of employees back to the West Coast pursuant to return to Primarily because those that typically leave California, such as the newly retired, probably left early in the pandemic when Businesses were shut down. In a moment, Angela will comment further on migration. Turning To the apartment transaction market, we have recently seen a few deals close at valuations that were negotiated before the most recent increase in interest rates and conditions have changed enough since then to significantly impact transactions.

Speaker 1

As expected, the immediate impact of higher interest will result in diverging buyer and seller expectations for property values, resulting in a larger bid ask spread. Generally, it takes more than higher interest rates to create financial distress, especially with recent strong rent growth given inflationary pressures. However, pockets of distress may develop from credit or liquidity events or excessive Fed tightening, although no major issues are At this point, broker price talk with respect to apartment transactions indicates that cap rates For high quality and well located apartments are in the mid-four percent range in the Essex markets. Finally, I wanted to note That our balance sheet is in great condition, thanks to the unwavering urgency of Barb and the finance team over the past several years. When the markets turn positive, we expect Excellent opportunities to invest accretively and we will be in a position to be opportunistic.

Speaker 1

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

Speaker 2

Thank you, Mike. I will begin by expressing my sincere gratitude to Mike for his mentorship and guidance over the past 13 years. I am honored to have the opportunity to lead this organization and to build upon the company's long history of thoughtful capital allocation And operational excellence. My comments today will focus on our Q3 performance, followed by some regional highlights, Then wrap up with the key operational initiatives that we are excited about. Starting with the Q3, during much of this period, We capitalize on the strength of the underlying fundamentals in our markets by pushing rents and achieved 10.3% Year over year growth in new lease rates in the 3rd quarter.

Speaker 2

Although this is a deceleration compared to the 20% growth in the 2nd quarter, Keep in mind that new lease rates in the first half of last year declined by about 6%, but in the second half, New lease rates surged to positive 17%. The tough year over year comps is the key driver of the deceleration And the Q3 results are in line with our expectations. In general, we have seen a normal seasonal rent pattern. Accordingly, As we approach the end of the Q3, we shifted to an occupancy focused strategy. Turning to the delinquency.

Speaker 2

In recent months, we have begun to recapture more units from non paying tenants. With the ending of eviction moratorium, it is no surprise That the number of move outs related to nonpaying tenants have increased. Looking forward, we plan for a higher volume of move outs, which may create a temporary headwind in occupancy for the rest of the year and into 2023. For this reason, Even though we have shifted to favor occupancy, we anticipate our occupancy to be slightly lower than historical levels. The good news is that regulations are being pulled back, which is allowing us to finally make progress on delinquency.

Speaker 2

Moving on to regional highlights, starting with Pacific Northwest. After a strong start to the year, rents in this region have peaked in late July. The seasonality through the Q3, which includes the typical decline in market rents subsequent to the peak, It is consistent with what we have experienced between 2016 2019. However, since mid September, We have been facing softer demand along with higher level of supply deliveries in the second half of the year. So we are monitoring this market closely.

Speaker 2

As for Northern California, this region has led our growth in net effective new lease rates since the start of the year. Strong job growth and return to office are 2 key contributing factors. Bay Area net immigration has continued to accelerate this year. In the Q3, over 35% of move ins were primarily from outside of our markets, which is an increase from 15% in the Q1. Notably, we are seeing positive migration trends from markets as diverse as Dallas and Boston.

Speaker 2

Consistent with our previous commentary on commitment of Tech giants to continue to expand in Northern California. We are excited to see Google break ground last week on its massive mixed use development in San Jose. This development is expected to bring 25,000 high paying jobs and effectively doubling the amount of office space in Downtown San Jose. This will be a long term benefit for Essex as we own almost 6,000 units in this region. Onto Southern California.

Speaker 2

Healthy job growth is continuing to drive incremental demand for rental housing. As such, this region continues to perform well. We are also seeing positive in migration to Southern California with 30% of our 3rd quarter move ins coming from outside the region compared to 17% in the Q1. Turning to key operations initiatives. We have completed the rollout of 1st phase of our property collections operating model, which focused on leasing administration and customer service.

Speaker 2

By way of background, this model optimizes our geographic density and transforms our business from operating each property individually To a collection of around 9 to 12 properties. The shift in business strategy enables us to leverage our team and technology to improve The customer experience and achieve significant efficiencies. I'm pleased to announce that Phase 1 is fully rolled out across the entire portfolio, ahead of plan and the progress is beginning to show up in our financial results. Year to date, administrative expenses were up only by 1.4% Despite significantly higher wage increases along with other inflationary pressures and expenses. The next step is to apply the collections operating model The maintenance function, as we have demonstrated previously, this model has created more career advancement opportunities for our employees through specialization, While improving efficiency and customer service, the maintenance collections pilot is currently underway and rollout is planned to start by mid next year.

Speaker 2

Lastly, on the technology front, the implementation of Funnel Software Suite is progressing well. As you may recall, funnel is a RET venture company with whom we have chosen to co develop applications to enhance our platform. The funnel product will handle the end to end customer experience from initial prospect inquiry through the full resident lifecycle, which will result in better experience for our customers. From an employee perspective, this technology will streamline or automate The manual tasks associated with roughly 60,000 transactions each year. Our initial pilot showed a promising 35% reduction in task associated with these activities.

Speaker 2

Continued refinements are underway, and we are excited to work toward a full deployment by the end of 2023. With that, I will turn the call over to Barb Katz.

Speaker 3

Thanks, Angela. Today, I will discuss our 3rd quarter results, Followed by an update on investments and the balance sheet. I'm pleased to report 3rd quarter core FFO per share of $3.69 A $0.04 beat to the midpoint of our guidance range. Half of the outperformance was due to lower operating expenses, which is timing related, And the other half was from higher co investment income due to better NOI growth at the joint venture properties and higher preferred equity income. For the full year, we are raising the midpoint of core FFO by $0.02 per share to $14.47 representing approximately 16% growth compared to last year.

Speaker 3

As it relates to delinquency, we are seeing continued improvement in our gross delinquency, which is helping to offset less emergency rental assistance funds. For the same property portfolio, gross delinquency improved sequentially From 4.5% in the 2nd quarter to approximately 3.5% in the 3rd quarter. October improved further to around 2%. We suspect the gross delinquency trends will continue to improve as we work to recapture delinquent units. However, the improvement is unlikely to be linear.

Speaker 3

One additional positive development that recently occurred is the City of LA accounts for approximately 40% of our outstanding bad debt and will allow us to finally get back to our historical level of delinquency. However, it will take time to achieve this goal and we would expect delinquency will remain elevated through the first half of 2023 with the expectation that we will get closer to our historical average of 35 basis points of schedule rent by the end of next year. Turning to our stock repurchase and investments. Consistent with last quarter, investing in our own portfolio and select preferred equity investments to close in the Q4. As it relates to other transactions, we closed $65,000,000 of new preferred equity and subordinated loan investments During the quarter and committed to one additional investment in October.

Speaker 3

These new commitments are expected to be match funded with redemptions of 2 structured finance investments that are slated to close in the Q4. Finally, I want to provide some additional color on the strength of the balance sheet. Our net debt to EBITDA ratio remains healthy at 5.8 times and we expect this to further improve as EBITDA continues to grow. It should be noted that we operated around the same leverage levels before the pandemic and our balance sheet metrics are strong. In addition, we are well positioned from a capital needs perspective.

Speaker 3

In October, we closed the delayed draw term loan that will be fully drawn in April of 20 3 with proceeds intended to repay $300,000,000 in bonds that mature next year. We have swapped this debt to an all in fixed rate of 4.2%. As a result of this transaction, we have all our known funding needs addressed until May of 2024. The company has no significant unfunded development needs and can fund the dividend, operations and capital expenditure needs from free cash flow. Additionally, our variable rate exposure, excluding our line of credit, is minimal at less than 4% of our consolidated debt.

Speaker 3

With over $1,100,000,000 in liquidity, no funding needs for the next 18 months and access to a variety of

Operator

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. Our first question comes from the line of Nick Joseph with Citi. Please proceed with your question.

Speaker 4

Thank you and congratulations both Mike Angela, maybe just starting on the building blocks for next year. Obviously, you provided the market rent growth of 2%. What's The earn in expected from 2022 leasing and then where is the loss to lease today and where would you expect it to be at the end of the year?

Speaker 2

Hey, Nick, it's Angela here. So on the earning for 2023, I think if it's okay with you, I want to just start step back and make sure we're using a consistent definition. For us, the way we look at earn in is, we look to the September loss to lease, it's not too hot and not too cold and take 50% of that. So in this case, September loss lease was close to 7%, taking half of it will be about 3.5% And that will be our earning and we assume no market rent growth. Now what we've heard is there's a Question about 2023 revenue growth And how does the earn in apply to that?

Speaker 2

And so what we've done in the past is explain that by saying, you take your earn in And then we look at our 2023 S-seventeen market rent growth and take 50% of that. So that would be the market rent growth is 2%, so half of that would be 1%. You add that to the 3.5% earn in, That gives you a proxy of about 4.5% for revenue growth for 2023. And so as far as the lost lease, where we are is we're about 2.5% Loss lease in October for the portfolio. And of course, it varies by region, but that's coming from a Loss of lease in September, and of 6.7%, so definitely a deceleration, but It is expected and loss of lease at this level for October is actually Better than our historical patterns.

Speaker 2

Typically, around this time of the year, we're at about 1% loss to lease and heading towards a 0 by year end. So at 2.8, we're feeling pretty darn good about the portfolio.

Speaker 4

Thanks. That was very helpful. And then maybe just on the transaction market, Given kind of the expected rent growth and where debt costs are today, does a 4.5% cap rate makes sense Most buyers or how are they thinking about getting to their unlevered IRRs, given maybe the negative leverage situation initially right now?

Speaker 5

Yes. Hey, Nick, this is Adam. There, as Mike mentioned in his opening comments, There are still deals going non contingent. And in talking to buyers who are still active in the market, They're willing to take a certain level of negative leverage for 18 months to 24 months is the number that I'm hearing now. And so with various assumptions about rent growth, repositioning, and those types of strategies, That's what we're seeing in the market.

Operator

Our next question comes from the line of Steve Sakwa with Evercore, please proceed with your question.

Speaker 6

Yes, thanks. Look, I guess the biggest thing that everyone's focused on is 2%. And Angela, you walked through the math, and I know this is not trying to get this into a debate about 23%. But The math that you just walked through would, I think, basically imply your revenue growth is several 100 basis points below several of your peers. And guess I'm just trying to understand, is that really a function of market mix?

Speaker 6

Is that a function of the conservatism, the 2%? I don't know what the history of that number is and if you start low and kind of work that number high over time, But it just strikes me as your implicit growth for next year is kind of well below the peers.

Speaker 1

Hey, Steve, let me try to handle that one. So F-seventeen, beginning a few years ago, Decided to start with the consensus of 3rd party economists as to the U. S. And then drill down from there into what that means for our markets. And we obviously have Chairman Powell out there talking about breaking things and pain to come And a mild recession, which is what this is based on.

Speaker 1

And so rather than using our own how we feel, We think it's important that we create a scenario that's based on the consensus of the people that are really studying these things And certainly not ignoring what they're saying. And so that's where this macro scenario comes Do we feel like that's a little bit dire? Yes, we do. But again, several years ago, we made the decision to Start basing, S-seventeen on the macroeconomist view of the world, which in fact is pretty dire. And it seems to us that we shouldn't ignore the Fed's comments about pain to be had, So that's where that scenario comes from.

Speaker 1

Do we feel like things are a little bit better than that? Well, yes, we do. And if we were basing this on how we feel, we would come up with something that is more optimistic than this. But Again, we shouldn't ignore the Fed and that seems like it's what's happening out there. And we think that's fundamentally misguided, I Does that make sense?

Speaker 6

Yes. Look, I agree that there are storm clouds. It would seem like you would need to see negative job growth Occurring in order to really diminish the pricing power that's out there. And so when I look at your job growth forecast The market job growth forecast of 40 basis points against supply growth of 60 basis points, those are largely In lockstep with each other, there's not big dislocations on the supply front in your market. So it would feel like occupancy is going to be relatively stable.

Speaker 6

And so I would have thought that rent growth wouldn't be off to the races, but that it might be better than 2%. If you told me job growth was very negative, I would agree with you.

Speaker 1

Well, that's and that's exactly what the 3rd party economists are saying. So up there in the upper left hand corner Is the consensus of the, again, 3rd party macro economists that say job growth is going to be minus 0.2% next year. And so that forms the basis of what we think. So we outperform in terms of job growth the U. S.

Speaker 1

Economy. And in fact, that minus 2% for the U. S. Is translating into 0.4% job growth for us. So not a lot, but again, It's a pretty dire scenario.

Speaker 1

And so that's where that comes from. Again, we don't feel like it's This bad. I mean, based on what we see in front of us today, we're having some seasonality here in October. We expect that. Your loss to lease typically goes negative by the end of the year, and it probably will this year.

Speaker 1

Keep in mind, The demand side of the equation is driven by jobs and obviously, we pay attention To the seasonally adjusted jobs, but the reality is if you look at total non farm employment, it gets pretty soft in the Q4 and so these things can happen. So Basically, we don't feel we feel like this is a pretty draconian scenario, but we're trying to maintain some consistency with respect to What we are trying to put out there with respect to S-seventeen and just following through on the historical pattern And looking at what the economists out there are saying, we think this is that scenario. Could it be different? Absolutely, it could be different, and we hope it's different. But again, I don't want to ignore the elephant in the room.

Speaker 1

It seems pretty important to actually consider What the macro economists are saying and what it means for us, and I would add to that, everyone across the nation As a reminder, today's conference call is being recorded. It's not just a West Coast thing. It's a national thing. It starts with the U. S.

Speaker 1

Job growth. And then we look at historical relationships to try to determine what it means for the West Coast, and that's where these numbers are coming from.

Speaker 6

I appreciate that. Thanks. And then I guess maybe just in terms of return hurdles and how you're thinking about underwriting. Can you just give us a sense for how you guys have altered either acquisition hurdles, development hurdles in light of Given where stock prices have gone, where bond yields have gone, I mean, how much have you raised your cap rates, IRRs in today's environment?

Speaker 5

Hey, Steve, this is Adam again. So consistent with what we just talked about, the 4 range is kind of where we see the market. We're probably not buyers at that range. We have better use for our capital And development yields will need to move off of that base, if not maybe slightly higher. So When we look at development deals, depending on where they are in the entitlement process, we're looking at a 20% to 25% spread over to adjust for the risks related to development.

Operator

Our next question comes from the line of Adam Kramer with Morgan

Speaker 7

Just wanted to maybe dive a little bit deeper into some of the markets. Looking kind of at the October new lease growth, kind of that 2.8% figure, wondering if you maybe give some color just on performance across kind of the different markets. I think that'd be helpful.

Speaker 2

Sure. Happy to. So on the new lease rates For October at 2.8, it's actually a pretty wide range. So with starting I'll just go from north to south. Pacific Northwest, It's negative, about 90 basis points, and that's consistent with my earlier commentary about the softness in that market.

Speaker 2

And then Northern California, the strongest at about 4.5% and Southern California close to 2%. So Southern California continues to be the steady Eddie and Northern California is rebounding as we have anticipated.

Speaker 7

Yes, that's really helpful. And just looking at the occupancy figure, it looks consistent kind of October versus Q3. Maybe just comment a little bit about kind of, are concessions being used? And I imagine maybe in kind of that weaker North West market, maybe they are being used. So I would love to just kind of hear, are concessions being used?

Speaker 7

Is that kind of being used as a tool to kind of maintain occupancy here?

Speaker 2

Sure. We concession usage is for us, we focus on where there's competitive supply. So of course, during our if we're doing our own lease up, we use concessions. We rely on that as part of our pricing tool. But Absent of that, it's a function of how many lease up do you have near your property and how do we remain competitive and meet So in terms of the concessions usage, just The change between October and Q3, it has ticked up and it's primarily driven by Seattle.

Speaker 2

So Seattle, in the Q3, and I've mentioned that we had a very normal Q3, With all the other markets, it's incremental couple of days more, which is consistent with what we expected. And so Portfolio overall, our concessions has gone up from, say, half a week to about a week Portfolio wise and with the key driver being Seattle.

Operator

Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.

Speaker 7

Hey, good morning out there. And Angela, congrats. And I guess now you get the joy of answering directly to George after each earnings season. So I'm sure you'll enjoy that part. So question two questions for you and going back Steve, to Steve's question.

Speaker 7

Traditionally, you guys are a conservative team. I don't want to say, I won't characterize it any more than that, but Obviously, the stats get warped with the COVID rebound. It sounds like you guys are saying that revenue is 4.5%, While your loss lease right now is 7%, so but you're only saying, hey, next year maybe 4%, Probably a little bit better than the national average because you don't have the OpEx, the property tax pressure. But as we think about bottom line FFO growth, Should 2023, assuming that it's not a bloodbath recession, should be sort of more of a normal type earnings growth? Or I'm just trying to figure out how much the year over year stats are impacting or clouding the FFO growth that is implied by What you guys have presented?

Speaker 2

Yes. Hey, Alex, there's obviously lots of moving pieces here and you're asking Good questions. Kind of what does that mean for the bottom line? Let me just clarify a few things and then I'll give it back to Mike to talk about To S-seventeen and maybe far from the SFO, the 7% that you're referring to is September loss release. And what we normally do is take half of that for the earn in.

Speaker 2

So that's how we got to the 3.5%. And Yes, that's pretty consistent math for proxy purposes. And as far as the expense comments, I do want to address that for a minute. I do think that we should perform a little better than inflation on average And especially on the administrative side of it, that should be quite a bit below inflation. And With, but since we have not yet rolled out maintenance collections, that will be higher than the admin growth.

Speaker 2

And so we Expect controllables to come in comparable to this year at about 4% for next year, but that's on controllables. And so that's some of the building blocks from the P and L perspective. And then Mike?

Speaker 1

Yes. Alex, I just wanted to add a couple of things Perhaps so, first thing is that, Angela, she takes for next year the kind of proxy formulas at 3.5 Plus half the growth of next year, which is the 2%, which is a pretty dire scenario. So I'd say there is some Potential upside of that dire scenario doesn't take place. So that would be one thing. And then I just want to mention that we feel pretty good about where the company is positioned right now.

Speaker 1

Core FFO right now is at the high end of the bicoastal peers when you go back and compare it to Q4 2019, so we feel good about that. And we've accomplished that with really Southern California at Sort of full recovery in full recovery mode, not Northern California and Seattle. And we attribute that to the fact that Both of them fell further and have a longer period of time that's required for recovery. And in Northern California, for example, Rent levels right now are roughly equivalent to where they were at pre COVID. So there's been no rent in Northern California.

Speaker 1

And Certainly, the tech markets are the driver of growth and I suspect that they will be the driver of growth going forward. We're just not there yet. So We feel good about this. When we think about some of the other things, incomes, median incomes, Household incomes in San Francisco and San Jose are now over $145,000 a year. That's the median, which is Pretty amazing and it's very affordable as it relates to rental value.

Speaker 1

And that's what draws people to the West Everyone talks about, well, the costs are higher on the West Coast, but the reality is they're drawn by the incomes that are much higher as well. And so we think that there's going to continue to be a recovery as we recovered jobs lost in the recession in Northern California We think that they will once again become the drivers of the company going forward and very little of that is priced into the stock, which makes us think that there's very good upside here.

Speaker 7

Okay. The second question is on your debt and deferred equity program. Obviously, one of your peers Had a default and they're taking the property back here in New York, the office companies converted 2 DTE positions. You guys have a number of investments. Do you see the risk profile of DTE?

Speaker 7

Or your view is that As you monitor the deals, they're all financially performing the way you expect them, meaning nothing you haven't seen anything outside of What you've been monitoring along the way, both in performance as well as in the developer's ability to get to procure financing?

Speaker 5

Hey, Alex. So at this point, we're not seeing any potential for material defaults. We constantly assess Our preferred equity book, so the short answer is no, we're not seeing anything at this point. A little more background behind it. Over 75% of our pref and mezz book was underwritten in 2020 or before.

Speaker 5

So we really we didn't go down to the depth So the mid-three caps chasing deals, we did very few deals during that time. And so with this recent expansion in cap rates, It really doesn't impact where we are in the STACK. And then you couple that with Pretty significant NOI growth and we feel like we're in a pretty good position.

Operator

Our next question comes from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.

Speaker 8

Yes. Hey, everyone. I want to explore one of the comments, I think Angela said in her opening remarks on the higher move outs. Is What you're expecting going forward? Are those higher move outs from non payers who I guess you'll be able to address With the LA restriction going away, just trying to get a sense of like will that lower occupancy kind of impact same store revenue?

Speaker 2

Sure, sure. There are 2 things happening on the move outs. The higher turnover is driven by 2 factors. 1 is, course, the Seattle softness that I've talked about earlier and it's attributed Mostly to a elevated level of supply in Seattle in the second half. And of course, when there's more supply, there's more Concessions and that draws people out of stabilized properties, that's not unusual.

Speaker 2

During a period where corporate hirings are slowing, Once again, that's what's happening in Seattle. As far as California, the higher move out is attributed to The nonpaying tenants moving out, which we see is a good thing. And so with the LA moratorium is airing next year. We do see another opportunity there. So we're able to make Good progress in the delinquency front there.

Speaker 2

So that's the hopefully, that's what you're looking for.

Speaker 8

Yes. No, that's helpful. And then you I think another comment you mentioned was Just shifting more to focus on occupancy. I guess what's driving that? Is it just like You want to hang on to occupancy assuming like it sounds like you guys are taking the big picture macro view that there might be like a recession?

Speaker 2

I see what you're saying. Yes. So the normally, when we See, market strength and which is usually during period of strong demand, we push rents. And As we head toward the end of the Q3 and into our season alone in the Q4, we historically switched That strategy to push occupancy. And so what we're doing here is consistent with what we've always done in the past.

Speaker 2

And what we're seeing is this is what I'm trying to convey there is that this is a normalized market that's stable and we're essentially Shifting this strategy to maximize revenue during this period of time. And the reason so normally what you would see is in the 4th quarter, our occupancy may run, say, in the mid to high 96%. But because of this eviction headwind, it may run a little bit lower, So maybe in the low 96%, but I wanted to signal to the community that That's not because there's any problem here. This is actually a good thing.

Operator

Our next question comes from the line I have John Kim with BMO Capital Markets. Please proceed with your question.

Speaker 4

Hey, good morning and congrats Angela and Mike. Angela, I wanted to ask your methodology on the earn in. I realize this is somewhat of a new figure, at

Speaker 9

least to us on the outside.

Speaker 4

And your use of taking the September loss to lease and approximating it by using half of the loss to lease. I would have thought the earn in was basically the rent contribution this year versus next year on rent that you've signed to date. I was just wondering, how this earn in compares maybe to prior years? And then also how accurate using September loss of lease Divided by 2, how accurate is that to the actual contribution?

Speaker 2

Yes. So if I look at the September loss to lease and use that 50% as a proxy, and I look at that number relative to Twice as high as the normalized period. Normally around September, the loss to lease Is around 3%. And so this is one of the reasons why we feel good about where our portfolio sets and as we head into next year. Absent, of course, a recession, we certainly should do quite well.

Speaker 4

So historically, your earnings about 1.5% per year?

Speaker 2

Yes. That sounds about right. Now the one thing I do want to clarify is Everybody calculates it a little bit differently. And so for us, we are not including concessions. So if we include concessions, that earning number obviously will be much higher.

Speaker 2

But we're trying to just keep it apples to apples, so there's to minimize confusion. So it's the same baseline.

Speaker 4

Okay. And I know this has been asked a few different times, but on your 2% rent forecast, I'm just trying to get a sense of What kind of range that you see this at? And how difficult it was to forecast job growth For next year versus prior year is when you come out with this initial forecast.

Speaker 1

Yes. Hi, John. It's Mike. So again, we're trying to start with 3rd party economists as to the macro scenario. And then what happens Across the country, we'll be a function of that.

Speaker 1

And again, typically, we outperform the national economy with respect to Job growth. And so the consensus of the big economists is for U. S. Job growth to be up minus 2% next year. And we think we'll do better than that.

Speaker 1

We're at plus 0.4%. But 9,500 New jobs under the 0.4 scenario is about 4,800 households against 50,000 plus New supply in the marketplace. So again, do we think that will happen? I mean, as of now and given what Angela just said, Seems like that's pretty dire. But again, we should not ignore what the economists are saying and we should not ignore the Fed Talking about wrecking things and paying points.

Speaker 1

So we don't know. Our visibility into next year is no better than yours. And whereas we feel pretty good today, as I said earlier, we can't ignore these numbers. So again, I'd rather have this So you guys know where we're coming from than to just create a scenario out of thin air because that doesn't When we do our budgeting process, we start with economic rent growth. I don't know how you do a budget without that because you can't leave it to Property teams to try to decide what rents are going to do, you have to have some macro view of the world.

Speaker 1

And based on that, you I don't know how else to do it. And I'm not saying our budgets are based on this scenario because that Again, it does seem somewhat dire. However, we are mindful of the macro economy. We're mindful of what the Fed is saying And we're going to adjust accordingly. Does that make sense?

Speaker 9

It does. I know it's difficult times too. So

Speaker 4

Appreciate it. Thank you.

Operator

Thanks. Our next question comes from the line of Nick Yulico with Scotiabank. Please proceed with your question.

Speaker 10

Thanks. First question is just in terms of your portfolio, I was wondering if you're seeing any Differences right now in the operating trends in recognizing you have a broad portfolio that's different price points, suburban, urban. As we think about return to office being most challenged on the West Coast, in San Francisco proper, in Seattle proper, in Downtown L. Proper, maybe Downtown San Diego too. Are you seeing a different performance of your apartment assets in those Urban cores, than the rest of the portfolio?

Speaker 1

Yes. It's Mike. I'll start and then flip it to Angela here in a minute. The answer is yes, of course. We see all kinds of differences out there.

Speaker 1

And I'm going to give you the Broader perspective of what our portfolio is and why it is the way it is, which is we hope to have Property throughout the fastest growing metros, and again, we look at supply demand to try to get to those numbers. That's how we deploy capital. We generally want to be in the B or Brenner by Necessity category Because when new supply hits or when you have a supply demand imbalance, which could happen next year, The properties that are hit the hardest are those that are near the new supply because the new when To a much greater extent. So our portfolio is mostly suburban in nature. Again, we're not trying to be in San Francisco and San Jose.

Speaker 1

We're trying to be in the whole Northern California metroplex within, let's say, A 1 hour commute distance from the major job nodes, that is our portfolio composition. And we think there are There's inherent safety in the Bs because you can't produce B quality property. And In a world where the As are more concentrated in the downtown and the newer product is more susceptible The impact of concessions, if they increase substantially, we think those are the areas that get hit the hardest. And the B So Angela, I'll flip it to you.

Speaker 2

Well, I think maybe I'll just give you a quick example of what Mike is talking about concessions in Downtown LA is about 1.5 weeks and concessions throughout the Rest of the LA area averages about a week. And so that gives you the Magnitude impact of the downtown versus the suburban markets.

Speaker 10

Okay, great. Thanks. My other question is just in terms of move out activity that you're seeing on like a real time basis In the portfolio, I mean, how much of that would you attribute to people who have tech jobs? And are you seeing any signs yet of tech freezing, layoffs hitting your portfolio?

Speaker 1

Nick, yes, I'm going to start with that, too. I mean, our portfolio is not positioned to be near the tech companies per se or to cater to the So we do have a couple of buildings that are predominantly tech related employees, but it's the exception And actually, not even close to the average. So we are a reflection of the broader economy. And therefore, the tech component in Northern California and Seattle will be more, but there's a lot of there's a pretty diverse job base there in general. And so again, that goes into the philosophy of the company.

Speaker 1

So I don't think that we're particularly exposed to tech. We are more exposed to supply demand imbalances and which we hope won't happen. But again, The dire financial scenario on S-seventeen sort of contemplates that scenario.

Operator

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

Speaker 11

Mike, first of all, congrats on the retirement and Angela, congratulations on the new role. Tim, what are you guys seeing on the preferred book? You obviously raised your commitments for the year. How do you see appetite for your investments Next year, obviously, with higher interest rates and how have returns changed? I know this came up briefly on the call, Do you see any distress related opportunities generally in the broader market as you think ahead?

Speaker 5

So a couple of questions in there. I'll try to go backward. As far as distressed opportunities, we're not seeing them as of yet. There's talk of the potential for rate caps expiring and a need for that kind of rescue capital. We're not seeing it yet and haven't really heard from anyone else who has seen it.

Speaker 5

There's definitely talk, But haven't seen any of those opportunities come to fruition yet. As far as let's see, I think your other question was Just what we're seeing right now on our press side, we have increased returns. So for deals that we are Currently pursuing, we've increased returns between 100 basis points 150 basis points. I would say Where the market is today, there are opportunities given the difficulty of debt today, but Underwriting is a little more opaque. So I think for the Q4, there's probably we have 1 or 2 deals in our pipeline right now.

Speaker 5

I Don't probably see more than that coming into the Q4. I think things will slow down a little and people may take a pause. And then going into next year, I think it will start back up and we will see more opportunities.

Speaker 11

Okay. And this one's going to be very quick follow-up. So I completely understand and appreciate the use of 3rd party And kind of the view of the world that is out there right now. But if we don't go into a full blown recession next year, is it Or is that a fair assessment?

Speaker 1

Of course, it is. Yes. I mean, I would say when I look at supply At around 0.6 percent of stock, that looks like it's probably the lowest anywhere in the U. S. That's what I'm guessing or on the low end, let's say.

Speaker 1

And supply is the enemy in our view and trying to avoid supply is A key part of why we're in these markets. So if we get a little bit of demand growth, I think we'll do just fine. And or if the recession is just a short Recession and we're in and then back out of it. That scenario would be better than what is on Page S-seventeen. So It appears that the F-seventeen is probably close to the worst case scenario, but of course, none of us really know.

Speaker 1

Appreciate your question.

Operator

Our next question comes from the line of Robin Liu with Green Street. Please proceed with your question.

Speaker 12

Congratulations, Mike and Angela, and thanks for taking my questions. So I want to start off with The preferred investments and subordinated loan business. So are you seeing Any capital providers that you normally see in bidding terms drop off as you, I guess, pursue the preferred deals Going forward?

Speaker 5

Great question. The answer is yes. Predominantly the debt funds, they have disappeared. They I know

Operator

we would

Speaker 5

Go into some of these deals and especially the debt funds, they would provide what we call stretch seniors. So it would be 0 to call it 70 percent. They have they're no longer in competition. So, we're seeing more opportunities coming to us because of that.

Speaker 12

And do you mind just expanding whether those debt funds are purely domestic players As opposed to also foreign players?

Speaker 1

Yes, this is Mike. I think most of them were domestic players. I mean, I don't I'm not sure that we know exactly where they're coming from, but We know that we were refinanced out of several deals with high yield funds. And I didn't Ken, we don't know exactly who they were, but it seemed like they were domestic funds, domestic high yield funds. So and there were a lot of them out there.

Speaker 1

And So we were these redemptions have come to an end consistent with what Adam said. And it looks like the market is Much less competitive now and going forward, which we think is a good thing.

Operator

Our next question comes from the line of Neil Malkin with Capital One Securities. Please proceed with your question.

Speaker 13

Thanks, everyone. Yes, Mike, I'll echo everyone's sentiment. Congrats, enjoy Not having to prepare for earnings, and Angela, looking forward to continuing to work with you. I guess, just along those lines, I think that California's struggles aren't lost on people and You're still kind of working through that and there's still a lot of uncertainty. And I guess, Angela, do you think that the Angela Kleiman era will see Essex Venture out from California, maybe like a Phoenix, Denver, Salt Lake, maybe even a Texas, Where a lot of the businesses and populations are going, I understand that it's easier to build supply, but Sunbelt markets are supposed to have I mean, have been outperforming you guys for like the last 3 years and on how the Angela Kleinman era could look regarding portfolio composition.

Speaker 3

This is kind of a broader

Speaker 2

strategy And so let me start with why we are here. And that's To you even said it, the Sunbelt has outperformed for 3 years. Well, To us, 3 years isn't exactly long term. And what drove these 3 years is a pandemic. And so The way we look at the world is we don't expect to have regular pandemics that will completely change Behavior and in legislation.

Speaker 2

But in terms of this general discussion about other markets, This won't looking at other markets is not a Angela Kliman era Specific point to that, it's a discipline that we've always had. Mike's been doing this for A very long time and I will continue that work and make sure that we are in the right place And where we can generate the highest long term CAGR for our shareholders. And Supply is definitely something that we cannot ignore because that is a key reason Of our outperformance combined with being in the center of innovation that drives demand and income growth and job growth, I mean, they're all interrelated. And so we'll continue that discipline. And if we do end up venturing outside of California, We will also do it in a very thoughtful way and consider our cost of capital, consider future growth and of course, The basic supply demand dynamics.

Speaker 9

Okay. Yes, I

Speaker 13

Appreciate that. And then, I guess the other one is on, I don't know if we talked a lot about The delinquency in California, the February 23, is that For sure going to burn out because I know that throughout the pandemic, there have been a lot of fits and Affirm date, it just seems like obviously every company is different, but people have had pretty varied opinions on how long it will take to So to get back to pre COVID bad debt, so I don't know, do you guys Is that like a certainty? I mean, how do you think about that? And potentially, did that go into any of your the market rent forecast by chance?

Speaker 3

Hi, Neil, it's Barb. Yes, the February 1, 2023 date is set with LA. The city council has approved that, So that is not changing at this point. So if a tenant is not has not paid current as of February 1, we can start eviction proceedings. We do think delinquency could remain elevated in the first half of next year as we work through, LA and the rest of our We are making progress, but it's going to take time.

Speaker 3

We think the second half of the year, things trend And as Angela said, there could be some temporary impacts to occupancy, but it we don't expect it to have a huge impact to the market and to Our results, we think the delinquency trend is favorable. The one offset to 2023 that you have to keep in mind is We don't expect to receive emergency rental assistance next year, which we received quite a bit this year. So that's why we think delinquency won't be A significant positive or significant negative in 2023, it should be pretty much a push we think at this point.

Operator

Our next question comes from the line of Brad Heffern with RBC. Please proceed with your question.

Speaker 9

Hey, everyone. Just going back to an earlier question. Are you seeing any sort of elevated levels of move out Stu to lost jobs, not necessarily tech specifically, but just in general?

Speaker 2

No, we really haven't. It's what we're seeing the move out, it's really attributed to just normal Market activities and then layer on to that the other dynamics that I mentioned earlier.

Speaker 9

Okay, got it. And then, I heard concession stats for the Pacific Northwest and for Southern California. Can you give where things stand in Northern California?

Speaker 2

Sure. Northern California is sitting about a week And that is a slight like 2 days uptick from last So it's just not a meaningful change.

Operator

Our next question Go ahead, I'm sorry.

Speaker 2

That's okay. I was just going to add that. Keep in mind, our Northern California portfolio is mostly suburban and San Francisco Consists only about 2.5% of our portfolio.

Operator

Our next question comes from the line of Austin Wurschmidt with KeyBanc. Please proceed with your question.

Speaker 14

Great. Thank you. Mike or Angela, I know you guys are about that 2% market rent growth feeling a bit dire. But I guess how do we get comfortable with the fact that the loss to lease was 7% in September Of this year versus a historical level of 3%, yet you still expect the loss to lease to go negative in December, which would imply kind of a disproportionate So how do we get comfortable with that? And then why do we expect it to get better as we enter into early next year?

Speaker 1

Yes. I'll start and maybe Angela will have a comment. It's a seasonal pattern every year, and It's not the same every year. There are variations. It's really defined by the drop off in demand, I.

Speaker 1

E, jobs from October to December and supply continues on being delivered during that period of time and so that causes the seasonal slowdown. And so it's not perfect. It's lumpy and all that other stuff. And so we're just commenting on The historical patterns. So by the end of the year, probably loss to lease is 0 or negative, a gain to lease.

Speaker 1

And then we January hits and we start getting all the new budgets, all the new hiring, etcetera It occurs in that Q1 and we're that makes the markets recover. So that's how it works. It's been like that for many years. Is there anything, Angela, Specific to this year that looks different?

Speaker 2

No. Other than that, it's so far better than historical patterns. I don't see anything different.

Speaker 14

Okay. And then just secondly, you certainly congrats to you both. And I'm just curious, Angela, With you moving into the CEO role, what are sort of the plans? Or are you planning to elevate somebody internally to take your place to oversee Operations and how should we think about sort of the timing of that announcement?

Speaker 2

Well, the transition is about 6 months. And so Mike is still the CEO until March 31, and I'm going to I plan to enjoy every single day of that until then. As far as the team is concerned, I am not we are not going to make any changes to the operating team. We have a terrific team and great bench. And if you look at our company history for Mike's 1st 9 years as CEO, we did not have a COO.

Speaker 2

So this is not we're not doing anything unprecedented.

Operator

Our last question comes from the line of Richard Anderson with SMBC. Please proceed with your question.

Speaker 15

Apologies, I had a mute issue here. Congratulations to both of you, Mike and Angela. Angela, maybe the first order of business, can you Simplify the page numbering, S18.2, there's an infinite number of numbers, just so you know, and I can make it a little simpler on all of us. But that's Just a little side note. When I think about this 2% number that we're all talking about, If you were to go back and say in a normal time and you were to look at S-seventeen And you look at the supply number that you're referencing of 0.6 and the job forecast of 0.4 and it's a normal time, What would be the number?

Speaker 15

So what's the and backing into that, what would be the Fed impact that's come to the 2% number? But If it were more of a normal type of a world, would that be 4, would that be 5, would that be 8? Could you comment on that?

Speaker 1

Hey, Rich, I just want to make sure I understand the question. So we have this 0.4% and 0.6% and That results in a 2% rent growth, primarily because we're mostly in the B area where most of the stock on the West Coast is a B by definition and there's just a huge housing shortage. It's the backdrop behind all of this. And so we think that we can get some rent growth. Obviously, moving into for sale housing is people are locked into the rental pool in the B space.

Speaker 1

And as a result of that, we think we can get a little bit. So I think that's so no matter what, we think we can get about Somewhere around 2%. And then we never except in recessions, we always have job growth and household growth Using sort of a 2:one ratio, it's almost always well above the supply. So it's only In a recession scenario that that occurs, if there isn't a recession next year, then we would expect and We'd expect the job to be much better and that pretty quickly covers supply. And again, in other Markets, you're going to have a lot more supply and they're going to have the same demand issues.

Speaker 1

So on a run basis, we still think we do better. Yes. So I'm just Is that Asia?

Speaker 15

Yes, not really. The 2% is impacted by Fed action as you described. I'm just asking, what's the factor in that 2% and what would it be if in the absence of This environment is based on the building blocks, but if you don't have an answer then No, no, no.

Speaker 1

Well, I'll go back to what Angela said then. You start with the earning, which is somewhere around 3.5 Using the methodology that she gets to and then you would take roughly half of the economic Our rent forecast, it would be based on the better scenario. So if the supply demand is Better next year and that 2% becomes 4%. We would expect the building blocks to be 3.5% plus 2% or 5.5%. Okay.

Speaker 1

All right.

Speaker 15

And second question is, we did some work on where all the REITs stack up relative to the entirety of their markets, Not just competitive to your existing portfolio, but the entirety of the market. And you guys registered the best in my opinion, Running from a rent perspective, just below the market average. I think that's a good place to be if people trade down to a cheaper alternative. If you were operating at the very top of the market, you could Lou, some people not have others coming in the front door. I assume you agree with that.

Speaker 15

And second, do you see any of that happening where people are coming from

Speaker 1

Yes. I think, Rich, you have to throw that is a great question, by the way. I think you have to throw affordability into the So incomes are especially in the tech markets, they are extraordinarily high. And the screening on rent to income Is very low as a result of that. I mean, during the pandemic, even though as I said earlier, rents in Northern California about where they were pre COVID, But the median household income has moved materially and so it screens very affordable.

Speaker 1

That's not The case in Southern California, and so I would expect to see and I don't have any direct, indication or reporting on this, but I would expect to see Some doubling up and or moving to more affordable units given the very large 35% from pre COVID roughly at that level. Even with some income growth, there still probably is They trade down, etcetera. So I think that's what you're getting at and I totally agree with the premise.

Operator

That concludes our question and answer session. I'd like to hand it back to management for closing remarks.

Speaker 1

Okay. This is Mike once again. I want to thank you for joining our call. Angela and I both really appreciate all the Congratulatory sentiment out there. Much appreciated.

Speaker 1

We look forward to seeing many of you at NAREIT in a few weeks. Have a good day. Thank you.

Operator

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful

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