Essex Property Trust, Inc. (ESS) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. This is Michael Lewis, Managing Director and lead multifamily REIT analyst at Truist Securities. I'm happy to introduce Michael Schall, President and Chief Executive Officer of Essex Property Trust. Also introduce John Burkart, Essex' Chief Operating Officer; and Angela Kleiman, Essex' Chief Financial Officer. So thank you for joining us today. Essex Property Trust, for those of you not familiar, ticker ESS, is a multifamily REIT headquartered in San Mateo, California, with a $17.5 billion equity market cap. And we'll jump right into it. Before we get into the market fundamentals and other topics, though, maybe, Mike Schall, for the investors out there who may be less familiar with Essex, maybe you could just give a very brief overview of the company and your broad strategy.

Sure, Michael. And hey, thank you for moderating the discussion. We appreciate it. Essex owns about 60,000 apartment units in 8 major coastal metros along the West Coast, from Seattle to San Diego. Keep in mind, California and Washington together comprise the fifth largest economy in the world. So this is not a small geographic area by any means. There are several unique things about these markets, which is what draws Essex to them, including the concentrations of tech companies that are driving the economy. And there's frequent housing shortages, supply constraints, and relatively expensive single-family housing. So the transition from a renter to a homeowner is a pretty onerous one. Our portfolio skews toward suburban properties and we like the major job centers, certainly, the technology industries, but places where people want to live, which means good schools, low crime rates, et cetera. We use a data-driven research approach to capital allocation, which relies on housing, demand and supply research, trying to quantify supply and demand for housing in each of our metros and then using our -- using a ranking process to try to determine which metros are most likely to generate rent growth and invest ahead of that. And our results speak for themselves. We've had 3,000-plus total shareholder returns since we went public in 1994. So even with the COVID effect, and we've raised our dividend every year for the last 26 years and have been named a Dividend Aristocrat by S&P last year, and we currently maintain a very low dividend payout ratio of approximately 66%. Part of that is maintaining a strong balance sheet and plenty of liquidity. We definitely focus on that. And that allows us to be opportunistic when there's disruption in the marketplace as there is now. So that's a quick snippet on Essex.

Yes, that's great. And you started to touch on this. Anybody who looks at the dock chart will see your West Coast focus has supported really strong long-term results. We still get sometimes asked by investors about a shifting landscape of people migrating out of California, perhaps because of high taxes or cost of living. And maybe that's even a trend accelerated by potential proliferation of permanent work-from-home strategies. Can you just talk about any high-level changes you're seeing and the benefits you see in sticking to this footprint going forward or maybe potentially expanding or shifting that footprint at all going forward?

Sure, Michael. Yes, I would think that the demise of California has been predicted many times during my career because these conditions you're talking about are really nothing new on the West Coast. And typically, some unique things happen during the recessions. And I would say, in general, recessions, we get punished a little bit worse than most of the metros around the U.S., but then we come back stronger and faster once we hit bottom. So there are unique things about the West Coast, which is what has driven us here. And I'd go immediately to the industries that are here, certainly, the tech companies and the tech infrastructure, which we believe will continue to produce high-quality jobs. We don't believe that we're near the top of the technology world. We think that continues to move onward, continues to generate high-quality jobs, which then provide -- we can provide housing to. And so we spend a lot of time trying to understand what the major industries are doing. Certainly, we have a -- for example, an index of the top 10 tech companies and how many open positions that they have we track, how much they're investing in the markets in terms of office space and a variety of other types of things, just to get a sense that they're here to stay and they plan to continue expanding in California. So far, we've seen very little disruption to that overall trend. And we think we are well positioned from that perspective. There are certain key ingredients, let's call it, that are part of a strong housing market. You need, for that to occur, high-paying jobs, companies that can afford to pay to attract their employees and talented people; and then certainly, housing shortages and/or limited to supply and expensive single-family homes that prevent renters from becoming homeowners very easily. So those conditions are things that we have focused on, we've identified in these markets and -- as part of the company. We also focus mostly on the suburban part of the market, so let's call it, B quality property. Average rent in the portfolio is about $2,340. No one can build a B quality apartment here. Everyone builds A. And we don't produce a lot of housing. Less than 1% of the housing stock is produced annually. So most of the property is, by definition, a B quality property. So trying to find good markets, so places where they have good schools, where people want to live, low crime rates, near the major employers has been the methodology in terms of picking our markets in general. And if you look around the U.S., you'll find that they're pretty unique. And so at this point in time, we continue to believe in them.

So obviously, the election was a few weeks ago. I don't know how many people still want to talk about the election, but California had some important measures on the ballot. Maybe you could just give us a quick rundown of the most important items on the ballot, what those results were. And where those issues go from here, if anywhere? And I'm thinking primarily about the rent control measure, the profit which was a property tax measure that didn't impact you directly. And then maybe also, I'll add on to that, the latest on eviction moratoriums.

Yes. Sure. Yes. Prop 21 in California was soundly defeated. We're really happy to be here to say that. I think it was defeated in all but one county, which I think was San Francisco County. And so it was a pretty decisive defeat. It was brought by a special interest -- it was proposed by a special interest group that really had very little to do with housing, but thought that they had a better idea than the legislature, which passed stabilized rent control, you'll recall about a year ago, AB 1482. So from our perspective, Prop 21 would have allowed some abusive types of rent control and generally known as vacancy control, which means vacated apartment unit subject to rent control, so this -- the cities can dictate what rent can apply to those units. So in our experience and actually, this was the reason why the law that Prop 21 sought to dismantle was called the Costa-Hawkins rental real estate law in 1995, it was passed specifically to eliminate vacancy control so that cities that had vacancy control in their rent control ordinances, they were not producing any housing because no investor would invest in those areas. So Prop 21 would have brought us back to the conditions that existed before Costa-Hawkins. And so it's -- that's why it's so important that it was defeated. So this is the second time it was decisively defeated. We fought a similar proposal in -- 2 years ago, in 2018. And with that done, we're left with statewide rent control that the apartment industry did not oppose in AB 1482, which we think is a reasonable compromise because it offers some level of protection for renters. But at the same time, it is written such that capital will continue to flow into apartments. And so it keeps the investment markets alive and healthy in California. We think that the state legislature did a very good job in terms of crafting AB 1482. So with Prop 21 and Prop 15 defeated -- just Prop 15 very briefly, it didn't affect apartments. It was a property tax proposal that would have allowed a rolling reassessment of commercial and industrial properties in California. So we were affected to a small extent to the extent that we have retail and similar businesses in our properties, but had a limited effect. But Prop 15 was also defeated. And so the property tax rules in California remain the same. I will note that Prop 15 sought to change Prop. 13, which was passed in the 1970s and it's been -- that particular proposition has been fought many times over the years, over the last 50 years and has lost each time. So Prop. 13 remains in place. And I think it's ultimately good for California to have some stability as it relates to these legislative proposals. And with those behind us, it feels like we're in a very good position. We have statewide rent control that everyone seems to find acceptable. A similar thing is happening with respect to COVID-related [ in a ] -- eviction ordinances, where the state stepped in on -- at the end of August, with AB 3088. And AB 3088 sought to create essentially a statewide law that would ultimately replace the patchwork of local eviction measures. So with AB 3088, it provides a path and some requirements for what our residents need to do. So beginning in September, for example, they're required to pay at least 25% of the rent in order to maintain their eviction protection. And they also made clear that we can pursue claims in small claims court if we're owed -- if landlords are at money. So it opened the door to those things. It's not a perfect bill in that it sunsets on January 31. And as a result of that, we need to -- there will be some other legislation that will come in. We're obviously not sure what that might be at this point in time.

Great. I'm impressed that you keep track of all those numbers for the different pieces of legislation. You talked a little bit about how Essex positions between Class A versus Class B and suburban and urban. Maybe you could dig into that a little bit more, particularly because there seems to be an advantage for the suburbs versus the dense urban area dictated because of the pandemic. So maybe just give us your thoughts beyond COVID-19 regarding urban versus suburban, Class A versus Class B and how you like to position assets.

Yes. Sure. No, we -- yes, it's interesting. We are generally a Class B type of company, although there is no such thing as building a B quality property. Therefore, everything we build is an A. And so -- and our preference for one versus the other will change a bit as time goes on. So I'd say as you are approaching -- let's say, the Bs generally do better earlier on in the cycle and during the recessionary periods because people are more focused on what amount they have to write on their rent check. And then when people feel better about their finances and recovery starts occurring, the As will generally do better because people -- because -- well, first of all, rents generally go lower in a recession and then they recover stronger. And so people then say, you know what, I can afford that A quality property as we're coming out of a recession. So that's typically how it works. But back to the basic point, if we're only producing 1% of our housing stock a year, that means in 20 years, we'll produce 20% of our housing stock, which means that 80% of our housing stock will be more than 20 years old. So almost by definition, a B. So we will always be a B-oriented company, and that probably won't change. Actually, it's interesting. In the last 2 years, we've sold about $750 million a property in the downtown. So we sold Mosso in Downtown San Francisco, 8th & Hope in Downtown L.A. and One South Market and another smaller property in Downtown San Jose. So we actually have been selling some of the A quality property and moving more into the suburbs, which is definitely our preference. And definitely, the suburbs, we didn't obviously know about COVID-19 at the time when we're doing a lot of this, but the suburbs has definitely been the place to be. I will quote Mr. Burkart on a recent -- on the recent conference call a couple of weeks ago, where he noted that our properties in Orange County, San Diego, Ventura and Contra Costa Counties are 97.9% occupied with only 2.5% availability. And so it's interesting, the Ventura County, for example, is currently one of the leaders of our portfolio, even though it really hasn't been a leader of our portfolio in the last 25 years. So once in a 25-year occurrence. And in fact, it's very interesting because everything we learned about real estate has been upended by COVID-19. And by that, I mean, that the high walk score places, the places that are near restaurants and coffee shops and lots of hustle and bustle in the cities are actually doing the worst in this COVID era. And those areas that don't have the proximity to all those services are doing the best. So it's a little bit of a -- something we couldn't have predicted because this is not exactly how these markets typically operate. But -- and so I suspect that a lot of these trends will reverse themselves as time goes on. As we get back -- having restaurants and coffee shops and lots of activities around you become more important, I think we'll get back to the old style of walk scores actually really matter.

Great. I think that's a good lead into a question about fundamentals in your markets. I've been optimistic about the back half of 2021, even more so, I guess, now with the vaccine because I think easy comps, a potential vaccine, a potential economic recovery and the way you took upfront concessions can kind of all come together nicely. Now I know you're not ready to talk about 2021 yet. But maybe you could give us the latest and greatest on fundamental trends in each of your 3 regions in terms of supply and demand and occupancy and rents and what you're seeing.

Well, maybe I'll ask John Burkart to do that. John, you want to handle that one?

Yes. And I'm glad to step in. So as I mentioned on the call, in Q3, we had a relatively good Q3. We built occupancy as we had planned. We used concessions to do that. And what we saw is in Q3, we were using concessions of about 3 to 4 weeks on 75% or more of our transactions. By the time we got to October, we were -- dropped down to 50% of the transactions. And by the time we got to middle of October, we dropped down to 25%. Our portfolio was positioned at that point at about 96%, 96.5% occupancy. So very well. We continue to maintain that situation right now. And our concessions are somewhere in the 25% of transaction area. So what we're seeing is we worked hard at the beginning. We dealt with the delinquency issues that we had. We put them in different buckets, specifically people that were easily able to recover. We worked with them. Those that appear to not be able to recover easily, we also worked with them. But typically, that meant helping them to find a different situation, different living situation. So we reduce the delinquency going forward, and then we use concessions to increase absorption, got ourselves positioned well. What we're seeing right now, as I mentioned on the call, there are some owners out there that didn't do that. And so they're playing catch-up in the low-demand period, which is, for us, the fourth quarter. So there's a little volatility out there but we're meeting that and dealing with it very well. Yes, you mentioned the supply. And this is -- it's absolutely a supply-and-demand situation where we see some of the -- more challenges out there in the markets. It's not a surprise. There's some challenges where there's supply in Downtown Oakland, San Jose, certainly in L.A. And our expectations for supply going into next year are roughly the same. And Mike had mentioned that in the call, roughly the same as this year. So somewhere in the 33,000 units for 2021. And so we'll have that as a -- certainly as a headwind. But what we're seeing is relative stability in the markets. And obviously, there's -- not predicting in the future, but where we're at today, it's relatively stable. Mike, did you want to add anything?