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

Great. Thanks, everyone, for joining this panel session with Essex Property Trust. My name is Jeff Spector. I head the BofA REIT team. With me today to my furthest left is Angela Kleiman, Senior EVP and COO; straight to my left, Mike Schall, President and CEO; and then Barb Pak, EVP and CFO. I'm going to hand it off to Mike, who's going to introduce Essex and have some opening remarks, and then we can get into Q&A. [Operator Instructions] So again, thanks for joining Essex Property Trust, and I'll pass it on to Mike.

Okay. Very good. Thank you, Jeff, and thank you, everyone, for coming. We have a couple of other Essex team members that I want to introduce that they are all sitting over here, and you can raise your hand, Jessica Anderson, who is Senior Vice President of Operations; Christos Savvinidis, who is IR; and Kyle Poirier, who run -- who's in our finance team. So I appreciate you being here. I thought I would provide a quick introduction on the company, give you a little bit of background, and then I'll turn it over to Angela for a quick operations update. So Essex is an S&P 500 Dividend Aristocrat. We own and operate more than 60,000 apartment units on the West Coast, 250-plus communities. We're the only public multifamily REIT dedicated to exclusively the West Coast. These are select markets within California and Washington, and they are fortunately unique markets. They have some conditions that we think lead to better long-term rent growth and they are generally better job growth than the U.S. average over longer periods of time. And that's inclusive of recent past where our job growth is probably 100 to 200 basis points above the U.S. average in the recent past. And we also have above-average income growth given the high-quality jobs that are represented by the tech companies and entertainment industry in Southern California, et cetera. And then finally, we have high cost of home ownership and higher mortgage rates, which makes a transition from a renter to a homeowner more challenging, and therefore, more people are locked into the renter pool for a longer period of time. We also have an extensive track record. We went public in 1994 at the price of $19.50 a share. And we recently announced our 28th consecutive dividend increase. At the IPO, we paid $1.67 in dividend. It's now at $8.80 and represents a 5.3% increase over the prior year, and over 400% above our IPO dividend. We've also generated about a 15% CAGR of shareholder return over 28 years. So that is something that only a few REITs have been able to do, and that's handily outperformed the major indices and the multifamily peer group. We also have a very strong balance sheet, and I give Barb great credit. She's effectively refinanced pretty much a whole balance sheet through earlier this year just before interest rates went up, including our joint ventures. So created a lot of value in that process. We have a well-laddered maturity schedule and only about $350 million maturing in '22 and '23. The other unique thing about the West Coast is relatively little supply growth apartment and for-sale housing supply. And in fact, because of COVID, we expect fewer supply deliveries going forward in the apartment space. And those numbers are roughly overall in our portfolio, about 15% less multifamily deliveries in 2023 versus 2022. And the biggest part of that is in Northern California, where we expect about 50% less supply deliveries in 2023 versus 2022. So that should bode well for our markets in that better-than-average rent growth -- better-than-average job growth plus less supply will be very good for apartments. And that sort of sets up our -- the next couple of years. And with that, I will turn it over to Angela and have her give you a quick update on operations. Angela?

Great. Thanks, Mike. And it's great to see everyone here in 3D. So thank you for joining us. With the strong fundamental backdrop that Mike mentioned earlier, we've had a good leasing momentum starting this year. And in the second quarter, we see the continuation of the acceleration. I will refer to Page 13 and 14 in the presentation in case anyone want to follow along. But on Page 13, we show that the blended leased rates right now is at 16.2%, which is terrific and has exceeded our expectations, which is what led to us raising our guidance by a 100 basis points shortly after our first raise only 1.5 months ago. There are a couple of key drivers relative to this guidance raise in which -- and I'll point to Page 14. It's mostly driven by demand. So job growth in our markets have come in much stronger. We had expected that it would outperform the U.S. and it has actually accelerated beyond that. And most noticeable in Seattle, up by 80 basis points in job growth and Northern California, 30 basis points of job growth compared to our original expectation, which is why we had originally expected that the overall market growth -- market rent growth, not including concessions, originally was at 7.7%. We now raised that to 11.1%. And so once again, all these different components inert to a stronger year for us, leading to a same-property revenue growth of 100 basis points that I mentioned earlier. And with that, I'll turn it over to Jeff for questions.

Great. Thank you very much. I guess let's maybe first focus on the markets and some of the skepticism on California, the job growth, it's surprising how quickly it's rebounding. I guess, what are you seeing real time? What are you hearing? I think you track jobs. I guess again and with the market pulling back in the last 2 months, again, this is kind of opposite of what I think people would expect in California at this point.

Let me start with that. And then Angela, you may have a comment after that. So I think to set that up, let's go back to earlier in the pandemic. So what happened in California early in the pandemic is the governments shut down, big parts of the economy, all the restaurants were closed, most of the service businesses were closed, travel was completely shut down. And in fact, the company headquarters were shut down as well. Every business that could rationally shut down, was shut down, including Essex, we were given notice one Monday afternoon that we couldn't come into the office the next day. So it gives you some idea of how dramatic that was. Well, all the -- pretty much all the tech companies shut down as it relates to all the people that are in the service businesses from travel, restaurants, entertainment, et cetera, all those jobs were lost. People came in the next say and said, hey, I want to go to work and the job was shut down. And if you think about those people, they're not huge income earners. So what did they do? They left. They left California. This led to this mass migration out of California at the early part of the pandemic. And so -- and then during the pandemic, those businesses largely stayed shut for a long period of time. We started opening up again in June or July of 2021. But even the tech companies during the pandemic as they were hiring and they're hiring rebounded actually fairly quickly. It dropped off a cliff in March of 2020. And -- but started to recover 6 months later. But they told people to stay put, where our office is closed, well, we're hiring you, but stay where you are. And when we open up the office, we'll have this return to office. So this -- so people were hired all around the country and told to stay where they were. And at the same time, in addition to those service workers, you have the normal thing. Our normal migration pattern is older workers and those that own homes, expensive California homes, selling their home, moving out of state and they generally don't come back. But then that's backfilled with these other workers from the tech companies, which again were told us stay put. So when California finally reopened, that's what's really driving the growth. And as the tech companies have brought people back to the office, it's not just the job growth that we're talking about. It's the reverse of the migration pattern out. The restaurants are now open. They're not well staffed, candidly, and the hospitality industries and all these related service industries are now open. They're generally understaffed but we're drawing people back into California to take those jobs. So it isn't really -- it's not just the generic job growth. It is really the recovery of all the jobs that were lost earlier in the pandemic, and that's why it's been so powerful in terms of this movement back into the office. And our -- just our basic job growth forecast is better than you might expect. We -- it's on Page 14 of our presentation. We expect 568,000 jobs. That's 4.4% job growth for this year, for 2022. And we only are producing about 0.6% of the housing stock. So you can imagine, if you got 4.4% job growth and you're only producing 0.6% of the stock, you don't have enough housing in California. And so that dynamic is playing out this year. And that's why, as soon as this movement back to the office, and to bring the service sectors back to work in California, that's why rents have rebounded so quickly.

And I believe Angela also said Seattle is rebounding quickly. I guess can you comment on Seattle at this point? And what you're seeing?

Sure. Seattle has had the strongest job growth. And so that's a key driver. And it has been -- and as a result has been one of our top performers in that market. And then Seattle is -- it also has -- compared to this year and last year has lower supply. So it has kind of the benefit of both numerator and the denominator impact.

And is this helping, I guess, your markets in Seattle and California? Or is it also downtown central and downtown Seattle, like?

It's almost -- it's a tale of 2 cities on that front. Downtown is still soft. CBD is -- even before COVID, there were challenges there because -- and I think New York has done a terrific job of cleaning up the city. And Mike and I were walking around. We're quite impressed. But in Seattle and downtown L.A., downtown San Fran, et cetera, there's still a lot of crime issues, homeless issues. And so that quality of life just isn't quite there. The second factor is that when we're talking about Northern California, the headquarters of these large tech companies, they're not in the city, Google's in Cupertino, Meta is in Menlo Park. And so it's much more spread out. And therefore, the growth would not automatically inert to the CBD centers, which is why we are -- less than 10% of our portfolio in the CBDs.

Way less than 10%, actually, yes. And actually, I wanted to throw out one other item. Just keeping you focused on what's happened to rents over this period of time. So from pre-pandemic level, Northern California portfolio is only up about 1%. So it has the highest income. So the rent to income, it screens very affordable from that perspective, whereas the Northwest is about 13% above pre-COVID levels in terms of rent. So it's farther along, let's say, in the recovery process relative to Northern California. And then finally, Southern California has been the big winner. It's up about 25% from pre-COVID. And really all the beach communities from San Diego through Orange County and into Ventura County have done really well in this portfolio. And as a result, from a rent-to-income perspective, they screen more expensive relative to the tech market. So our view is that the tech markets are really going to probably be the growth leader for the next couple of years.

And I guess talking about your positioning, are you currently still happy with the portfolio in California, in Seattle, has anything changed based on what you've seen over the last couple of years in terms of migration trends or tech growth in other cities? I know we talk about this a lot on our earnings calls, but maybe for this audience, what's your latest view on your current footprint?

Yes. We have some slides that go through this point. And we're always looking for data points that either support or lead us to believe we need to make some changes. So there's some pretty compelling data points, I think, on the West Coast in terms of recovery. And one of them is on Page 21 of the presentation. So one of the things that we do is we track the job openings of all the big tech companies. So the top 10 largest tech companies, Apple, Google, Meta, Microsoft, et cetera, and we scraped their job data off and we -- through across the U.S., and we try to determine where they are hiring. And so one point and actually, recently, the number of job openings ticked down for the first time in about 1.5 years. So there was a small tick down in jobs. However, even with the most recent reading, which was 51,000 job openings for this group, that's about 77% higher than it was in March of 2020. So again, still we're talking about a lot more jobs. And then we also look at how many of those jobs are in the Essex markets versus other markets across the U.S. And actually, we're concerned like anyone -- like everyone that we're going to have -- we're going to lose more jobs to other markets across the U.S., and so we try to track that metric. And so we have actually increased the number of job openings on the West Coast, 59% of the corporate jobs, not all the other jobs, but just corporate jobs, about 59%, compared to about 55% a year ago. So from that perspective, it makes sense. We also track the major leases that are being signed by the big tech companies and where they're buying office buildings and all those other things. And once again, that seems to indicate that there is demand for office space, especially not in all of our markets, but I would say, certainly in San Jose and up the Peninsula and in Seattle, we still see very significant demand for office, it really represented by the current development pipeline for office properties. And then we track the leasing activity and the purchasing activity of the big tech companies in terms of where are they making -- where are they buying office buildings, where are they signing big leases and what types of things they're doing? And what does that imply? Is that consistent with the job data, the job opening data? And -- so that's Page 22 of our presentation, please take a look at that. But very recently, Google agreed to move forward on its $3.5 billion invested in the Bay Area, for example, as they developed their campus in -- near the Diridon station in San Jose. And -- but there's many other investments that are part and parcel to their activities. So we put all this picture together, it tells us that the tech companies expect to grow. The big tech companies expect to grow. No doubt that the venture capital part of the equation will change somewhat. There will be some of the smaller tech counties that are VC backed that will have dramatically lower valuations given what's happened. And -- but we think that the big job growth and the big movement in jobs is -- has been over the last 20 years, migrated to the big companies. And so that's who we're relying on. And certainly, that seems to make the case for these markets going forward.

On the last earnings call, you talked a lot about the return to the office as a driver of this demand. I assume since the last earnings call, part of this boost in demand is the return to office? And where do -- in your markets, where do you stand on return to office? And I guess that would -- I would expect that to continue through the end of the year.

Yes. Well, it's interesting. I mean, the most anecdotal piece of evidence, but sometimes that's almost the best, given all of the -- we have all this research that we do. And we have a research function, and this is basically all they do. They literally do their own ground-up research on supply because the data providers on supply data for housing are so far off and have proven to be so far off over the last couple of years. So we do our own fundamental research on that. All the other research on these various activities. But sometimes, the anecdotes are just as powerful. And I know from personal experience, when you drive through Southern California, it's much like it was pre-COVID and traffic is horrible everywhere pretty much and it starts very early in the morning and prevail at night. So you don't even really get a sense at the hybrid-work environment has really made all that much difference in Southern California. In Northern California, it's changed dramatically over the last couple of months. So traffic patterns have tightened up, and it's -- it's not quite back to where it was pre-COVID, but it's getting there. And by that, I used my airport drive into -- from San Mateo to San Jose, so the main route along Highway 101 into Silicon Valley. And it's -- it was literally 3 months ago, I drove that at 7:30 in the morning and went 60 miles an hour and hit the brakes 3x and more recently, I did it. And the same drive, and it took me about 45 minutes, and I didn't stop and go the whole way. So things really have changed. And again, I think it's the things that I just talked about, it's bringing back the return to office. And we were somewhat frustrated because the tech companies talked about return to office late last summer. They started in July, August, announcing plans and what they're going to do. And then they put them off for the Delta wave and then the Omicron wave and then finally, they're now in the office at least 2 days a week. And that's -- people can therefore maybe commute longer distances, and we expect that. So we may push out our target markets somewhat, given the hybrid structure that most of them are following. But we think that, that has really been the catalyst for our most recent rent growth, even more so than or as much as the job growth.

And then on the guidance bump and I can't remember in the past how often you bumped guidance at Nareit, but it seems unusual to me, maybe I'm wrong, given we just had your earnings call in April. So I was really surprised to see that, the guidance bump. And again, I think you've talked about the demand. But I mean, in the last, let's call it, 60 days, like -- or 30, whatever it is, like -- I mean, what really surprised you? I mean was it the ability to push rent? Is it -- was it that additional traffic, again, people coming in? What exactly happened to give you comfort to boost guidance at this point?

Yes. Well, actually, it's all of the above. First of all, Barb was practically giddy and she's never giddy.

If we can have her talk about delinquency...

Well, I was going to go there. So -- but it's -- we had another -- so back in April, what we saw was strong momentum. But there's a question mark on the durability of this momentum. And also another question mark is the timing of the delinquency because we have -- while we have a large delinquency, we also have a large amount of application outstanding for federal assistance. And so we wanted to see that play out for another couple of months. So fast forward to now, we now have seen May job numbers with good indication where June is headed. And similarly, on the rent side, when I look at that from the market rent growth, which is now on Page 14, it's 11% just overall market. That's an increase of -- from 7.7% at the beginning of the year. And the breakdown matters because what we had assumed was first half about [ 8.5% ]; second half, about 7%. This 11% is essentially now 15% in the first half, and we now know we're getting that. We kept the second half about the same, maybe 20 basis points higher. And so it's just realizing more of that upside, and we decided to share that upside. So the 100 basis points guidance raise relates to 75% from rent growth, which is great. 25% of from collecting our delinquency recoveries, which is what Barb loves to talk about.

Yes. So that 75% that's realized to date, and now it's just reflected in our guidance so that we don't have to achieve it. It's real. In terms of delinquencies, we are making progress. April, May, we've seen kind of net zero delinquencies in our portfolio, which is significant progress from where we were in the first quarter, where we were at 2.2% on a net delinquency basis. It's a combination of factors, which is driving this positive result. We are seeing emergency rental assistance come in. They did change the program as of April 1. No one can apply anymore, and I think that's changing tenants behavior. Tenants that were previously delinquent are now paying because we now can evict if you're not paying your rent current, in all markets except for L.A. and Alameda. And so the emergency rental assistance, coupled with better gross delinquency, it's still high, it's still well above our historical average, but improving, is leading to the better outcome on delinquency. In terms of collections, we have $77 million of gross delinquency since the start of COVID. That balance hasn't changed or grown since the end of the first quarter. We had -- on the first quarter call I said, we had applied for $64 million of emergency rental assistance, half of which was for our current tenants that are living in our properties. The other half, we applied on behalf of past tenants. We now know a little bit more about that second pool of tenants that we applied on behalf of, if they didn't engage in the process as of 3/31, the application is not valid. So the number that we can now go after is about $44 million today in terms of emergency rental assistance. We think there is a higher collectability on that $44 million because we know who isn't qualified and who is qualified. So we think that, that -- there's still some tailwinds from collecting on that. And then we're working through getting the tenants to pay in the other markets. Obviously, L.A. is going to remain a headwind until the eviction moratorium expires. But I think we're making good progress, and this is starting to become better news for us than it has been in the last 2 years.

Barb, will you hit, how much of that has been recorded as revenue?

Yes. And so in terms of our financial risk, we've recorded $4 million of the cumulative delinquency, that $77 million number I alluded to in our revenues. The rest of that, whatever we collect will be upside to the financials, we would record it at the time we collected as revenues and it would hit same-store revenue growth in core FFO. So very little risk in terms of our financials of collecting it. We think we will collect a substantial amount of this delinquency. It's more of a matter of timing and predicting when that money is going to flow in. But we have a big team working on it behind the scenes.

Is it fair to say then that even with the guidance bump, the guidance still has some conservatism in it?

Yes. What I would say is in the back half of the year, we still do have 1%, 1.5% or 2% of net delinquency forecasted in the numbers at this point. The timing on emergency rental assistance when that's going to flow in is outside of our control. And our ability to evict tenants, while we can initiate the eviction process at this point, it still takes many, many months. And so I think there's going to be fits and starts, but we feel like we've -- we're in the right direction.

I know we only have a couple of minutes left, still a lot of questions. So on the demand side, where are these folks moving in, where are they coming from? Are they -- these folks were from California left and they're back in or they're just moving within California?

On the demand side -- I'm going to focus my conversation in Northern California since that's the market, we're in the midst of recovery. And when we look at our growth in migration, what's interesting is that 75% of that is coming from within our California -- Northern California market. So people moving from San Jose to San Francisco or Alameda to San Jose. So it's within those kind of -- that geography. 5% of the in-migration is coming from, once again, our own markets of Seattle and Southern California. 20% is coming from outside of our markets. New York, Dallas, Boston, Sacramento, those are the 4 big ones. So when I look at that, that tells me that there's still more to come. And the piece that is obviously missing to us is the international, because in the past, especially with Northern California and Seattle, we have met in-migration driven by international coming in. And that is still muted. And so we do believe that there will be, at some point, a tailwind from that.

And then on the '23 supply comment, like you made initially, how much confidence is there in the supply outlook through '23 at this point?

Well, we -- this is the area that we do our own fundamental research on. So we're using a variety of techniques, we keep an eye actually on the building and what its current status is and -- the problem that the data providers have is they know when it starts leasing and when it's done leasing. So a lot of times, they don't know how many units within that building has been leased and therefore, they tend to double count it. And so we -- our effort is to try to drive the properties or use some various photographic surveillance to try to figure out where they are in their lease-up process. And then -- so fundamentally, beginning at the ground up, develop our own supply forecast. And almost every year, by the end of the year, if you look at what RealPage comes up with, it's pretty close to what we had at the beginning of the year, but it's twice as much at the beginning of the year. So that has come down, and we tend to be pretty much spot on with our forecast.

Okay. Great. Well, thanks, everyone, for attending Essex Property Trust, and I hope you have a great rest of the conference.

Thank you.