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

[Audio Gap] to Citi's 2025 Global Property CEO Conference. I'm Nick Joseph here with Eric Wolfe with Citi Research. We're pleased to have with us Essex and CEO Angela Kleiman. This session is for Citi clients only and disclosures have been made available at the corporate access desk. To ask a question you can raise your hand or go to liveqa.com and enter code GPC25 to submit any questions. Angela, we'll turn it over to you to introduce your company and team, provide any opening remarks, tell the audience the top reasons that investors should buy your stock today, and then we'll get into Q&A.

Well, thanks, Nick. It's great to be here, and it's wonderful to see everyone here for the Essex company presentation. To my right is Barb Pak, our Chief Financial Officer; and my left is Rylan Burns, our Chief Investment Officer. I'll just start with a brief overview of our company and update on the operations and then turn it over to -- and of course, touch upon why -- reasons for owning Essex stock and then I'll turn it over to Q&A. Essex is an S&P 500 company with over 62,000 units and the only public multifamily REIT dedicated to the West Coast. We have generated one of the highest total returns of all public REITs since our IPO and have increased our dividends for 31 consecutive years. The key driver of our long-term outperformance is favorable housing supply and demand fundamentals, combined with our disciplined capital allocation and operating strategy. On the fundamentals, starting with supply. California markets produced supply well below the national average primarily because of lengthy and costly entitlement process. It is 2.5x more expensive to own than to rent in our markets. And because our markets produce very little supply, we do not need much job growth to generate healthy rent growth. That said, on the demand side, we have historically produced some of the strongest [ levels of ] job growth, especially in high-paying sectors. And this favorable fundamental backdrop is not anticipated to change in the foreseeable future. Furthermore, our efficient [ operating ] model, which has produced sector-leading operating margins, which is on Page 9 of our presentation, and disciplined allocation of capital drives cash flow to the bottom line and enhance total return to our shareholders. And lastly, on the operating update. So far, we are experiencing a good start to the year with our markets performing slightly ahead of plan. But keep in mind, it's only [indiscernible] months. We are well positioned heading into the peak leasing season with solid occupancy and low concession levels. So why buy Essex stock today? Well, first, the reason I [ outlined ] earlier, the dynamics that produce the long-term outperformance. But the second is in the near term, from that perspective, we have [indiscernible] ahead of us in a very visible way, particularly in Northern California, which is just starting to [ recover ]. The fundamental [ is compelling ] in that supply is at a historical low. Affordability is at all-time best because rents are only at 5% above pre-COVID level versus elsewhere in the country that have gotten 25% to 30% above pre-COVID level. But on the other hand, in Northern California, personal income has grown over 20% in the past 4 years. So that fundamental backdrop is very strong. Lastly, on the demand side, we see a catalyst for accelerating demand. Now we don't know the timing, but 85% of artificial intelligence companies are headquartered in Northern California. And every single one of them have announced additional capital investments or office expansions and have been purposeful on communicating hiring, which means job growth and demand for housing.

So many of your peers have been speaking recently and talking about becoming more diversified. So I think they looked at the COVID period and they realized that maybe they were overrepresented to certain coastal areas that either had a regulatory response or maybe they just thought more of their customers were going to be in the Sunbelt, I don't know. But either way, each of them keeps talking about being diversified, and that's how they're investing. You've decided to focus a bit more on your core markets, but as we've seen with sort of the wildfires, COVID and regulatory response, there are some unpredictable risks out there. So maybe just talk about why you're so confident in your West Coast markets and why you don't feel the need to diversify away from some of the risks that are more specific to those markets.

That's a good question, Eric. I think there is a time and place and there's a price for all [ activities ]. And so we're not saying we would never diversify and -- nor that it is not a good strategy. Our view is in the foreseeable, say, 3 to 5 years, there is upside where you have all the fundamental building blocks in place for outperformance in Northern California. And of course, I think that's going to benefit Seattle and certain parts of Southern California region. So to take that benefit in front of us and where cap rates are generally about the same across all major markets, to trade that and go elsewhere where rents have improved or increased by 25% to 30%, that is not a compelling trade for us in the near term. Now as far as the legislative concern is -- that's a valid comment. And we would have considered diversifying more aggressively if we see that legislation continue to move in the wrong direction. And from the November election and also from some of these proposition proposed that went in our favor, it was a moderate sweep, especially in California. So that gives us confidence that the extreme legislation is not -- is no longer on the table. And the voters have spoken that they don't want things in extreme. And so if you look at what happened with LA fire, this is a great example. So LA County did enact an eviction moratorium last week. LA City is voting tomorrow on it. But this is not the same eviction moratorium that occurred during COVID where anyone can claim that they were impacted and can live rent-free. I think the legislatives -- legislatures have learned that, that didn't work out well. It hurt a lot of landlords in a market that was already undersupplied, but more importantly, rampant fraud occurred. So it was a bad policy. Now understanding that they're trying to protect those that may be vulnerable, this time go-round, this eviction moratorium had requirements that actually makes sense. You have to be a tenant on or prior to the date of fire, so January 7. Your income has to be 150% below the median. So it goes to the needy. You need to actually demonstrate that you are impacted much more than 10% financially and show that you're pursuing unemployment and other benefit and relief. Those are very reasonable policy, and it actually will help those in need, but also doesn't essentially put the landlords in harm's way.

So I mean what would it be that would -- so you said that if legislation started moving in the wrong direction, that would maybe be a little bit more of an impetus to get you to think about other markets. You don't want to give the upside away from the West Coast over the next couple of years, which makes a lot of sense. But I'm just trying to picture what the legislation would be? Would it be like rent freezes in LA? Would it just basically be more price controls and rent controls at the local level? What is it that would cause you to rethink some of your market exposure, at least from a [ regulatory ] and legislative perspective?

Yes. Well, in the current legislative environment, we have operated incredibly successful over 30 years. And now I want to just clarify that there is not a rent freeze in LA. [indiscernible] emergency ordinance essentially states that you cannot raise your rent by 10% from the date of enactment for 1 year. So it's not a freeze. But once again, under this environment, we have statewide rent control of AB 1482, which is CPI plus 5%, max of 10%. This, to us, is really more of an anti-gouging provision. Essex has had a self-imposed 10% rent cap on renewals for a very long time, almost 20 years. So we can be very successful in this environment.

Got it. Yes. And I didn't mean to imply that they put in a rent freeze, more like if they did do that at some point as a response to the wildfires. Is that something that would make you reconsider your exposure there? But...

Yes. I think that once again, the devil is in the details, right, which is, is it for a specific population for a specific period of time? Or -- and are there reimbursements available to the landlord? All these things will influence how we think about the markets.

Yes. If you think about people's theses around the Sunbelt, it's generally there's just ton of demand. And at some point, that's going to fall off because we can see the construction starts and then rent growth is going to accelerate. In your markets, it's a little bit different because [indiscernible] lower for the last 2 years. And so you're really kind of trying to find that demand piece. I guess why -- what gives you the confidence that you're going to see that sort of demand that's going to start generating that excess rent growth? Obviously, it's accelerated, I think, from last year. But do you think it's a real possibility that we see things like 4% or 5% type rent growth in the upcoming years?

Well, I think it's an interesting paradigm in that if you have a significant supply in an environment where supply outpaces job growth, it doesn't matter if you have legislation. You're sitting duck. Nothing is happening with rent growth. Let's just start there. So as far as where we are and one of the reasons why we were able to raise our guidance 3 times last year was because in a low supply environment, you don't need much job growth. Having said that, on Page 19 of our presentation, we show and we track this, it's third-party data, job openings of the top 20 tech companies. Now these are companies that have an enormous amount of wealth. And the largest 8 out of the 10 companies in the U.S. are in these -- are in this group, and they're all in our markets. So we track job openings because that is a -- there's a direct correlation and a strong leading indicator of what the expectation of hiring is to come. If you open a job, typically in about 3 months, you're going to have a hire. And that's meaningful because as we looked in the past -- track over the past 2 years of activity, we've seen a steady increase. And more recently, in October, we saw a breakthrough number to us, which is the level actually met and surpassed pre-COVID averages and -- which is a great indication that these companies are in growth mode and that the job is coming because they're hiring for it. And so you'll see that dip in November, December on the number of job openings. And so 2 things could be happening, either they fill the job opening and they're not hiring anymore or it's seasonality. Now as you look [Audio Gap] graph, you see a pickup in January, February, again. Now it's also once again back to pre-COVID level. So that tells you that that pause was not a retrenchment, it's a seasonality, and they're back to hiring mode again. What we would want to see is that level to be steady for 3, 4, 5 months, because that will be the basis for acceleration because right now, once you hire, you fill the opening spot, that's essentially contributing to the current base case needs. And if that elevated level of hiring continues, then we're back to the levels of 4%, 5%, x percent much higher rent growth that we are anticipating at some point.

Got it. So you want to see the listings that have improved, but it's only been a short period of time. You like to see that consistently improve. And your experience tells you that when you see those listings at a high enough level over a long enough period of time, that, that does end up converting into real jobs. It's not just a listing that ends up converting to an actual job and new renter in your markets.

Yes. It becomes a durable job growth, right? So right now, the current level essentially meets our base case. And so we're in a great position relative to our expectations. But you're speaking of acceleration. So the backdrop of that would mean a steady elevated level of hiring.

Got it. And it seems like people are deliberately not putting the sort of blended spreads by month in there to sort of encourage people not to focus on 1 month and 2 months. But maybe I just want to go back to your point that things have been a little bit better thus far. Maybe you could just say, is it just on the rent side? Is it on the occupancy side? What are you seeing thus far that's a little bit better than you would have expected?

It's on the -- mostly on the rent side. So for example, in December, concession was a little over a week. Now it's half a week. In December, new lease rates were negative. It turned positive in January. Even though we [ think ] about supply pressure in San Jose and Seattle, the absorption rate was really fast. It was 3 months versus what we had expected that was going to take a little bit longer. So these are all data on the ground that gives us confidence that, one, we're going to obviously hit our numbers; two, things are -- the fundamentals are in good shape.

Got it. And I think you're a bit unique than some of your peers in that you try not to raise your renewal rents above, I guess, predicted market levels. I guess in an environment that's changing like this and that you theoretically might see some acceleration as your occupancy is higher, are you a bit more aggressive in terms of how you think about those renewals because you assume that market rents are going to move up a little bit faster over the next 2 to 3 months? And especially, I think there are some markets, I think, like Seattle, right, where you have to actually give renewals well ahead of time. So maybe just talk about that dynamic. Talk about for your renewals, what level of sort of market rent growth do you think you're going to see over the next couple of months.

Yes. That's a great question. Typically, what you've seen us do is that we favor occupancy. So we don't in the first quarter, and then we push rents in the second and third quarter and once again in the fourth quarter back to focusing on occupancy. So that's a general trajectory that follows our seasonality. As far as our renewal and new lease rate strategy, the focus is on maximizing revenues. And there are 3 major levers there. There's renewals, new lease and occupancy and then minor ones, other income and concessions, et cetera. But the big 3 are the renewal and new and occupancy rate. So if you push renewal above market, what's going to happen is some people will take it because they're sticky, they don't want to move, and some people will leave. In an environment where you think market rent growth is only about 3%, close long-term CAGR, not very exciting, we are not likely to push renewal aggressively because when you force vacancy, there's a cost. It shows up either in your occupancy, you have lower occupancy, or it shows up in lower new lease rates. You take a hit at some point. And so this is why when we talk about market appropriate and renewals, that's the focus. And if we see market rent growing at 4%, 5%, maybe during, say, May and during peak leasing season, sure, we are definitely going to push that renewal rate. And we're perfectly fine incurring that vacancy because we know we can capture a greater market rent growth. So there's a breakeven calculation that we do where it's worthwhile to do so. Keep in mind, 1 week of [indiscernible] cost you 2%. So 3% market rent growth is not sufficient.

Got it. So really -- so I guess where -- maybe ask [indiscernible], where are renewals today going out...

They're around low 4% and then we negotiate. So expect to land somewhere in the mid- to high 3s.

Mid to high 3s. And so what you would want to see before you change that strategy as you get into peak leasing season, you see more new lease growth like 3%, 4% such that you're like, okay, we can start increasing our renewals from this, call it, 4% level to 5% or 5.5% because we see the path toward future rent growth that's already showing up in our results.

Absolutely.

Okay. And then LA, maybe we should talk about some of the markets. Obviously, anyone, just jump in with questions. But you mentioned the bad debt or, I guess, the eviction moratorium. And I understand it's completely different this time. There's a lot of restrictions and things put in place to hopefully make sure that people don't take advantage of it. I guess the question is, how do you know that people won't just take advantage of it anyways and sort of how confident are you in that? Meaning like if someone says, hey, well, I lost 12% my income, how do they -- how do you even prove it, right? It's just -- there's a lot of things that someone could do if they want to be dishonest about it.

Yes. No, that's a good point. What they actually have to do is they have to prove it. So first of all, they have to notify the landlord within 7 days, and they have to justify and show evidence like pay stuff or whatever it might be. And we, as a landlord, have the opportunity to contest it. So the intention is to keep everybody consistent and honest and also make sure that it's not a one-sided conversation. And if we, as landlord, do not believe that the evidence is sufficient, you can go through the court process. And so it's no longer they get to say no matter what.

So I guess how many units are impacted by this eviction moratorium? And I guess how many have you seen come to you so far that have said, yes, I've been impacted, and then you go through that process that you just talked about?

Well, at this point, it's 0 because it just got enacted last week. Having said that, when the fire first started, we had very few inbound calls from our tenant that they needed help because we've always been [ proactive ] in our outreach and working out payment plans, et cetera. But we've not heard of it -- of anything that got impacted. And keep in mind, it was awful that these homes burned down, but very few businesses were impacted. And so it's -- we don't expect this to be a meaningful population in our renter pool.

Got it. And then someone asked this on the call, but I thought it was a good question. So I guess I'll reask it and maybe phrase it a little bit differently. But there's -- the wildfires were incredibly unfortunate and, I think, showed that there's a real need to rebuild, but also there's a real need for housing in and around LA. I guess do you think that the attitude there -- I mean, as you talk to politicians, to people, that there's maybe a little bit more motivation to change the attitude towards zoning, entitlement and development, at least in the medium term? Or do you think after this, sort of the effort, it kind of goes back to status quo in terms of just being, again, one of the most difficult places to build?

Yes. That's a good question in that it's hard for me to predict what will happen. The -- what I know right now is that Governor Newsom enacted several pieces of legislation to minimize the obstacles to rebuild single-family homes. The CEQA and these various requirements were essentially tabled and so -- to essentially move the rebuilding along. However, just a cleanup is going to take a year. I mean there's so much toxic materials out there. And so I do think that's going to take time. But what happens thereafter in a market that's already so supply constrained, too early to tell.

Got it. And then one question we get asked pretty frequently, again, don't have a great answer. But as you think about the new administration's policies around immigration, have you started to see any impact yet? Do you expect any impact? What are the main things that you're watching for, if it's like a change in approach on H-B1 (sic) [ H-1B ] visas? Like what is it -- the main things that you're watching to understand whether there could be an impact or not?

Barb?

Yes. So we are -- have been focused on the legal immigration side. That's where we -- the tech companies and the large employers are bringing people in to support their businesses. And from what we've heard, there is no talk about changing the legal aspect of immigration. And so from what we know right now, that will remain unchanged with the H-1B visas. And there's also been talk about allowing people who come here to get educated to stay here and work. And that would actually be a net benefit to our markets because we do import a lot of highly educated workers. I think on the illegal side, I think there is going to be some impact, but not necessarily to our portfolio. I don't think they're our renter base and in the industries -- they work in the farming industry and are in different parts of California. So there is the illegal aspect, but we're not as concerned about that versus the legal aspect.

Got it. Maybe switching to capital allocation, external growth. It looks like you're acquiring around $500 million on a net basis. Can you maybe just talk about your funding plans there? And I guess to the extent that you're using debt, I mean, one of the things that struck me is that you talked about cap rates in your market somewhere in the 4.5% to sort of 5% range. I think that's -- well, maybe it's pretty close to your cost of debt today just given the decline in tenure. But it's -- as of a couple of weeks ago, was below. So like, I guess the question is, how do you grow externally? How do you get into growth mode when cap rates are in the 4s and your cost of capital is higher than that?

Yes. It's a good question. And I'll answer this very carefully. So what we've been doing for the past year is arbitraging our portfolio to increase into markets and submarkets where we have higher conviction of future rent growth at neutral or accretive levels. So given the long history of FFO growth in this company, we need to make sure that we're doing accretive deals. And so as we look to '25, we are seeing some opportunities, in particular, in submarkets where we own existing assets where we can increase the yield on day 1 by putting them on to our operating model. So these are in the regions that we believe are prime to have the best rent growth and we can add them into an asset collection model to make them immediately efficient. That certainly helps in that accretion math. But again, we're not going to grow for growth's sake. We are growing to grow the bottom line. So we look to 2025, we have several sources of capital and free cash flow, our preferred redemptions, which are starting to wind down, which are going to help on those. And then we have several other capitals we can pull, including our joint venture partners, if we saw the right opportunities. But you are not going to see us grow, I'll repeat it one more time, just for growth's sake. We are growing to grow the bottom line.

Got it. And then typically, when you buy an asset, what is the sort of level of improvement that you typically see off of a stabilized asset? So obviously, a lease-up asset, that's completely different. But if you buy a stabilized asset, what's the NOI uplift that you get from doing things like [ podding ] management or putting them all in like a national type of a West Coast contract, like the expense savings you get from that? Just trying to understand, you buy something for, say, a 5 cap. What is it after it's implemented in your system?

It depends on the asset collection and how efficient those collections are. So the bigger collections tend to be more efficient. And I'm reluctant to provide a number. There's competitors and brokers that might be listening to this call, and they could be used against us. But it's real and it's tangible and we're achieving in year 1. And it's kind of been the -- one of the underlying strategies for this asset collection over the past several years is to allow us to give us that advantage when we go out and we acquire new assets. So I'd hate to give you a number for competitive reasons, but it's real, and you should see it in our bottom line results.

Got you. So it's 50 basis points [indiscernible]. I've asked a lot of your peers and, I guess, in the storage and other spaces today about buybacks. I'm not saying you guys are at a level I would buy back. But you have a history of [ issuing ] equity when you think it's the right time, buying back stock when you think it's the right time. That is a bit different than you sometimes see among REIT peers because they say their job is not to be market timers. Maybe talk about why your approach is a little bit different in that regard.

Well, whenever we make a capital allocation decision, the objective is to grow FFO per share and NAV per share. And if it's a direct buy, we make sure that the growth of that asset is in the top quartile of the portfolio average. So let's start with that fundamental. So if we're buying back stock, it's highly likely because we are able to sell an asset or have capital funding that enable us to buy stock back in a way that it generates accretion. And the reverse is true. If we're buying an asset, we wouldn't automatically issue stock. As Rylan mentioned, we look to all the different cost of capital and pick the tranche that is the most optimal. And that's how we think about capital allocation.

Got you. I guess they would then argue that capital is precious and that if you issue equity at some point, then you're trying to grow the asset base from that. And if you just go back and buy back stock with it later on, you're sort of making a shorter-term decision. I guess do you disagree with that sort of logic? I mean, if you're only able to buy back, say, $10 million, and it's the right decision at the time, it's still the right decision. I'm not sure if my question is completely clear. But [ what I'm basically ] saying is that they seem to think that you have to do [indiscernible] things only in size and that this kind of logic around capital being [indiscernible] has meant that you have to do things that would be super impactful, not something that's just marginally accretive.

I think that denominator effect is real, right? So what do you do that can really make a difference? And you may or may not have that luxury. So that transaction at one point in time, you have to look at it in such a way of optimize what's in front of me. And so we -- and you've seen our history, we're not the kind of company that will just go out and buy back [ $20 million ] of stock because it's just not that efficient. But we do try to find ways to do things in a way that you could benefit from scale.

On the call, you mentioned that there's a couple of initiatives that you're piloting on the other income side. Maybe just talk about what those are. Over the last couple of years, we've seen other income be a bigger contributor to same-store revenue growth. Some of that is really just from the bulk WiFi programs that are out there. But curious how you're looking at other income opportunities today and sort of how you make sure that you're not just adding on another fee for a resident that ends up cannibalizing rent.

Well, I'm glad that you mentioned that because the way we look at income, once again, is focused on total revenues and -- because we don't want it to be a case of geography like do [indiscernible] other income or whatnot. It's definitely a focus on total revenues. In the past couple of years, we had several initiatives. The most pronounced one was the master lease renters liability program that generated additional true other income, where it didn't -- it was not an impact to our total revenues. And that benefit occurred. We monetized that benefit in 2024 and thereafter, and it's now in our run rate. So 2025, it's pretty muted. And now we're piloting other initiatives. Like you mentioned, bulk WiFi is one of them and some AI products. And our focus is more holistic, which is it's either revenues or it's expenses, but ultimately, the goal is to optimize that income. And so we have a few that we're working through [ piloting ] this year. So probably that side of the business will be a little quiet, but then in 2026, 2027, thereafter, [ it will pick up ].

Got it. And then the last question I had is in terms of development, obviously, for the next couple of years, it takes a long time to develop in your markets. But I think for the first time in a while, I'm hearing some of your peers talk about developing on the West Coast. It is a little strange to me because I think to your point on Northern California, you haven't really seen much rent growth there over a long period of time. So maybe they're talking about more Southern California. But maybe just talk about what you're seeing in terms of the preplanning on development. I know the next 1 to 2 years will be quite low. But if you're starting to see more projects trying to get entitled, more activity on the development side, more opportunity on the development side than you've seen in the past.

Yes. I would start off by saying it's a bottoms-up approach, right? Again, we've got our kind of by geographies that we're focused on. And our Head of Investment Development underwrote 93 deals last year, not one of them met our threshold. So it's been 5 years since we last started a new project. We are going to move forward with one in 2025. But this is a unique asset where it's a great location, really attractive basis. Hard costs are down 8% since 2022, and rents are starting to show some positive momentum. So we are not saying, hey, we need to allocate x billion dollars to development. We are saying, what can we find source land in good locations where we can underwrite at a significant premium to where we can buy to compensate us for that risk. So as of right now, I would say the opportunities remain few and far between, but we are cautiously optimistic we're going to continue to be able to backfill several more projects in the coming years.

Got it. And then we did have a question, I guess, just quickly -- insurance maybe.

Yes, just on the insurance market on the West Coast, if there's any early indications of what's -- what may change there just with wildfires.

So far, we don't have any new information. We did go into [indiscernible] for our renewal in December, so we got ahead of the LA wildfires. I will say, though, the commercial market, which is where we are housed is different than the residential market, the single-family market. And over the last 2 to 3 years, our insurance premiums have gone up 50%. This year, we're seeing a small reprieve in insurance rates, but we have seen big increases whereas the single-family home market has not. And so there is a different -- we'll have more to follow later this year when we go back to the insurance market.

Really quickly, rapid fire. Same-store NOI growth for the apartment sector overall next year in '26?

3.5%.

And then a year from now, will there be more [indiscernible]? [Audio Gap]