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

Welcome to the Essex Company presentation. It's good to see you all here. I'm Angela Kleiman, the President and CEO. To my left is Barb Pak, our Chief Financial Officer; and to her left is Rylan Burns, our Chief Investment Officer. I'll just start with a brief company overview and a high-level operations update, then I'll turn it over to Q&A. Essex is an S&P 500 company that is the only dedicated multifamily REIT that focuses in the West Coast markets, and we have generated the highest total return since our IPO and have raised our dividends for 31 consecutive years. So I'm very pleased with that track record. The key driver of our long-term outperformance is favorable supply-demand fundamentals combined with our capital allocation discipline and unique operating strategy. So let me give you an example as far as the fundamental side. Supply, for example, we historically produce well below U.S. levels of housing supply, especially in California. Currently, our supply level is only a 0.5% of total stock. Compared to the rest of the U.S., new stock is coming in at 1, 2 or even higher percentages of total stock. But having said that, the cost of home ownership is 2.5x more expensive. So that transition from being a renter to an owner is very difficult for our markets. And so in this environment, we don't need much job growth to have -- to achieve healthy rent growth, but our markets have historically generated some of the strongest job growth numbers, particularly in the high-paying sectors. And over the long term, this fundamental backdrop is anticipated to continue, especially with the center of innovation and technology in our Northern California region. As far as our operating model is concerned, we have produced sector-leading operating margins. If you look online, we have our presentation that shows on Page 9. Our operating margin is on average 300 basis points of our peers. And it's really how we run the business and how we orient certain functionalities and our disciplined capital allocation, and that means there are times that we would issue equity to grow and there are times that we actually would sell assets to buy back stock to benefit the company. And we're very disciplined about that and generating accretion in all that we do. And that has -- that discipline to drive cash flow to the bottom line has enhanced the total return for our shareholders. So as far as the operating update, just high level, first quarter, we slightly outperformed our expectations, but this is incremental. And second quarter, currently, we're trending on plan as expected. Certain markets are doing better. Certain markets have remained soft as we have expected. But overall, we are in good shape. Heading into the peak leasing season, we have strong occupancy level and low levels of concessions. So we are well positioned. And with that, I'll turn it over to Q&A.

Yes. Thank you. So 2025 has seemed sort of a return to form for the West Coast tech markets that have been so negatively impacted by COVID. Can you just give an update on the recovery there?

Sure. No, that's a good question. It's interesting to see how the cycles have performed throughout the different major events. And COVID really hit Northern California hard because everything was shut down. People had to leave because they couldn't even find jobs. Where we are today, we are just starting recovery and so it's an exciting time for us. And you'll see how we made investment decisions and capital allocations. But net-net, rents are only at about 5% above pre-COVID in 2019. That is very muted. But supply is only 0.5% of stock, and it's decreasing. And job growth has been steadily improving. But most importantly, even though rents have only grown by 5%, income growth has grown by over 20%. And so this is a very unusual dynamic, and I've never seen this in my 30-year career in the business, where you have all three major pillars in your favor, supply, affordability and demand with 85% of technology AI companies based in the Bay Area.

Maybe moving to tariffs? And what ways would you expect tariffs to affect the company? .

Yes. No, that's a great question. I think -- when we look at it, it's difficult to know because the rules keep changing and what the tariff is moving around. But we're watching more closely is on the operating expense side and really on the repairs and maintenance side. Our appliances going to cost more and is it going to cost more just to maintain our buildings. We think if we look at this year, if we do start to see any impact, which we haven't so far, it could start to hit in the fourth quarter and then really it will be a '26 event. But just too difficult to know at this point on the cost side of the equation.

And obviously, we just talked about the tech markets. Can you talk about your expectations for hiring in the tech markets, just given how uncertain the macro is?

Well, it's -- the AI side, which is really the sector that's driving job growth has been steadily increasing. And we're seeing now at a level when you look at open job positions at a level close to near pre-COVID averages and that's a great sign, and it's continuing. And what I mean by that is, if I post a job opening, it takes about two to three months for me to actually hire that job. And if I post a 100 job opening and I fill 50, the next month, you will see job openings decline. But we've not seen that. We've seen it either stay flat or increasing. So that tells us that they are hiring and they're still growing because they're continuing to have either adding to the job openings or they're elevating their needs.

Okay. In contrast to the tech markets L.A. continue to be a struggle. There was a lot of delinquency during COVID that was an issue. We're also starting to see more sort of existential questions given the fires and struggles in the movie business. What's your outlook on L.A?

Barb, why don't you talk about the delinquency first. And I cover the market.

Yes. So as it relates to delinquency, you're right, Brad, it's been a struggle for 5 years, but we do see light at the end of the tunnel. Today, our delinquencies at 1.3% in L.A. That's a percent of our scheduled rent. A year ago, just to put it in perspective, we were at 3.9% in the first quarter of 2024. So we've made great progress. We've seen the courts go from 12 months to evict down to 4 months to evict. We're not quite back to pre-COVID levels, but we're getting there. So we do see that ultimately being a benefit to the market as it continues to improve towards that long-term average.

Yes. And as far as our view on the market as a whole, there are a couple of challenges. Film industry is -- has not been doing well. It was -- has been steadily declining since COVID. And a lot of the business went to different states or overseas. And there is a concerted effort by the legislatures to bring that back. And so there is hope because at least the conversation is happening. The governor doubled the film industry tax credit from $350 million to $700 million, it's not enough, but it's a good start. And ultimately, what we would -- what we anticipate is that there has been a $20 billion infrastructure spending announced for -- that's going to start next year for the World Cup and the Olympics to come. And that will help stabilize L.A. as a market. And as we get through delinquency and concurrently build occupancy, you layer on the infrastructure money coming in, which will bring in jobs and construction workers. It will stabilize L.A. What happens after that, two, three years, the film industry and that liability will have an impact. And if that industry does not return to L.A., then what we see L.A. will behave similar to the U.S. average. It will grow at that long-term CAGR, somewhere in that 2%, 2.25%. So that's not bad. It's not a doomsday scenario. The disappointment is that there will not be a robust acceleration as what we otherwise would have enjoyed in the past.

Okay. We've seen a lot of sort of unusual leasing season trajectories over the past couple of years because of COVID and just recovery. How does this one look versus a normal pre-COVID leasing season.

Well Brad, fortunately, we are back to, there, I say, a normal environment. We had -- in last year, we had a normal seasonal curve, which is great. And what that means is first quarter and the fourth quarter, that's our seasonal low. And typically, our market peaks around the end of second quarter, middle and the end of second quarter. And that is replicating this year. And so what we're seeing is Seattle, we're expecting that Seattle will peak sometime around between now and the next 10 days, and followed by Northern California, which typically peaks between June and around mid- to end of June, then Southern California. And so things are so far playing out as expected.

And then how has market level rent trended versus your expectations.

Market level rents have trended generally in line with expectations. And just to give you a little more granularity. L.A. and expectations is in the eye of the beholder, right? And so some people are expected much better numbers for L.A. for example, we did not. We expect the L.A. to be soft. And L.A. has met her expectations, unfortunately. But that's okay. So Southern California is generally pretty soft, but Southern California has also had 25% plus growth during COVID years. So that's fine. Northern California has been our shiny star with L.A. -- I mean, with San Mateo and Santa Clara leading the pack at slightly above our expectations and Seattle in the middle of the pack.

Okay. You touched on the low supply levels in your markets. Can you just sort of granularly go through the medium-term outlook that you have? .

Yes. So supply is a benefit to the West Coast. It's very difficult to entitle and build. And so we deliver very little supply annually. This year, we're expected to deliver 50 basis points of supply as a percent of stock. And when we look at supply, we look at total supply. So it's single-family and multifamily. And we think it's important that you look at both, because single-family is a substitute for the multifamily supply. When we look out next year, we do see supply continue to go down. So we're only at 50 basis points this year. We're going down to 40 basis points next year. We expect about a 20% reduction in total supply deliveries mostly driven by L.A. and Seattle are two of the bigger markets where supply is going to further abate into 2026.

Okay. And then Oakland has been a really supply challenged market for a while now. What's the outlook there?

Yes. So we're getting through the final throes of the supply deliveries in Oakland this year. I think most of the units have delivered and they're working through the lease-ups and most of them are in that final leg of that. I would say with Oakland, the bigger challenge is just the crime and the homelessness and the political factors that are still a challenge in the city and we're hopeful that they'll make progress on that front. But I think the supply picture looks much better for the next few years than what we've had for the last few years. .

Your suburban asset base and the price point are both differentiated versus a lot of your peers in the same markets. How does that set you up in the current environment?

Well, the -- our portfolio mix of about 85% suburban and 15% in the downtown. It's intentional, because California is very different compared to New York in that all the major employers are in the suburbs. And so for example, Google is in Mountain View. Meta is in Menlo Park. Apple is in Cupertino. So having a suburban asset, which most housing decisions is driven by your jobs is important, and that has benefited us. And we do expect that those major employers are the key catalysts to job growth, therefore, demand for housing and which we do believe that how we position our portfolio is going to benefit from where these being close to job nodes.

Okay. Maybe moving on to capital, what's the best use of incremental capital right now?

The company has been targeting fee simple acquisitions as well as developments. So given the fundamental backdrop that Angela detailed, we have been very active as it relates to deploying capital into our Northern California region. We just started a new development project in the city of South San Francisco, and we have purchased over a $1 billion of new acquisitions relatively new vintage, high-quality locations in the Bay Area where we see a very attractive fundamental backdrop at an attractive initial valuations. The other thing we're doing is really target asset acquisitions in close proximity to our existing asset base. We have a very unique operating model called the asset collection model, where we're generating significant accretion just from operating more efficiently by putting them onto our operating model. So a high level, looking at the Bay Area and the Pacific Northwest to deploy incremental capital in close proximity to our existing assets.

And then on the acquisition front, what cap rates are you seeing in your markets right now? And are the transaction volumes normal, below normal, above normal?

Yes, I'll start with the transaction volumes. Last year, we saw about $10 billion of volumes, excluding the portfolio transaction. So for comparison purposes in '21 and '22, that was around $20 billion of volume. So relative to the peak post-COVID when interest rates were quite low, we have seen a decline in volumes, but this is relatively healthy if you look over a longer time period. So it feels like a relatively healthy transaction market. Cap rates broadly up and down our market for well-located, high-quality product is consistently in the mid- to-high 4% range. There's very little dispersion as it relates to cap rates across our markets. Again, we can do better than that if we're buying close proximity to our existing assets because we can operate them more efficiently.

Okay. You mentioned rotating or putting new capital into Northern California and Seattle. That's come at the expense of Southern California in terms of the dispositions. Is that something that we should continue to expect that you'll sort of re-weight the portfolio? .

Correct. Yes. We've done $550 million of acquisitions in the Bay Area year-to-date funded primarily through free cash flow as well as two dispositions at our Southern California markets. And each asset disposition typically has a unique story, but where we can do that in an FFO neutral bay -- an FFO neutral manner, improve the average age of the portfolio, which we've been able to do and set us up for better rent growth over the next several years, we're going to continue to target that strategy for the foreseeable future. .

Okay. You started your first development in a number of years in the first quarter, what changed about the environment that made you comfortable with pursuing that? .

Yes, it's a good question. So just some backdrop. Our investment team has underwritten approximately 100 land sites a year for the past five years. These are the first development projects that have made sense in several years. So the asset in South San Francisco, we purchased in 2019. So we have a very attractive land basis. We bid out the project in 2022. Didn't make sense. We're looking for at least 100 basis point premium to where we can buy for shovel-ready, fully entitled sites that did not make sense in 2022. Hard costs came down approximately 8% between '22 and 2024, as well as we started to see some positive rent momentum in that specific submarket. So it's a combination of factors, a really low basis, hard costs coming down. And what we really like about this project as well as one other land site that we purchased in Mountain View last year, is that we feel very confident that when we deliver these projects, it's going to be in an environment with very limited competitive supply, because broadly, we're seeing permits come down, other developers back out, and we're trying to be that contrarian investor and developer. And so we're feeling very excited about the environment in which we will deliver these units.

Okay. Historically, Essex has had a preferred mezzanine sort of book. You guys have been winding that down of late. Can you just talk through the rationale for that and where we would expect that book to level off at.

Yes. So we have, over the last two years, taken the preferred equity redemption proceeds when we've gotten them back and put them into fee simple acquisitions. We do think it's a better long-term growth and cash flow support for our investor base. The reason we got into this business and grew the platform as much as we did is -- it didn't pencil to do development, and ground-up development was very expensive, and we earned a better risk-adjusted return investing in the preferred equity capital stack position. Today, though, we see different risk-adjusted returns. There's been a lot of capital that's flowed into the -- this segment of the book. And so it's much more competitive and rates have come down. And so we're not earning that same risk-adjusted return that we once were. So for us, by taking those proceeds when we get them back and buying wholly-owned acquisitions makes a lot more sense. You will see us continue to wind down this book if we can't find the appropriate opportunities. Right now, we're at about a little over $500 million in total book, preferred equity and mezzanine book outstanding. It's about 4% of our core FFO. And we have a target of 3% to 5%, but that will depend on the opportunities out there. If we see opportunities, we'll move forward, but it's got to be the right position for us.

Okay. And then moving on to valuation. Angela, in your prepared comments, you said sometimes Essex sells equity, sometimes you buy it back. How do you view the current valuation? And which of those would you be more inclined to do today?

Right now, where stock prices, what we view is it's -- we're in a no man's land. We're not trading at a meaningful premium to [ NAV ]. So to issue stock to buy assets, it's not going to generate the accretion that we would want. And -- but once again, it's not trading at a significant discount to NAV. So selling assets to buy back stock because there's a frictional cost embedded in there. Not compelling. What we have been doing is we have been selling assets at a very attractive price and using those proceeds and, of course, free cash flow and preferred equity redemptions to grow to buy newer assets in the Bay Area, and that's how we've been thinking about capital allocation.

And then often on the West Coast, we end up talking about the regulatory environment. Is there anything that you're tracking, either local level, state level, even federal level that investors should be paying attention to?

Well, we actually have been consistently tracking key legislations, and it's been a positive surprise to us. And I think this is the first time I've said this in my 15 years with Essex in that November was almost a moderate sweep in elections. And I think that the voters have recognized and the policymakers as well that we need to do better as a society, be a little bit more balanced in how we think about legislation and enact programs that's good for businesses and good for the citizens there. And an example is, recently, there was a proposal to essentially replace the rent control that we have in place, which is the AB 1482, that's CPI plus 5%, max of 10%. That's very reasonable. We were supportive of that. Essex has had a self-imposed 10% rent cap forever. And there was a proposal to reduce that level. Well, the proposal, which was started by the committee chair of a housing committee, it didn't even make it out of committee. I think -- and that is a dramatic shift to what has happened in the past. So it gives us some hope that California is -- I won't say that it's becoming moderate, but it's becoming more reasonable. And so while there's always legislative proposals out there, and we track them. We haven't seen anything that gives us a concern that it's going to have a major impact.

Okay. That's all the questions I have prepared. Do we have anything from the audience?

[indiscernible] you address and complication there?

That's a great question. So California, first of all is a fourth or fifth largest economy in the world. So it's well diversified. It's one state, but it's very diversified. And what we do is we operate 9 to 12 assets as one business unit. And the reason we can do that is concentration. And so while we have this concentration risk of being in only two states, we've converted that concentration into a benefit. And within that 9 to 12 properties, we will have a different -- all different range of properties because 80% of our properties are within 5 miles of each other. And that group will have brand-new, A all the way to older more affordable, B- pricing range. And so that gives us the diversity to with which we can operate from. And in running this as a business unit allows us to be very efficient in terms of acquiring -- the cost of acquiring a new lead cross-selling customer service and then, of course, allow our personnel to be very efficient that way.

The long-term L.A. growth scenario we laid out in [indiscernible]. And my question, I realize [indiscernible] that plays out and growth profile for L.A. is very different than your typical West Coast, the reason why you are, where you are -- how do you think [indiscernible] maybe exit that market? Or is there still value being all [indiscernible] lower growth profile.

That's a great question. And it's something that we do debate. We have not decided to redline L.A. Because at the end of the day, if you look at our portfolio mix, we're about 40% Northern California, 40% Southern California and 20% Seattle. So we are 60% weighted to high-growth environment. Southern California to us mirrors the U.S. with a higher level of professional services and lower supply. So in that environment, if you're growing at pre-down close to long-term CAGR of the national average and you still have a lower supply, people still want to live there, and it has a diversified economy, unless there's a secular crack in the fundamentals, we don't see a compelling reason to just shift completely out of L.A.

Sure. What's the state of long-standing [indiscernible].

Yes. So it's definitely showing up. We saw it last year in our numbers with Northern California being fairly strong, and we're seeing it again this year. And we thought we were through most of it earlier or through last year, but then you see the Googles of the world, on grandfathering remote work and you're like, well, maybe there's further legs to this demand cycle. So what they said is, if you're permanently grandfather to remote, you now have to come back to the office. I do think the tech industry is innovate or die, and they know that. And they're behind on getting their people back to the office. They want to recreate that ecosystem they had pre-COVID and so I think there's a concerted effort to get people back to the office. They're laying off remote workers, rehiring back in the Bay Area. And so it's definitely happening at multiple front. And we're seeing it in the demand. If you look at the BLS jobs numbers, Northern California has negative job growth year-to-date, but it has the best rent growth. And so those two dynamics wouldn't be occurring if there isn't some other dynamic happening, which we believe is partly due to return to office.

The [indiscernible] looking at the California. How accretive is the one [indiscernible] year 3 and just if [indiscernible] you're talking about, right? And so how much do you look at Southern California and say, it looks like the realities are if you're able to buy something at a better value [indiscernible].

Yes, it's a great question. We have funded our acquisitions year-to-date through a combination of free cash flow as well as two dispositions in Southern California. So the net effect on the FFO is going to be neutral year one, and we anticipate that to grow -- the disparity to grow over the next several years, given our fundamental outlook over those two, given what we've said about the fundamentals in Northern California versus Southern California. We underwrite everything that comes into our markets. So we are looking in Southern California as well. As I mentioned, there's very limited cap rate disparity between the regions at this point in time. If that were to change and we were to see some cap rate expansion, I think that would be more -- we would obviously have to underwrite that in a different way. So we are not agnostic. We continue to evaluate every opportunity and every opportunity has a price at which we would invest, but right now, we think the highest risk-adjusted returns are in the Northern California and the Pacific Northwest regions.

Time for one more question.

[indiscernible].

Yes. As it relates to insurance in California, I think it's a tale of two markets. You've got the home insurance market, which is definitely makes a lot of the news, and that's where a lot of the carriers have left the state. On the commercial side, which is where multifamily sits, it's a different story. We're impacted by national natural disasters, not just wildfires in California. And so it's one component. But if a hurricane hits in Florida or when the Texas freeze occurred in Texas a few years ago, our premiums could go up, and they did go up. And so what we're seeing is we saw two big years of big premium increases on the commercial side. This last year, though, we renewed our insurance in December and we saw a slight premium reduction. And that's because the reinsurers carriers came back into the market. We had -- they had left the market for a while. They're now back because premiums are much higher. So we're monitoring it closely. We won't be back in the market until the fourth quarter. But so far, what we're hearing is that the wildfires in L.A. aren't necessarily affecting the commercial premium. The home residential market is a different story, and I think there are some challenges there.

Okay. The red light is going to turn on right now. .

Well, thank you all very much.