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

Bank of America's 2026 Global Real Estate Conference. I'm Jana Galan, BofA's residential REIT analyst. And we're thrilled to have with us Essex Property Trust's President and CEO; Angela Kleiman and CFO, Barb Pak. I'll turn it over to Angela for opening remarks, and then we can jump into Q&A.

Great. Thanks, Jana. It's great to be here. Thank you all for attending. And thank Bank of America for putting together such a fantastic venue. So it's very productive, I think, for all of us. So we're happy to support this event. As it just a high-level overview. I think most of you I see a lot of familiar faces and know us well. when an S&P 500 company focused in multifamily space in the West Coast of United States, so is California and Washington about Depending on the day, about $24 billion in total market cap and 63,000 units across this footprint. And we focus our markets on in areas where there's low supply and catalyst for demand drivers. And so as a result of that, we have a disciplined capital allocation program that essentially converts the top line growth into the bottom line growth that outperforms the peer, which results in long-term outperformance on a total return basis in the top tier of all the REIT space. But more importantly, we have where a dividend aristograt was 32 years of consecutive dividend growth. And also pleased with that. And with the fundamental backdrop of low supply and demand catalyst with AI in the technology space. We are operating in a stable environment with potential upside in terms of rent growth and which is driven by strong fundamentals.

Great. Thank you. Maybe we'll start off with the operations, and you guys did provide an update. If you can just kind of go over some of those highlights and how did the peak leasing season this year compared to expectations.

Yes, that's a good question. We actually have a presentation published that's available online. So on Page 12 of our presentation, we present the rent curve of what we've experienced to date relative to long-term averages in 2016 to 2019 and also compare it to last year. And so in both of those cases, our rent curve is doing better than long-term average and last year. And the rent curve also shows that we have an extended peak leasing season, which is fantastic that peak is 100% driven by Northern California. So Seattle has experienced a normal seasonality. In Southern California really didn't have a peak. It's pretty much performing on top of last year's performance, and that's understandable with the broad economy. And what we're seeing that rent curve right now is that it's starting to flatten which also makes sense as we now enter into the typical slower seasonal part of our business, especially in the fourth quarter, when employees don't typically hire and tenants don't typically want to move between, say, Thanksgiving and Christmas. And so we'll wait to see how that deceleration trend occurs. But right now, what we are anticipating based on leases that we've signed today through August is about 150 basis points of earn-in for 2027. And which is good news compared to last year, it's 65 basis points above last year. And so things are doing well on the ground here.

Great. And maybe focusing first on Northern California, you've been through other kind of apartment rent cycles. Do you think that the rent growth for that region could be even stronger in 2027?

Yes, that's a good question. I think it's too early for us to predict '27. I do think, though, that the fundamental backdrop for Northern California, the demand catalyst with AI, what we're seeing with job postings and company formation, office leases that are being taken down does and then the affordability component of Northern California gives it -- it does give it legs for several years. What '27 is going to do, we're still working through our budgets, and we'll provide more color later this year. But in terms of in having an extended cycle. I think we're in the early innings of the recovery. In Northern California, if you look back, it really has done nothing since 2019. It was negative and flat for several years, and we're just starting to see rent growth. And so I think given the demand catalysts that are out there and the low supply that is in this market and will be in '27 and into '28 and even into '29 because we know it takes so long to get things entitled and developed. I think we have a long runway here.

And can you maybe touch on the opportunity with rent as a percent of income in the region?

Yes. So if you look at the rent-to-income ratio today, we're at 21%, and this is for the market in Northern California. Historically, pre-covered we were at 25%. And so what that means is we could grow rent, if rents go up 20% from here with no increase in wages, we would get back to our pre-COVID rent-to-income ratio. But what we are seeing is significant wage growth in the Bay Area. And so rent growth, while it is going up significantly, it is not impacting our rent-to-income ratio because wage growth is also going up at a pretty significant clip. . So there is some of the best affordability on the multifamily apartment side that we've seen in years. And as you guys all know, it's very expensive to own a home. It's much cheaper to rent than to own a home in the Bay Area. That dynamic hasn't changed. It's actually gotten even cheaper to rent versus own. It's about 2.5x more expensive to own a home than to rent in the Bay Area.

And I've gotten some incoming questions just on the kind of regulatory front or the different types of rent caps for your markets? Maybe if you could share a little bit about that.

Oh, happy to. So for the state of California and actually Washington as well, their state wine control, and they're pretty much on top of each other. So California has AB-1482 that CPI plus 5 kept at 10%. Seattle is CPI+7 capped at 10%. And in both of those scenarios, we view that as an anti-aging measure. And so in that environment, Essex has had a 10% self-imposed cap well before these legislations were passed. And so we will do just fine in those situations. And in terms of where the markets land, Northern California, no surprise, it's pushing up close to that cap on the renewal side. And as far as the other markets, we still have quite a bit of room.

I guess for those that are newer to Essex, and you talk about the philosophy, the history behind the 10% self-governed 10% cap in why is that a good thing?

Yes, happy to. Our theory is that our leases do turn pretty quickly. They're 9 to 12 months on average. And so seem like a -- for us, a reasonable number in terms of just being responsible corporate citizens. -- because it doesn't take us long to recapture or get close to where the market is. At the same time, it doesn't create so much stress for the the tenant base, especially in an environment where California produces so little housing. And it's tough for tenants to find alternative places to live, we didn't want to create such distress, and 10% is an environment where you can still operate efficiently and be able to manage your business and invest in capital recycling quite efficiently. I guess.

10% is great, 5% would be awesome. And there's some pretty favorable regulation. Is there any noise at all in upcoming election period of anybody trying to suppressive that changed the legislation to be more restrictive.

We haven't heard proposals less than 10%. Let's start there. And there's always going to be noise because there's a lot of rhetoric. I do think that in the recent years, what we have seen is the California legislature learned from COVID, where owners and less regulation and onerous eviction moratoriums really hurt the state of California and certainly didn't help creation of new housing, which is I think they do recognize that it's needed.

And so before the state had a limit -- you guys had your own limit your I guess, the scale that you had in your markets is not enough to, let's say, impact the market. So your competitors might have been doing the 15, 20, there were a few years where the work boom years, I guess you're saying the shorter leases, you were still able to capture the upside over those couple of years regardless so now the new governor, everyone at this 10%, this would be a new right? This is the first it was enacted a couple of years ago. So this would be the first time that we may see the markets actually pushed to that, potentially, it sounds like it a few years.

Yes. I think that's a reasonable assumption. So this was AB-1482 was enacted in 2018. The Seattle legislation was enacted last year. And when you look at our growth cycle coming out of the great Recession, we had a long tail of high single-digit, low double-digit growth from 2012 to, say, 2016. And because of this legislation that is now market-wide is it possible that going to be longer tail? I think that is a reasonable assumption, especially in light of the current market dynamics, our supply as a percentage of total stock is only 30 basis points. That is record level low. And the rent-to-income ratio, that Barb mentioned, I've never seen a gap like this in my 30-year career in this business. And then you layer on the technology catalysts to as a demand driver. It's like the perfect storm of solid fundamentals, creating a long tail for this market.

So the biggest risk, of course, then would be if the state was able to incentivize supply, right, we've seen in the that the real way to limit rent growth is supply so to confirm, I guess, what are what's the latest on the supply front in California.

It's still very anemic. And part of it is well legislation, there's been legislation proposed to facilitate supply we've seen some tick up. It's mostly in the affordable space, which is actually good because we're not we don't operate in that space in a meaningful way, and we really need more affordable housing than anything else. So if you look at San Jose in the next 2 to 3 years, supply is actually in affordable space. And in L.A., the reason the uptick is mostly unaffordable. So that's a good thing. But as far as generally speaking, we underwrite we underwrote a 100 land sites last year and picked 1. And partly because even though there's accelerated entitlement available and people think about FastTrack, if you take it take that word at a face value, we think, oh, it's like immediate. Well, no, what the practical reality is that when we went through this we're going through this with our loan view site is that, okay, instead of 3 years, it's 2.5, 6 months pickup. Yes. Now and this is by right. We're not rezoning. So this is entitlement by right, and we're just going through the permitting process. So you go through the process, that's 2.5 years to put up a building like a podium mid-rise 250-unit plus type building. So in down the fairway for us 36 months minimum. So you can see in California with high conviction when supply is coming your way. And we have high conviction that the next 4 years, not a lot is going to change. Even if they fast track everything and more likely 5-year. Pocos structuring costs. continued to increase. And so that is construction costs and labor costs are 2 governors that continues to essentially temper supply in addition to the entitlement process.

Could you give us an idea of the rate of increase and compare that to a few years ago in terms of.

It's better than a few years ago. So free coin and even during COVID, not a whole lot happened during covet, ut precoat construction costs in our markets was going up in the low single -- low double digits to mid, so say around 10% to 15%. And Today, it's closer to, say, inflation plus. So it's probably around 4%, 5%. And so it's probably moving depending on your market, right? So if you're in Northern California, then it's better economics. But in Southern California, it's still not going to pencil and of course, Seattle it depends on the pocket.

It's lower than rent.

Slower than Brent. But you have to go back to what's the land cost on the basis as well. So all those components influences our expected yield. .

And can you give us a little bit of color on land, land cost in the land transaction market. .

It's actually a wide range because every -- most landholders are their individuals, and they all have different holding cycles and different kinds of capital. And so what we have seen is very little land site coming to market, even in Northern California, and land sellers have, for the most part, a higher expectation of what the value of the land is then what the builders are willing to pay, which is why we underwrote over 100 and only picked 1 to move forward with last year.

Maybe I go ahead .

I was just going to add just a follow-up. So we do see some supply numbers hitting. It's really going to saying at least half of it will be affordable housing. And that doesn't impact your more B pricing it does not impact.

It does not really impact our our market rate business. And the affordable, what I'm referring to is San Jose and L.A.

Maybe we could shift a little bit to greater Seattle, Leasing improved last quarter, but post COVID, it's really kind of been plagued by stops and starts. Maybe if you could share with us how have trends progressed in your portfolio and the difference between downtown and Bellevue.

Yes. So Seattle, as you mentioned, has had some pockets of starts and stops. And last year in the fourth quarter, it was a little bit more challenged and even into January, there were some layup announcements with Amazon and Microsoft -- we've got those behind us. We also were dealing with some more heavy supply deliveries. That's starting to abate as well. And so the market is stable. It's not overly strong. but there are some good foundational building blocks for it to improve over the next 12 to 18 months. And really, what we're focused on is when you look at supply, and we do have a chart on Page 14 of our presentation. In 2024, we delivered 2.4% of stock. And then that came down in '25 to $1.7 billion. So those are still pretty elevated years of supply and now we're sub-1% and declining. And so the supply backdrop looks much better now than it has for the last few years, which will allow us to put up better rent growth numbers with less job growth. And then on the jobs front, what we are seeing is AI companies, some of the big names are taking office space in the Seattle market. in Bellevue, a lot of the leases that have been signed are in Bellevue. There are some in CBD, but the vast majority have been taken down in Bellevue, which benefits us because 80% of our portfolio is in the East side or North and South and 20% is in CBD. CBD will do just fine, but I think Bellevue and the Eastside will benefit more. Now it's going to take time for these office leases to turn into employees because it's going to take time for them to build out their TIs and get bodies there. So we think end of next year into '28 is really when we're going to start to see better rent growth than what we've seen in the past. And then just to go back to the Amazon comment, they did retrench last year, but what we have seen more recently is they actually have job postings for the first time in a long time. And so they are back hiring in that market, which we think is a good sign for the overall health of that market. So things are slow right now, but we think there are some green shoots for the future.

Do you anticipate the new mayor Seattle impacting business conditions for yourselves?

Yes. So far, what we've seen from the new mayor is let's start with rent control. The new mayor cannot change that has a statewide measure. And so on the margin, there's been proposals, but it hasn't been extreme from that perspective. And so obviously, we don't really have a whole lot of track record with this new mayor, but I do think that the legislature, including Numero recognize that if you timber, if you make it business unfriendly, well, you've seen what happened using the company will start to look elsewhere. But also what's important is you need to keep that supply coming in order to have affordable housing. And so we haven't seen anything in the extreme.

And then maybe just turning to Southern California and curious kind of the evictions or bad debt in L.A. How is that trending?