Essex Property Trust Inc (ESS) 2016 Q2 法說會逐字稿

Good day, and welcome to Essex Property Trust second quarter 2016 earnings call. As a reminder, today's conference call is being recorded.

Statements made on this conference call regarding expected operating results and other future events are forward-looking statements that involve risk and uncertainties. Forward-looking statements are made based on current expectations, assumptions, and beliefs, as well as other information available to the Company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found in the Company's filings with the SEC.

When we get to the question-and-answer portion, Management asks that you be respectful of everyone's time and limit yourself to one question and one follow-up. It is now my pleasure to introduce your host Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, Mr. Schall, you may begin.

Thank you, operator. Thank you for joining us today, and welcome to our second-quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments, and John Eudy is here for Q&A. I'll cover the following topics on the call: First, our commentary on quarterly results and market conditions; second, an investment market update; and finally, the latest on rent control proposals in California. On to the first topic.

The second quarter was challenging operationally, as job growth was weaker than expected in several key markets, often coinciding with peaking apartment supply deliveries. With that said, we're pleased that we exceeded our core FFO per share guidance for the quarter, and are increasing our 2016 core FFO guidance by $0.06 at the mid-point.

We are also tightening the revenue guidance range, leaving the mid-point of our revenue guidance slightly lower, largely attributable to reduced rent growth expectations in northern California. Once again, I thank the Essex team for their focus and effort in driving bottom-line growth in a demanding and changing environment.

Generally speaking, the West Coast economy continues to out-pace the slow-growth national economy, which we now estimate will produce 2016 job growth of 1.8%, down from our prior estimate of 2%. Throughout our California markets, we have pockets of strength and weakness, coinciding with the quantity of new apartment deliveries, and the level of concessions being offered by landlords.

In response to these conditions, we have lowered our 2016 market rent forecast by 50 basis points to 5.5% on Page S-16 of our supplemental package. Generally, B-quality apartments and locations continue to perform better than As, as lower price points become more important to renters as affordability pressures increase.

In my 30 years at Essex, I have not seen the divergence and performance between Seattle and northern California that we're currently experiencing, and our Seattle results have been a huge positive surprise. The economies of Seattle and northern California have a large tech component, and thus usually follow a similar path in terms of rent growth. Seattle generates more housing supply measured as a percentage of stock, which has historically moderated its long-term rent growth, again relative to northern California.

The cause of this divergence is largely on the demand side, driven by job growth. To demonstrate this, I'm going to refer to non-seasonally adjusted job growth from January to June, primarily because the year-over-year job numbers are significantly influenced by the strong second half of 2015.

Seattle had the strongest job growth for the first half of 2016 compared to each of the past six years, and the margin of out-performance is notable. In 2015, which you likely will recall was a very good year, Seattle increased total jobs for the first half of the year by 30,000. The comparable job growth for 2016 was 43,400, or 44% more jobs added relative to 2015. To contrast this with northern California, in January through June 2016, we added 27,000 jobs, down from 44,100 in the comparable period of 2015.

Based on this activity, we are changing our 2016 forecast on Page S-16 of the supplement as follows. In Seattle, job growth increases 15% to 55,800 jobs, and our 2016 market rent forecast increases to 8.5% from 6.1%. In northern California, job growth is reduced from 93,100 to 74,200, and our 2016 market rent forecast goes from 6.5% to 3.8%.

We still believe that our apartments located in the centers of technology and innovation will deliver above-average rent growth. This belief is supported by the integration of technology into virtually every part of our lives, resulting in high-growth expectation, higher income levels, and better wage growth.

Southern California remains on track to achieve our targets for 2016. There are, however, pockets of supply that impact price in certain sub-markets. Overall, we had solid results through the south land, especially in L.A. and San Diego. As a result, we're leaving our 2016 rent growth expectations unchanged.

As noted on our last call, apartment supply deliveries are inherently lumpy, which affects market rents based on the concession level and other pricing considerations. Last quarter we estimated that approximately 70% of the 2016 supply will occur in the second and third quarter in San Francisco, San Jose, and Los Angeles. In San Francisco and San Jose, we expect apartment supply to begin to moderate in the fourth quarter of 2016, and we expect new deliveries of apartments in 2017 will fall about 20% to 30% in San Francisco, and 30% to 40% in San Jose.

Second topic, investment markets. Our 2016 guidance called for $400 million to $600 million in acquisitions, and $200 million to $300 million in dispositions. Through the second quarter, we've acquired around $150 million and disposed of about $110 million, including our pro rata share of co-investments. We've also added approximately $67 million to the outstanding balance of our preferred equity investments.

We are working on several acquisition deals that we expect to be largely funded through dispositions. With this activity, we should be in the range of our guidance assumptions for acquisitions, and at the high end of the range for dispositions. We also have about $50 million in potential preferred equity transactions that are being underwritten.

During the quarter, the stock traded at or marginally below net asset value, making accretive acquisitions and dispositions challenging to execute. We continue to wait for market conditions that allow accretive transactions, strongly preferring that to acquisitions or dispositions that accomplish little with respect to growth in NAV and core FFO per share. We will also continue to selectively call the portfolio, re-investing in lower-risk or higher-growth opportunities.

Cap rates have been stable for the last quarter, with A-quality property and locations trading around a 4% to 4.25% cap rate using the Essex methodology. From time to time, more aggressive buyers will pay sub for cap rates. B-quality property and locations typically have cap rates 25 to 50 basis points higher than A-quality property.

While rental growth rates are moderating, so is the cost of debt, such that the percentage of positive leverage on real estate deals is approaching record highs. We continue to see fewer development starts in northern California, largely attributable to increased cost of construction, and discipline shown by lenders. We expect a small increase in apartment supply in Seattle and southern California in 2017.

Market-clearing cap rates for development deals typically generate a 4.5% to 4.75% un-trended cap rate, which is below our yield threshold. We continue to look for development opportunities that meet our underwriting criteria, and we are not likely to lower targets in the near term.

Then finally, third topic, rent control. Generally there appears to be less urgency related to rent control now that rents have moderated in northern California. However, the process started by tenant rights groups in several northern California cities has led to several ballot initiatives. So far, qualified initiatives exist for the ballot in northern California cities of Mountain View, Richmond, San Mateo, and Alameda. Burlingame remains in the qualification process.

Generally, these proposals provide for CPI-based rent increases on renewals only, subject to a cap. These are in addition to changes to the rent control ordinance in San Jose that I discussed on last quarter's call. It is important to note that all local rent control ordinances must comply with state law, which mandates among other things, that vacant apartments are prohibited from rent control. We believe that these various ordinances will have limited impact on Essex, primarily because the vast majority of our properties are newer than the rent control cut-off dates, and the various stabilization ordinances or state law, whichever applies.

Finally, in our experience, rent control ordinances generally shift the pricing burden from the renewing renter to the new resident. In other words, while rent control reduces renewal rent increases, it also reduces turnover in all rent control property, which means that fewer apartments are available to rent for people looking for a new apartment, which likely pushes rents upward on the vacant and available apartment inventory. Thus, while renewals will often occur at below-market rates, this impact is partially mitigated by higher rents on new leases, reflecting the unintended secondary effect of rent control.

That concludes my comments. Thank you again for joining the call. I'll now turn the call over to John Burkart.

Thank you, Mike. We had another good quarter, delivering total same-store revenue growth of 6.9%, and NOI growth of 8.2% relative to comparable quarter. As northern California has slowed down due to the factors that Mike mentioned, Seattle has strengthened and Southern California continues to perform. Now I will share some highlights for each region.

The strong demand in Seattle fueled by the surge in employment through the first half of this year, which is above our expectations, enabled the market to absorb the new supply and continue to grow revenues. Our Seattle portfolio grew revenue 7.5% in the second quarter of 2016 relative to the comparable quarter. The sub-markets performed similar to last year, with the CBD growing revenue about 5.4%, and the east side, north, and south sub-markets -- where over 80% of our portfolio is located -- growing revenues between 7.7% and 9% for the second quarter of 2016 relative to the comparable quarter.

In the Bay Area, the market has strengthened from the first quarter. July rents are up about 5% from the beginning of the year; however, due to the tough comps from last year, net effective rents are up only about 0.5% from last year's rents at this time. San Francisco and San Jose continued to absorb the supply at a rate of approximately 19 units per month per lease-up, and 30 units per month per lease-up, respectively, per Axial. Concessions have decreased from six to eight weeks, down to four to six weeks.

The East Bay has been stronger, however. It has the toughest comps for the peak leasing season. Our two lease-ups in the East Bay, The Galloway and Agora, are leasing up as planned with The Galloway absorbing about 30 units per month, and the 49-unit Agora leasing about 15 units per month.

The Bay Area economy continues to be a vibrant economy, benefiting from the ongoing expansion of technology into traditional industries. Numerous corporations have created innovation outposts in the Bay Area, such as General Electric, Wal-Mart, BMW, Nissan, and General Motors. According to a recent study, there were over 50 corporate innovation outposts located in the Bay Area. The next-largest concentration is in London with only 10.

Office absorption was positive in all three Bay Area MSAs, from 321,000 square feet in Oakland MSA to 790,000 square feet in the San Jose MSA. There were numerous leases signed in the Bay Area recently by companies such as FitBit, Lift, Stripes, LifeLock, Tesla, Uber, and Twitch, a video gaming division of Amazon, all combined leasing over 1 million square feet of space in the quarter.

Currently there's approximately 10.8 million square feet of office space under construction in the Bay Area, of which 46% is pre-leased. LeEco, the Chinese electronics maker, just purchased nearly 50 acres of land that belonged to Yahoo near Levi stadium in Santa Clara, California. The acquisition adds 3 million square feet of space for LeEco's operations, which spans smart phones, bicycles, virtual reality headsets, and eventually electric cars, and is enough for about 12,000 workers.

Finally, the city of Santa Clara recently approved related $6.5 billion major project just north of Levi stadium, the largest private development in Silicon Valley history. The project includes 5.7 million square feet of office space, 1.1 million square feet of retail space, 1,360 apartment homes, 700 hotel rooms, and 450,000 square feet of restaurant and entertainment space. Construction is expected to start in late 2017.

The southern California region continues to be a solid performer overall. In the L.A. MSA, the CBD grew revenues 3.8% for the second quarter of 2016 compared to the prior year's quarter, as it continues to absorb new supply. The Woodland Hills and Tri-City sub-markets were the strongest in the L.A. MSA, growing revenues over 7% for the second quarter of 2016 relative to the comparable quarter.

Silicon beach continues to see new investment from technology companies. Google is out-growing its 100,000-square-feet space in Venice, and is expanding to the 319,000 square-foot hanger where Howard Hughes assembled the wooden sea plane called The Spruce Goose. Google purchased the adjacent 12-acres of empty land next to the hanger a couple of years ago.

In the Orange County and North Orange sub-markets -- in Orange County, the North Orange sub-market out-performed South Orange sub-market in the second quarter of 2016, with revenues growing 5.9% and 3.1%, respectively, over the prior year's quarter. Revenue increased 7.4% in San Diego's MSA, with the northern sub-markets out-performing the CBD and southern sub-markets relative to the comparable quarter.

Recently, Google signed a 60,000-square-foot office lease in northern San Diego's tech-heavy Sorrento Mesa area, expanding its southern California footprint into San Diego for the first time.

Currently our portfolio is at 96.2%, and our availability 30 days out is at 5.2%. Our renewals are being sent out in the 5% to 6% range in both northern and southern California, and at a 6% to 8% range in the Pacific Northwest for the third quarter. We are positioned well for the second half of this year, and we look forward to 2017, when we expect the supply to decrease in northern California. Thank you, and I will now turn the call over to Angela Kleiman.

Thanks, John. Today I will comment on our second-quarter results, the state of our balance sheet, and the updated full-year guidance. Once again, our core FFO per share for the quarter exceeded the mid-point of guidance by $0.08, although $0.04 of the out-performance primarily related to property tax refunds and timing of expenses. The remaining $0.04 was driven by stronger-than-anticipated operations, capital, and investment decisions, which benefited the bottom line.

In addition, our total FFO for the quarter was actually higher than core FFO per share by $0.07. This was primarily attributed to successful insurance recoveries for lost rents, due to the MB360 fire, which occurred prior to the BRE merger.

As for our balance sheet, during the quarter we issued $450 million of 10-year unsecured bonds at a coupon of 3-3/8%, and retired our Series-H preferred stock. Our only remaining debt maturity this year is a $200 million term loan due in November, which we plan to re-finance with a new five-year, unsecured term loan, and we expect to obtain a more attractive pricing than the current 2.4%. So far this year, we have funded our development equity needs with disposition proceeds, and have not issued any common equity.

Currently, our debt-to-EBITDA ratio is inside of our target range, and we are comfortable with this ratio resting in the high fives, as this range has proven to have successfully weathered the great recession. With our $1 billion revolver undrawn, a strong balance sheet, and numerous sources of equity and debt capital, we continue to be well-positioned for future growth.

Turning to our revised guidance for the full year, as Mike commented, even though northern California is facing head winds this year, we still expect the region to perform well relative to the nation, and produced over 7% same-property revenue growth. However, the lumpiness of supply deliveries in northern California, coupled with lower job growth in the region, will impact our full-year same-store rent growth. Therefore we have tightened our range and lowered the mid-point.

Our expense growth assumptions remain unchanged at 3.8%. The resulting expected NOI growth is now 8.1% at the mid-point, which remains within the guidance range provided at the beginning of 2016.

From an FFO perspective, the projected reduction to same property growth rate is approximately $0.05 per share to the full-year core FFO; but due to favorable year-to-date results which have exceeded our original forecast and accretive capital markets and investment transactions completed so far, we are able to raise our full-year core FFO mid-point by $0.06 per share to $10.98.

For 2016, we are projecting core FFO growth of 12%, which represents our sixth consecutive year of double-digit growth. Thank you, and I will now turn the call back to the operator for questions.

Thank you.

(Operator Instructions)

Our first question comes from the line of Jordan Sadler with KeyBanc.

Hi, good morning, guys. It's Austin Wurschmidt here with Jordan. I was just curious if your guidance in northern California assumes steady-state rent growth, or what you've achieved in 2Q or July in the back half of the year? Would you expect there to be a re-acceleration, since we've surpassed peak supply now, and it sounds like concessions are abating a bit?

Yes, this is John Burkart. We're not necessarily expecting acceleration up in rents, but we are expecting to have a better fourth quarter than last year. Our guidance assumes that the rents don't fall off as much as they do normally seasonally, that we maintain rents a little bit better than we have in the past, that we take advantage of increasing occupancy a little bit, and that we continue to achieve our -- what we've been achieving on our renewals around 5% to 6%.

Thanks, that's helpful. Switching over to Seattle, you mentioned increased supply in Seattle in 2017. Is there any concern that Seattle could see some similar head winds that's been seen in northern California next year?

Hi, Austin, it's Mike. It's interesting, when we talk about how unusual this has played out this year, it almost means that we have to determine whether it's a one-time occurrence, or if this is part of trends going either direction, both in northern California and Seattle. The answer to that is it's I think unknowable. It becomes one of the things that we're very focused on trying to figure out.

I think the expectation would be -- well, let's go back to where we started the year. We started the year with the expectation that Seattle would have continued good job growth, and because of the supply, there would be pressure on rents. I think we started the year with a rent growth expectation of around 4.9%. What happened is we got the supply, but we dramatically exceeded the job growth, as noted in my comments.

I suspect that some of those conditions will even out. Again, I've been here for 30 years, just had my 30th anniversary here at Essex, and I've never seen this divergence. I would say two things. One, we don't know. Two, we suspect that we will see a more normal balance, more consistent with 29 of the 30 years I've been here. Number three, we're going to be studying it to try and determine what we think the longer-term trends might be. Does that make sense? The answer is we don't know.

Yes. No, that's helpful. Not to jump around here, but last quarter you talked a little bit about a disconnect between the supply and the demand. Has that started to correct a bit here into the second quarter and early third quarter?

I'm not sure exactly what we're talking about, but I think that we are seeing -- but we saw the concentration of supply. Are you talking northern California? Let me just try to be clear.

Yes.

Northern California, part of the issue was that 70% of the supply in San Jose and San Francisco hit in Q2 and Q3. We've had some slow-down in jobs. Again, I suspect that will work itself out. The supply picture is declining, fortunately, next year. I think we start seeing a little bit better pricing environment beginning in the fourth quarter of this year.

Great, thanks for the detail.

Thank you.

Next question comes from the line of Gaurav Mehta with Cantor Fitzgerald.

Yes, thanks. A couple of questions on investments. I think you talked about cap rates for As and Bs, but I was wondering if you would comment on any changes that you have seen in cap rates in northern California, given a slow-down there?

Yes, this is Mike. We have not seen changes in cap rates, and I think you've got -- as I tried to comment in my prepared remarks, you have two forces. I think on the one hand, you have lower growth rates. Although, to put that in perspective, the growth rates that we saw over the last four or five years are extraordinary in northern California. I don't think that most of the private investors that were buying property in northern California had the expectation of the rent growth they got over the last several years. I think the growth that we got over the last several years was an anomaly, not a normal thing. I don't think again that most buyers have that expectation.

Having said that, as it relates to the longer-term picture, the private markets tend to be long-term oriented in terms of making these investments. I think they still see northern California as one of the strongest long-term CAGRs of rent-growth generators that there is in the United States. They know that, and they play a long-term game. I don't think that the attractiveness in the investment markets of property in northern California has changed very much.

Then finally, the third factor is you have debt costs that are lower now. The amount of positive leverage you have on apartment properties is pretty extraordinary. We're 26% levered. A lot of investors out there are 60% or 70% levered, and obviously that makes a huge difference.

I don't see anything in the near term where you can buy a property that yields somewhere around 4.5%, finance it with a lot of positive leverage with some growth over time. I think in this environment that looks like a winner, more broadly. I wouldn't expect cap rates or valuations to change very significantly at all.

Okay, and as a follow-up on the preferred equity transaction side, are you seeing more product? What's your appetite to grow that platform?

Yes, we are seeing more, because of some of the conditions that we talked about earlier. The increase in construction cost and lenders cutting back loan-to-cost ratios on construction loans have both have the effect of property owners or developers need more equity. This is a targeted program on property that we would like -- that we could own, that's consistent with our portfolio; but it's a unique opportunity in the market place.

In terms of our appetite for it, I would say that it probably is in the $300 million to $400 million range total outstanding, probably not more than that. Again, it's limited because we're not going to deviate outside of our markets, and we're going to continue to look at property that we could own if things don't end well.

Okay, thank you.

Thank you.

The next questions come from the line of [Brian Melakor] with Canaccord Genuity.

Hi, thanks for taking my question. I wanted to talk about a little bit of a big-picture topic. It's one that we probably haven't talked about too much over the past year or so -- that's Airbnb. I'm wondering if you guys have given any thought to the new regulation in San Francisco and Anaheim. It sounds like things are in the works in Seattle, and whether that's going to have any impact on overall market fundamentals, if there's a lot of long-term -- a lot of short-term rentals now entering the long-term rental pool. Do you think that's been a tail wind for you guys over the past couple of years? Are you -- do you have any expectation for it to be a head wind as some of these regulations take shape over the next 12 to 18 months?

Yes, this is Mike. It remains to be seen. Obviously, any product that enters the market for rental is incrementally -- puts more pressure on the market, and provides more availability or more supply. That is a given. It's hard to extract or to focus on that component and determine what impact it is having, other than that general statement that I just made.

We continue to study Airbnb, and we have some experience in the area as a pilot program type of thing. I think that there's so much noise and so many issues as it relates to an apartment community, where if you have people showing up with their roller boards day in and day out, it's generally not a good thing.

We continue to evaluate Airbnb. We realize that again, as you point out, long term more rental is going -- has a pricing impact ultimately on the market place, but I think it's fairly minimal. It's going to be something that we're going to continue to evaluate. Over the next several years we'll make some decisions about to what extent we want to participate in that area.

That's helpful. I guess I'm coming at it from the perspective of there's some reports that there are over 12% of Seattle stock has been pulled out of long-term rentals in favor of using Airbnb for short-term rentals. People are running businesses renting out apartments instead of long-term competing with you, short-term competing with hotels. In San Francisco, we've heard something like 9,500 apartments that don't have registrations.

With all the regulation, have you guys looked into trying to figure out what the number, the amount of supply that really would be competitive with you guys is out there that's working in the short-term rentals, or is that something you haven't focused on yet?

It falls within the area of -- in a supply/demand analysis, there's always going to be factors you have trouble quantifying, and you're going to make some broader assumptions surrounding. As you point out, I agree with you on Airbnb to the extent you have more apartment units that are pulled out for a hoteling type of use. Obviously that helps us. The flip in San Francisco, for example, where you're going to start regulating them and they're going to flip back the other way, it's going to hurt you. We have not tried to do that.

Again, I think there are other factors that are similar to that, to the extent people are doubling up, to the extent that employers are allowing people to work from home X days a week so that they can commute longer distances, and/or connect by telecommunication devices, et cetera, and not come into the office at all.

There's a whole cadre of things that we try to capture in our relationship between job growth and demand, or households. To the extent that Airbnb or any other factors might enter into the equation, we would alter our -- it's generally two to one relationship, so two jobs equal one household. That one household covers both the for-sale and the rental stock. We would start changing that ratio if we thought that any one of these factors became more significant.

But it sounds like that's not something that you guys have looked into making any changes to yet?

No, that's not the right answer. In fact, right now we're -- as I mentioned on the last call that based on the job growth in various sub-markets, we could not explain why X amount of job growth -- well, let's take L.A. for example. 176,000 jobs, given what I just said, should give us somewhere around 85,000 households, and they're producing 32,000 units of total supply, so there should not be an issue there.

Having said that, that's at a two to one ratio. Our tendency is actually starting to push the two to one up to a higher ratio, and actually doing that in connection with affordability, as well, because people make different decisions based on relative affordability of apartments within a market place. It's all part of a discussion, but it's a larger discussion than Airbnb, is my point.

No that's fair, that's helpful. That's it for me. Thanks a lot.

Thank you.

Our next questions come from Nick Joseph with Citigroup.

Thanks. Sticking with affordability, can you talk about how rent to income metrics, or any other ways that you measure affordability have changed over the last year?

Yes, Nick. They are increasing, and have increased. This is Mike Schall again. Again, going back to northern California last year, for example, where we had an incredible surge in rents, it pushed the affordability in San Francisco to about where we -- it's well over the long-term high. We have that at almost 29%, and the long-term average is 26.5%, and the high is 33.1%. We're starting to push beyond that range that people can afford.

Our view is that affordability basically is a constrain. It doesn't mean that if it's super cheap that's good. Having a very low ratio of community -- you just have too much housing in the market place, and that's obviously not a good thing, either. There are a couple markets in San Francisco and the Bay Area that are pushing that ratio to a level that we haven't seen in a couple decades, so that is an area of concern.

Having said that, with rents moderating this year, and personal incomes increasing, it helps take pressure off of that ratio. Again, my view is that last year we got -- let's say two years of rent growth in northern California, and there's a little bit of a breather. Part of that is caused by affordability, and part of that is pushing renters into the other markets, the East Bay for example, which is where we're getting the best rent growth this year. It's part of the equation that we consider, again when we start pushing up into the mid 20%s. When people are paying 25%, let's say, or higher of the median income in rent, or in their rent, then it starts becoming an issue.

When was that 33.1%, what year was that?

That was in -- I don't have the year, was it 2000? It was the dot com. But again, it's interesting, because I've heard the comment made that southern California -- actually there's an Axio chart that has this, but southern California CAGRs of rent growth is the same as northern California over the last 15 years. But it misses the fact that rents in northern California went up 40% in two years to establish this 33% ratio that I just referenced. The 15-year period misses that. It picks up the decline of rents over that period, but before that in two years rents went up about 40% in northern California. Again, these things have to all be considered. These are just facts, and they have to be explained in context in order to be meaningful.

Thanks. Quickly on the transaction market, have you seen any changes in the buyer pool, either in terms of the number of bidders, or the composition of those bidders?

We have. In general there are a few bidders, but there are certainly plenty of bids out there, and it's still an active market place. Again, I would characterize it as going from a market place where you have many bidders, several rounds of best and finals, et cetera, to a market place that has fewer bidders, still pretty aggressive, still looking for product. Still see a number of the institutions involved in transactions. Some have talked about foreign buyers and investors being active in the market place. I think the REITs have generally taken a step back here.

Thanks.

Thank you.

Our next question comes from the line of John Kim with BMO.

Thank you. I just wanted to follow up on your commentary on Seattle, Mike. This period you took up your market rent forecast by 240 basis points, but it sounds like you're a little bit cautious on the potential impact of supply, in an answer to a prior question. Is this because this is very sensitive to employment growth? Can you also talk about the rent income ratio in Seattle versus San Francisco?

Sure. Maybe John or someone can help me out with this question. In general, going back to the beginning of the year, we had Seattle as our weakest market. It wasn't because we thought there was some implosion in tech, or even a problem in tech. It was just simply -- if you just look at the ratio of supply and demand, it looked like it was more exposed than either northern California or southern California. That's what caused that. Again, we do this based on experience, history, and judgment, and sometimes we're wrong. Certainly that's the case in Seattle at this point in time.

As to going forward, are we going to continue at 3.5% job growth in Seattle, which will take care of whatever supply the market can produce? I would guess that it's going to continue to be better than we think, but I don't know if we can sustain 3.5%. I still rank our markets in terms of desirability as northern, southern California --obviously those big geography -- but northern and southern California as being more desirable than Seattle, because we've seen supply really get out of whack in Seattle in prior cycles. That's how we would judge it.

California has all these various other elements where they're trying to convert from a suburban-type housing profile to more of an urban high-rise residential around transit. That's going to be a long-term difficult thing to do. I think it will have the overall impact of muting supply deliveries. I guess that's why we give California the urban core and coastal California markets a little bit of a positive relative to Seattle.

As it relates to the rent to median income, Seattle's current ratio is around 20%. The long-term average is around 18%. This is a good example of the long-term average not being all that meaningful. You might say yes, there's plenty of room for rents to grow there, because it's only 18%.

The problem is it's 18% because there's too much affordable housing in the market place. The lower that ratio gets, the less pricing power you generally have in the market place. It's why I say that rent to income acts mainly as a constraint, not as sort of a driving force. There's plenty of room for price. Seattle has very high median household income levels, in the $80,000 to $90,000 range. The rents are pretty attractively priced. I don't see that as a constraint.

Okay, thanks for that. Sticking to Seattle, it's not part of your development pipeline, so is your preferred method to increase any exposure if you'd like to, through the preferred equity investment, and through selective acquisition?

Yes, I think we would look to trade assets in Seattle. Actually, we're looking at the same strategy up and down the coast -- not necessarily, for example, trading out of northern California and into southern California, which we have done in the past. We don't think we're at the point at that point in time. Again, the thing that makes us more cautious in Seattle in the long term is its ability to produce a lot of housing. It's going to probably remain our third choice, looking at things very big picture relative to the three marketing, northern and southern California, and Seattle.

Great, thank you.

Our next question comes from the line of Tom Lesnick with Capital One.

Hi, thanks, and appreciate you taking my questions. First, it looks like a lot of the supply is concentrated in San Francisco proper and San Jose. What are the necessary conditions for that over-supply issue to begin to spread outside of San Jose and San Francisco in the Bay Area, and what is the most likely scenario for further slowing in quality shops?

Yes, this is Mike again. John Eudy, who heads development and is Chief Investment Officer, along with Craig Zimmerman, can maybe comment on this, as well. I think it's just rents and cost to build. You need really high rents in order to pencil a development deal. Where do you find those really high rents? You find them in San Francisco proper and on the peninsula and in San Jose, and to some extent in various parts of L.A., which again, it has more supply than it's had over the last several years. That's what moderates construction outside of the core area is the rents aren't quite as high, and construction costs are pretty darn similar.

The issue that this brings up is how deep is the A tranche of the rental market, because now we've had several years of delivering As into that top tier, how deep is that, how long can you continue to get those, achieve those rents, before you're really dipping down into the B part of the renter pool, and you're making some of that top level of the Bs, you're pushing them into the A product, which is I think part of the problem here.

Again, we're watching that. I think there's a certain level at which what California needs is more affordable housing. The current solutions to this situation are to produce more very high end luxury housing, so there's an obvious disconnect that needs to play out. Do you have any comment to that one, Mr. Eudy?

The only other added would be the exactions that cities are getting now on the entitlement side add to the burden of the cost. Then with construction lenders pulling back as Mike mentioned earlier, you add all that up, and that speaks to why we're seeing muted supplies next year and the following compared to what we've seen this year and the prior. There's a lot of pressure to try to put deals together, but at the end of the day, the 4.5 cap development transactions, a lot of them aren't going to come to fruition that may be being bantered about, but have to be executed on. We'll see.

Appreciate that. Then my second question having to do with the income mix. You guys are clearly doing demand forecasts, but for those incremental jobs, what is the income mix of those jobs, and if so, how has that shifted over the last few quarters, and how does that affect your future outlook?

Yes, hi, it's Mike. We don't have perfect information there. I think the comment we would make is that there's some indication that the quality of jobs in northern California has deteriorated somewhat. In other words, we have a ranking of all the different industries, and what the average wages are within the industries. There's more, for example in northern California, more leisure hospitality jobs than there have been typically technology jobs.

Again, in the short-term lots of things can happen. Actually the flip is also true in Seattle. But in the short term lots of things can happen. If I've learned anything in this business, it's don't take a couple of bullet points or data points and start creating a trend line, because you're going to often be wrong.

I realize that human beings and making decisions have a number of biases. We try to work through those biases as thoughtful as we can. I would hate to take some very short-term information and try to extrapolate what it means. That's all we have at this point in time. I don't think that any of it is conclusive. I can say we're looking at it and trying to see if we can determine what the longer term implications of this divergence that I talked about in my open remarks, which includes what you're talking about now. We just don't know at this point.

I appreciate the insight. That's all I've got.

Thanks.

Our next questions come from the line of Alexander Goldfarb with Sandler O'Neill.

Hi, good morning out there.

Good morning.

Hi, how are you John, Mike? A few questions here for you. First, Mike, going back to Seattle, historically the Seattle, San Francisco linked as far as health of tech, but it sounds like those trends may have disconnected a bit? Is your view the markets have disconnected, or again to your earlier point about don't take a data point and make a trend, or is it just there's a little bit of nuance here and there for the markets are still linked over time to tech, but right now there's just a little bit of de-coupling.

Well again, I get to celebrate my 30th year here, and Mr. Eudy has been here for 30 years, too. He's been an amazing partner, and Mr. Burkart for 20 years. We've seen this one time in 30 years. Now we're going to pay attention to this one divergence and ignore the last 30 years? That's essentially the dilemma we're talking about.

Tech is tech. Businesses are going to make decisions, people are going to make decisions based on the opportunity before them. They're going to live where they can afford to live in a good place, high quality of life, et cetera. Wherever that opportunity presents itself, they will find it. People are smart. They're smart when it comes to making rental decisions. They're smart when it comes to making career decisions, for the most part. I wouldn't see any divergence at all

I think that the market is fluid and things change. I think that you could have some tech companies opening more office space based on where their people want to work. That's a possibility. Having said that, as John said, there's millions of square feet being of commercial space being delivered here, and you have these tech giants which have enormous amounts of cash and enormous financial capabilities that are building, that are investing in these office buildings. Every part of the Silicon Valley, I think, has been essentially re-made in a number of different ways.

I'll give you another stat that hasn't come up on these calls before, but there are at least 50 non-tech companies that have innovation centers here. Actually, John may have mentioned this in his remarks. But non-tech companies with innovation centers here, because technology is so integrated in everything we do. Alex, my belief is that this is an anomaly, not a trend, and as a result of that, things will go back to a more normal balance between the two markets.

Okay, and then going to southern Cal, where like L.A. you've had a lot of permits. I think the fourth-biggest metro for permits. Given what we've seen of the over-building at the high end in San Francisco and New York, where that's all that penciled, is your view that the supply coming on line in L.A. again is all high end? Do you think it's going to be an impact as those permits are put into the ground, or because of either where it's located or just the size of the market, that supply will be absorbed in a normal fashion?

Alex, this is John. Number one, you're right on LA as far as the total number of permits, but it's a huge market. We always look at it in the sense of percentages, and then that changes the perspective. Where the supply is located in those pockets, it's very competitive. There's no question about that. The downtown location and other, Playa Vista. It's sub-market by sub-market.

The supply, you asked what is it in the sense of A/B. Pretty much anything getting delivered these days is A quality, so the competition is high. If you're an A-quality building across the street from a lease-up it's very high. To the degree that you're a B and a sub-market away, it's not so much. As we said, Woodland Hills performed well, CBD a little bit lesser. Does that answer your question?

John, but do you as this stuff comes on line, are we going to see in 2017, are we going to be hearing about horror stories about two months free all over L.A. impacting apartments, or it's just not big enough to really impact the way we're seeing it impact San Francisco and San Jose?

I don't expect a horror story. I don't expect that, Alex. I think that was a combination of a little bit less job growth and the supply hitting in the fourth quarter. NorCal and Seattle tend to be more seasonal. SoCal's is less seasonal. Southern California, I don't expect to see horror stories in the fourth quarter.

Perfect. Okay, listen, thank you.

Our next questions come from the line of Karin Ford with MUFJ.

Hi, good morning. There was an article in the Wall Street Journal talking about Facebook building 1,500 new units for the general public on its land on Menlo Park. I know it's coming along with 6,500 new jobs from them, but tech companies obviously have a low cost to capital, incentives to accept lower returns. Do you see this as a potential source of new supply in the Bay Area?

Well, obviously, it's absolutely new supply. But in the sense if you mean competition with technology companies building multi-family, I don't expect that. In the articles that I read, I think what was -- what they were trying to achieve was get approvals for their development. There's been a lot of stress, of course in rents, so they were trying to build a more balanced development, where they had some housing as well as the jobs-related construction for the office space. I don't think they're going to be in the business of building multi-family.

Are you hearing of any other tech companies looking to do something similar?

I haven't, no.

Okay, thanks. My second question is just for Mike. Just going back to the cap rate question, in your experience how severe and how prolonged would the growth slow-down need to be before we should expect to see a change in cap rates?

It's a good question, Karin. I'm not sure I have an easy answer. Cap rates tend to be pretty sticky, because the first thing that happens is buyers and sellers do not agree on what the price is. Sellers remember the last 10 transactions, and buyers think the world has changed, and so they demand something different. That can go on for some period of time, and you would see it in the transaction volumes of the deals that close.

Normally, the things that motivate transactions are financial distress and those types of things, which in a world of positive leverage, we don't really see that happening, and really great economics as well. I would say that you would have to see maybe I'd say a year before you really saw a real directional change in cap rates. Again, I think you're going to end up with a dearth of transactions in the mean time. Maybe the dearth of transactions will be the indicator that maybe something is changing, but you won't actually see a change for some period of time.

Thanks for the color.

Thank you.

Your next questions come from the line of Wes Golladay with RBC.

Hello, everyone. Looking at the concession comment, you said they were down. Curious if it's starting to spread though to other sub-markets, getting outside the core?

No, the concessions really started -- they're standard, of course, with development lease-ups. You're typically -- commonly it's four weeks. What happened is concessions moved up, people got a little bit more aggressive when the demand was in the slow season, so it moved up to six to eight weeks, and now it's moved down. But other than assets that are head-on competition, a brand new asset next to a lease-up, there's not a lot of concessions in the market. We do not see it spreading outside of those very competitive zones where the lease-ups are.

Okay, and do you have a loss to lease for the portfolio, and maybe northern California?

Sure. Loss to lease for the portfolio overall is about 5%, and for northern California right now it's about 5.2%.

Okay, thanks a lot, and congrats Mike, on 30 years.

Thanks, Wes, appreciate it.

Our next questions come from Rich Anderson with Mizuho Securities.

Thanks, still good morning out there, I guess. Angela, maybe you did this and I missed it, but can you break out that $0.11 that offsets the down-draft that allowed you to raise guidance this quarter? Are there factors outside of same store?

Sure, happy to. We beat by $0.08 last quarter and by $0.08 this quarter, so that gets you to the $0.16, right? We raised by $0.06 for the year. The remaining $0.10 is really the break-out. $0.05 of that $0.10 is timing related. These are G&A items and other items that we'll spend in the second half of the year, and $0.05 were really more of the -- I'm sorry, by the way, I'm only talking same store, just so we're clear. The other $0.05 were the really more of the one-time spend.

Okay, maybe we can talk about that off line.

The $0.05 was the lower same-store growth, so that's the other $0.05 hit.

Yes, okay. Maybe I'll talk to you off line. Let's imagine for a moment like you said that we go to a more normalized balance between Seattle and San Francisco in the future. I guess it's a question for Mike or whomever. How does that not mean there will be a meaningful deceleration next year if that does in fact happen, since Seattle has basically come to the rescue so far this year?

Rich, this is Mike. I don't know. It's interesting. If I would have said to you that we got 5% rent growth in northern California this year and 12% last year, that's 17%. Let's say it happened at 8.5% and 8.5%. I think we all would have been really happy with that, because we can't sustain the amount of growth that we've had. Again, I think that we've missed how incredibly great northern California has done. We've assumed, maybe partially because it's done so great, that it has to do very poorly in the future.

I don't follow that logic. I don't think that's right. I think that we can end up with a more normal growth rate in northern California and this business works just fine. I'd be the first to tell you that getting 12% rent growth in a year, as we did in 2015, it's great while it's happening, but it has a secondary effect. We're seeing part of that secondary effect this year. Again, it stretches affordability. It has implications beyond that one year.

I don't think that the fact that you're seeing a slow-down this year -- again, relative to what happened last year, the extraordinary year we had last year -- as being somehow indicative of what's going to happen next year. I just don't see it.

All right, so you're saying that the closing of that gap is a decline in Seattle and a similar level of improvement in the Bay Area. Is that what you're saying?

Well, let's just say that the Bay Area goes to be a more normal market, as opposed to an extraordinary market that it's been for the last several years. Again, these businesses -- our business was not founded upon 6% annual rent growth for long periods of time, because income levels have to have some relationship to rent levels in order for people to afford it. There are constraints within this industry or within the housing market that will constrain you, ultimately.

Again, it doesn't mean that we're going to go from being a great market to a lousy market. I think that maybe investors are focused on the great recession, which I think was an extraordinary period of time, or the internet boom/bust period, where often neglect the fact that rents went up 40% in two years and then went all the way back down in the ensuing three years. Nonetheless, those things I think are dominant in people's memories, but I think that the normal cycles would not be nearly that extreme.

Again, I think northern California goes back to being a more normal market. What does that mean? It means let's say 3% to 4% revenue growth. Let's say we're going to add some value in renovation, and maybe can add some value in transactions, and the business runs well at that, with that.

Okay. Then how are you able to -- or maybe you're not -- but you had this lumpiness effect to your supply in the Bay Area this year. Is there a way to judge that for next year and have a relative level of confidence that won't be the case again, or is that a wild card as well?

Well, in the sense of -- this is John. In the sense of what buildings are out there, it's pretty easy to judge. Our people drive all the sites, and they know what's out there. The thing that moves around a little bit relates to construction timing. What we expect to happen doesn't necessarily happen. Things tend to be slowed down a little bit, and they get pushed into a future period. To the extent that things get slowed down and they get pushed into a future period, it's to the benefit of the current period, right? That's a little bit what happened last year.

It's not perfect, but I don't want to give the impression that we can't know the buildings. We know the buildings very well. We literally drive the buildings and have detailed spreadsheets outlining each building and what's going on. It's just as far as seeing those, and when they start to lease up and get occupied that moves around a little bit. It frankly always moves out; it never really surprises us in the sense of being sooner.

Right, so no one is asking you for a perfect crystal ball, but based on what you're seeing right now, you think that lumpiness effect that happened this year -- who knows for sure, but feels like it may be a little bit more of a typical pattern next year?

Currently it does, yes. I think it's really difficult.

Actually, it's interesting, in our economics department we have it broken down by quarter, but they said please don't give that out on the phone call, because it's not only timing of construction, but phasing and absorption rates and all those things get into the equation, as well. It's really challenging to get this exactly right.

Come on, 30 years, you can't figure this out by now? (laughter)

Way to rub it in. Thanks, Rich. I'll leave it to you.

Thanks.

Thank you, our next question comes from the line of Conor Wagner with Green Street Advisors.

Good afternoon.

Hello.

Howdy. Angela, you mentioned your revised guidance from northern California a little over 7%. Could you give us revised full-year guidance for your three regions, please?

Sure, so northern California is somewhere around 7%, a little over 7%, but I'll just talk about the mid-point. Southern California up slightly at the mid-point, around 5.9%. Then Seattle's up from the original mid-point by about 120 basis points, so closer to around the 7.7% range. That gets you to the math.

Yes. Okay, great, that makes sense. Then for northern California, the slow-down you guys see in the second half moving more towards low 6% in the second half. It sounds like based on your view of supply that you wouldn't expect a large drop-off in 2017 in northern California. If you're trending towards low 6% revenue growth for the second half of the year, you don't expect a similar level of decline throughout 2017 that you saw this year, is that a fair assessment?

Well, the -- you're right about northern California. The second half, to get to the mid-point is around that mid-6%, about 6.5%. But it's difficult to just interpolate that to 2017. We do know that supply is going to be lower, but we still have to look at what our job growth expectations are, and we're still evaluating that.

Okay, and then into 2017, maybe Mike or John on that, what's your forecast for Oakland? Do you see that if rent growth in San Francisco is taking it the hardest this year, do you expect there to be a greater impact on East Bay rents or rents that are pricing off of San Francisco?

Conor, it's Mike. No, we still see muted deliveries into Oakland. Again, we don't want to go into the 2017 guidance too far. Supply numbers are fine. Barb wears pointy shoes on days like today, and she will kick us if we start giving out too much detail.

But we're all on the call, we're all here.

Put her on the call? (laughter)

She knows we're all here. This is open, everyone's hearing it.

Yes, Conor, if you want to ask her a question, it's fine. No, but actually, it's about the same supply, which is very muted, 1,600 units roughly in 2017.

Just with San Francisco slowing down, I'm thinking more of the -- for people who are looking -- going to the East Bay for a discount, does the slow-down in San Francisco in this year, does that then start to show up more in Oakland next year?

It's all relative, obviously. Well, the one issue we have here throughout California is lack of transit, which I think you know a little bit about, and traffic-snarled traffic. People in general don't want to commute unless you're right against a BART line. That's why Mr. Eudy has a couple development deals that are actually near public transit to do it.

Basically, I think there will be maybe some movement because of relationships. I think what's happening is again, you're producing more in the A category and pulling some B, the top echelon of the Bs into the As. With concessions, they're at a net effective that's too close to what some of the Bs are.

I think the movement probably is more the other way. You're pulling people out of the Oakland MSA and into the city, because the net effectives aren't that different, is I think what's happening. But there's not enough supply. To answer your question, there's not enough supply in the East Bay to really make a difference.

Okay, great, thank you. Then last one, what was the decision to delay the phase 3 and 4 on the development in San Mateo?

This is John Eudy. It's not so much a delay. We should have broken it out into the two-phase building one and two and three and four, originally, to be honest with you; because they're not going to be all delivered at exactly the same time.

Okay, but yes, just the initial occupancy got pushed back, as well, but that's not related to the break-up?

Well, we had the site work that we did on the site improvements. It's a squishy soil, for lack of a better word. We had to firm up -- took a quarter longer than we had anticipated, and it drug things out. That's the majority of the reason for the slow-up on the initial occupancy.

When we talk about construction cost increases, we're not immune to that, obviously, because the costs were also increased. We chose to just do the front half, bid out the front half of the building, as well. It's a variety of things, but as John said, typically when we have multi-phase projects we do break them out right up front. In this case, we lumped them all together.

And in this case it's four separate legal parcel buildings surrounding a park, so they're individual buildings, if you will.

Great. Thank you very much.

Our next questions come from the line of Richard Hill with Morgan Stanley.

Hi, good afternoon, everyone. Just a quick question. Obviously a tremendous amount of focus on San Francisco. I think you touched upon this a little bit earlier, but I'd like to get a little bit more color and clarity on what you're seeing in San Francisco between Class A and Class B. It's really all the weakness that you're seeing in the Class A space, and are you seeing more strength in the Class B? How's that working out? Any color you could give would be great.

Sure, this is John. There's no doubt that the Class A is highly competitive because of the new developments that are out there. As far as Essex's portfolio and what we break out, we don't have very many assets in that area, so we have Fox Plaza and Park West, and both of those are older assets. There's renovations going on at those assets, and that impacts their performance. They're impacted a little bit, but not at all to the same level as the A product that's out there that's going head to head with the other product that's coming on. Most of the B product is impacted to some extent, but not at all to the same degree.

Okay, that's helpful, thank you.

The next questions come from the line of Tayo Okusanya with Jefferies.

(no audio, technical difficulty) my questions have been answered, but a quick one I had, just in regards to July trends, and especially in areas where there's still concern about new supply. Could you just talk a little bit about what you're seeing, whether it feels like there's some type of stabilization, or whether there's a lot of competition and concessions going on?

July is rolling through just like June. June was an up-tick from May. The market's not -- I wouldn't describe it as being on fire, but when you say are there more, it sounds like you're looking for a tick down. More concessions going on, we're not seeing that. Usually July, though, is the peak leasing season, so you wouldn't really expect to see that, either.

Thank you.

Thank you.

We will take our last question from the line of Dennis McGill with Zelman & Associates.

Hi, thank you for squeezing it in. Just a bigger picture one for you, Mike. When you talk -- the industry in general I think is looking at the lending environment and seeing tighter lending criteria, and assuming that's going to be a governor on supply. But at the same time, I think as you alluded to, cap rates haven't moved and valuations haven't moved. Has there been times in the past where those two things can disconnect, where lenders are pricing in more risk but investors are not?

Dennis, and welcome to the call, that would be something that I don't think I've seen in 30 years, as well. The lenders at the -- let's say we're not -- say we're in the second half of the cycle somewhere, and the lenders at some point tend to get more aggressive. John and I have seen loan to cost -- or actually loan to values on construction loans get to 75%, and now we're somewhere in the 55% to 60% loan to cost.

I don't think we've ever seen really this amount of discipline by the lenders ever. I think it's an extraordinary time, in that I think the banks have been -- it's probably a bad word, but somewhat neutered in terms of what they're able to do, probably for fear of too big to fail, and a variety of other political issues.

The regulatory hangover from the last drop-down left a lot of baggage where they're being watched extremely closely, and I think they're over-reacting a little bit because they have to, and that's what's causing it. It's not a conscience disconnect. It's a disciplinary disconnect from regulatory folks looking over their shoulder. That's what I think.

Yes, agree. That help, Dennis?

Yes, it does. Appreciate it, thank you.

Okay, thank you. Well, this concludes today's question-and-answer session. I'd like to turn the floor back over to Michael Schall for closing.

Okay, great. Thanks, operator. Thank you once again. Very much appreciate your participation on the call. I have to say that I am incredibly grateful to be able to lead such an amazing Company over the last several years, and really over a 30-year career it's been quite an experience. With that said, we wish you all a safe and relaxing end to your summer of 2016. We always look forward to continuing the discussion next quarter. Thank you and good day.

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.