Essex Property Trust Inc (ESS) 2016 Q3 法說會逐字稿

Good day and welcome to the Essex Property Trust third-quarter 2016 earnings call. As a reminder, today's conference 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 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 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 for joining us today and welcome to our third-quarter earnings conference call. John Burkart, Angela Kleiman and I will make brief comments, followed by Q&A. I will discuss the following three topics, the third-quarter results and current conditions, our 2017 preliminary market forecast, and an update on investment markets.

First topic, we are pleased with the Company's performance during the quarter in which we reacted opportunistically to rapidly changing conditions. As a result, we exceeded our core FFO per share guidance for the quarter by $0.05. I think the E team for their great efforts and results. Similar to the second quarter, Q3 was challenging from operations perspective against a very tough comp in 2015. Job growth remains strong relative to the US, especially in Seattle, where September month-over-month job growth increased from the prior year to 3.5% in 2016 versus 3.2% in September 2015.

Northern California continues to significantly outperformed the US in job growth, although it has decelerated. For example, and San Francisco, September 2016 job growth was reported at 2.6%, significantly below 5.1% reported for September 2015. Southern California job growth was significantly better than the nation in Orange County and San Diego and slightly behind in Los Angeles and Ventura. Overall, against a backdrop of decelerating US job growth, the West Coast economies continue to outperform.

Rent growth continue to be muted in northern California, which we attribute to the large concessions being offered by lease-up communities. Job quality, ranked by annual salary levels for each industry, was another issue in northern California, as there were more service jobs and fewer tech jobs being produced. In San Jose, for example, approximately 10% of the jobs created year to date were in the highest paying information and manufacturing industries as compared to about 32% in 2015. Less significant deterioration and job quality occurred and San Francisco and Seattle.

It's not surprising that more service jobs are being created, given the wealth effect related to the financial success of so many tech companies and their highly compensated workforce. Our venture capital contacts tell us that there is considerable movement of personnel within the technology industries as the next wave of new products, services and companies emerge. Recent loss of pricing power in Northern California and a few other sub-markets could indicate that we've achieved equilibrium between housing supply and demand. We don't believe that this is correct and we use historical data from San Francisco and San Jose metros to demonstrate.

For the period 2011 to 2016, San Francisco and San Jose have produced about 440,000 jobs. Assuming two jobs equals one household, that would equate to demand for about 220,000 homes. The actual total housing units built over that period was about 65,500, or less than a third of the expected demand that would ordinarily result from 440,000 jobs. We experience exceptional pricing power and San Francisco and San Jose from 2011 to 2015 and the delivery of about 10,000 apartments in 2016, which are included in the 65,500 previously noted, has done little, we believe, to eliminate the pent-up demand from prior years, which leaves us with the question of why such a large concessions are required if there's so much pent-up demand.

We believe that the answer to that question relates to the concentrations of supply, the fundamentally different financial objectives of an apartment lease-up versus the stabilize community, and affordability factors. Apartment developers, in an effort to minimize overall free rent over the lease-up period, typically set absorption targets of 25 to 35 leases per month. In some markets, as many of five lease-ups are directly competing for this lease volume. That means that over 100 leases per month are needed in that sub-markets to achieve leasing velocity targets.

Recent job growth does not to generate sufficient demand and so large concessions draw renters out of stabilized communities. Two months free rent, again, equating to 60% of annual rent, drives that absorption and at least temporarily resolves the affordability problem at the same time. We see this as a short-term phenomenon that will likely clear the market as a supply deliveries decline in 2017.

Higher incomes are probably the most important solution to the affordability issue. Many renters are displaced by large rent increases and search for more affordable housing when rents grow faster than income levels. The opposite occurs when incomes begin to grow faster than rents, which is now happening. In Q3 2016 as compared to the comparable period of 2015, San Francisco and San Jose are estimated to have produced 6% growth in median household income, which is a huge growth rate that improves affordability relative to a year ago.

As to supply, we expect about a 20% drop in apartment supply in San Francisco and nearly 30% in San Jose in 2017 and fewer deliveries in each quarter throughout 2017. Therefore we expect the supply pressures to moderate in northern California, especially in the second half of the year, assuming of course the job growth remains on track. Southern California apartment supply will be similar to 2016 and will decelerate throughout 2017, with the exception of Orange County, which is expected to have a 30% to 40% increase in supply.

We wanted to provide a quick update on rent control. There are ballot proposals to enact rent control in five northern California cities. While slower rent growth has removed some of the motivation for rent control, there are well organized and financed groups that are pushing ahead. At this point, we expect some but not all of the ballot proposals to pass. In any event, these measures are not expected to have a significant impact on the Company for reasons provided in previous conference calls.

Onto my second topic, market outlook for 2017, page S16 of the supplement provides an overview of the key housing supply demand and economic assumption supporting our market rent growth expectations for 2017. As before, our macroeconomic scenario for the US relies on leading third-party sources. The Essex Economics Groups then estimates how the national economic picture will impact housing supply and demand for each sub-market we have selected for potential investment. For 2017, the US economy is expected to experience muted growth, with US GDP and job growth of 2.2% and 1.6%, respectively.

This year we made three notable changes to our assumptions that are incorporated into S16, including first, we've modified our definition a multifamily supply to be similar to Axiometrics, which includes multifamily properties under development with at least 50 units and excludes senior, student and 100% affordable communities. We diligence this information by driving each property to understand delivery schedules, phasing, and remove project duplication. Therefore, our supply estimates should differ from the data vendors. We have observed that the various research providers estimate supply in a variety of ways, often with materially conflicting conclusions. We hope others will follow our lead with respect to using a similar supply methodology.

Second, as we approach the top of the cycle, development deliveries are often delayed due to shortages of trained construction personnel. This causes some development deals to be pushed into the following year. Thus, some of our 2016 scheduled deliveries have bee moved into 2017 and the same thing may happen at the end of 2017. Therefore, our supply estimates may be too high.

Third, as noted in my previous comments, the typical relationship between supply and demand disconnected in northern California in 2016. There's no historical precedent for the adjustments we made to consider affordability. They represent our best judgment. Notably, on page S16 each of our West Coast metros is expected to outperform the national average job growth. In each metro, again, assuming that two jobs equals one household, housing demand exceeds total expected housing supply. That's both rental and for sale.

The resulting 2017 market economic rent growth is slightly above the long-term CAGR of rent growth in southern California and Seattle and slightly below in northern California. In summary, 2017 seems likely to produce a soft landing, thus the extraordinary rent growth from the last several years should transition to the long-term averages in the Essex portfolio.

Now the third topic, investments. We experienced a relatively quiet quarter from an investment standpoint as outlined in the press release. During the quarter, the stock traded mostly at or below net asset value, making accretive acquisitions challenging to execute on a match-funded basis. We expect to be more active in the fourth quarter, with all new deals being with disposition proceeds. Cap rates remain stable in the last quarter with A-quality property and locations trading around a 4% to 4.25% cap rate using the Essex methodology and from time to time more aggressive buyers will pay sub-4% cap rates.

Generally there are fewer motivated apartment investors in the market as compared to a year ago. We don't see rate to cap rates changing materially, given the extraordinary amount of positive leverage that is generated when cap rates averaged around 4.5% and a seven-year fixed-rate loan is approximately 3%. In connection with our preferred equity program, we look at both existing and to be developed apartment communities that are consistent with the Essex portfolio. Recently we've noticed an increasing number of development transactions that don't meet our criteria typically used due to increased cost of construction and conservative construction lending practices. This supports our belief that 2017 will represent the peak of supply in coastal California.

That concludes my comments. Thank you for joining our call today. I will now turn the call over to John Burkart.

Thank you, Mike. The Essex team had another good quarter, delivering total same-store revenue growth 6.9% and NOI growth of 8.3% relative to the comparable quarter. I want to thank our associates for their daily commitment in providing exceptional customer service and for their enthusiasm in achieving our Company objectives and helping make this possible.

Our markets are reaching the point where the strong performance in southern California will enable the region to outperform northern California, although this quarter they both were equal at 6.5% revenue growth. In Seattle, the strong demand in the market, fueled by above-expectation employment growth, enabled to market to absorb the new supply and continue to grow revenues. Our Seattle portfolio grew revenues 8.5% in the third quarter of 2016 relative to the comparable quarter. The CBD sub-market outperformed expectations, growing revenue approximately 7%. East side, North, and South sub-markets, where over 80% of our portfolio is located, all grew revenues between 8.4% and 10.8% for the third quarter of 2016 relative to the comparable quarter.

During the quarter, the market absorbed 950,000 square feet of office space, or about 1% of total stock. Amazon continued to expand with over 10,000 posted job openings and signing another 360,000 square foot office lease for a building under construction located in Bellevue, where the company was founded. Currently, there is approximately 7.2 million square feet of office space under construction, with 41% of it pre-leased.

In contrast to the strength of Seattle, the Bay Area rental market has been impacted by affordability and aggressive lease-ups. Currently, (inaudible) shows September rents in San Francisco and San Jose markets relatively flat compared to the beginning of the year. Sub-markets that are most impacted our those with higher levels of new supply and related lease-up concessions. Concessions in the marketplace very. They are driven by the concentrations of high-end lease-ups which, are largely podium and high-rise buildings, where in order to obtain their certificate of occupancy, the entire property needs to be largely completed, resulting in hundreds of rent-ready units at each property hitting the market simultaneously.

Generally, the lease-up managers generously give away concessions to achieve certain coupon rent and absorption goals. In certain markets with concentrations of supply such as San Francisco and South San Jose, we are seeing selected cases where managers are providing two months free rent or more. During the quarter, we completed the lease-up of Agora, a 49-unit luxury property in downtown Walnut Creek and continued to successfully lease up the Galloway at Pleasanton BART station. Currently Galloway is 63% leased and in order to maintain leasing velocity, we've increased concessions to about six weeks per lease, which is up from four weeks offered during the peak demand season of the summer.

Office absorption continues to be positive in all three Bay Area markets, with over 800,000 square feet being absorbed in the quarter. Some of the quarter's leasing activity included General Electric expanding their footprint, adding an additional 100 square feet in San Ramon and Google signing a lease to occupy the entire Moffat Gateway campus, which is approximately 612,000 square feet. Currently, 11.5 million square feet of office space is under construction in the Bay Area, of which 46% is pre-leased.

Moving down to southern California, the region continues to be a solid performer overall. In the LA market, CBD grew revenues up 4% in the third quarter compared to the prior-year's quarter as it continues to absorb the new supply. The Woodland Hills and Tri-City sub-markets continue to be strongest in the LA market, growing revenues about 8%. And Orange County, the North Orange sub-market continues to outperform the South Orange sub-market and the third quarter, with revenues growing 6% and 4.4%, respectively. With 1.9 million square feet of office space under construction, this will support the addition of approximately 11,000 jobs in the Orange County market.

Finally, revenues increased 8.4% in San Diego, with northern sub-markets outperforming the CBD and southern sub-markets relative to the comparable quarter. The third-quarter office absorption in these three southern California markets was over 1.4 million square feet, with San Diego leading the way, absorbing almost 1% of the total stock. Currently, our portfolio occupancy is at 96.7% and our availability 30 days out is 4.4%. Our renewals on average are being sent out at about 4.5% for northern California, a little over 5% for southern California, and about 6.3% in the Pacific Northwest.

We are positioned well for the end of the year and 2017. Thank you, and I will turn the call over to Angela Kleiman.

Thanks, John. Today I will discuss our quarterly results, the full-year outlook and comment on the balance sheet. We are pleased to report that our core FFO per share exceeded the high end of our guidance. The out performance this quarter was primarily attributed to favorable operations, accretive investments and lower G&A, some of which is timing related.

Turning to the full-year outlook, we are reaffirming the midpoint of our same-property guidance of 6.8% revenue growth and 8.1% NOI growth. As for core FFO, we have increased the midpoint by $0.05 per share to $11.03. We are now projecting a 12.3% year-over-year core FFO growth, which represents our sixth consecutive year of double-digit growth.

Onto the balance sheet, our net debt-to-EBITDA ratio improved to 5.7 times this quarter from 5.9 times last quarter, primarily due to continued growth in EBITDA. In addition, we received an upgrade on our senior unsecured debt rating from Moody's to BAA1 and from S&P to BBB-plus with stable outlook. The upgrades substantiated the strength of our balance sheet and our improved debt metrics.

The rating agencies also base their upgrade on the solid operating track record and long-term favorable economic fundamentals in our select West Coast markets. We believe this upgrade will enhance our cost-of-debt capital going forward. That concludes my comments. I will now turn the call back to the operator for questions.

Thank you.

(Operator Instructions)

Rich Hill, Morgan Stanley.

Thanks for taking my call. I want to get a little bit more color from you about the comments about the peak in occupancy, or excuse me, the peak in supply in 2017. Does that mean you see supply pressure still accelerating into 2017? Looking forward into 2018, when do you really start to see these supply pressures starting to decelerate and maybe providing a little bit more relief for many of the reasons that you mentioned?

Hi, Rich. This is Mike. Thanks for joining the call. I would say what we're seeing is movement of some of the supply from 2016 into 2017. We see it continuing at a pretty significant level through about midyear in 2017 and then dropping off pretty significantly from that point. Again, I think there's a lot of deals being discussed out here on the West Coast.

The issue is, because of construction cost increases, delays in the cities because the cities a very busy, and the construction lending environment which is becoming more and more conservative, that is starting to make deals, push them off and/or they're not achieving the level of return required to make the deals work, so we're seeing those deals pushed off. That gives us confidence that the supply that's under way will be delivered. It will be delivered late and hence the movement from supply from 2016 into 2017. But it gives us confidence that we're going to see a pretty significant slowdown in the middle of 2017.

Got it. That's helpful. Two quick follow-up questions about that. Your same-store revenue growth and same-store NOI growth, should we think about that as the steady-state right now with supply pressures being moved into 2017? As a follow-up to that, thank you very much for the disclosure on high-end job growth. That's really helpful. Did I hear you correctly that you thought the high-end job growth would begin to reaccelerate as some new products coming to market?

Well hitting that one first, we don't know. We can't tell you. We think there will continue to be more service jobs created and more services consumed for the reasons noted, mainly that we have a very high income workforce and they're going to consume more services. We feel pretty confident with that.

We do think there will be more tech jobs. Again, we think that tech is going through a, essentially a retrenchment or really defining what the next chapter is going to be in tech, which is a variety of things, for example, the Internet of Things, the use of big data, more mobile applications, sensors and security devices as it relates to many, many applications, including apartments, for example, sustainability and cyber. There's a whole bunch of things that are happening in the tech world that are being pursued but we're not really seeing it in the job numbers yet. Again, we view the tech industry as an ongoing revolutionary type of process and -- but it's not a straight line. We expect it to take on more momentum as we get into the next -- get through the next couple of years.

Got it. Helpful. The same-store revenue growth, is that a steady state that we can expect at this point, do you think? I know it's hard to project.

We don't want to get into giving guidance at this point in time, but from our perspective here we think that probably Q1 and 2Q will be weaker. You have our market forecast expectations on S16, so you know what the overall view is for the year. If I were to look at the first part of the year versus the second part of the year, I think we will have somewhat of a slow and then pick up momentum as we go through 2017.

Thank you, guys. That's all really helpful. I will stop there.

Thank you.

Nick Joseph, Citigroup.

Sticking with that theme, what's the loss to lease for the portfolio today versus at this point last year?

This is Mike, Nick. Welcome to the call. It is September 2016, it's about 1.9% and it was 7.2% last year. It was, back in July, typically we hit the peak of loss to lease in July. It was 4.9%. There's been a fair amount of deceleration since July.

Thanks. For the 27 economic rent growth economic forecast, when it took about the potential variability in each region, which regions, which region are a must confident in and which has the widest range of potential outcomes?

Let's see. That's a good question. I would always point to southern California as being more stable. It's more like the US. It doesn't have really the upside or the downside typically, because you've got more pieces to the economy and they tend to move slower.

When I think about northern California and Seattle, I think of overall, over the long term, it grows faster but it's more volatile as it's generating faster growth over the longer period of time. I think that's always the case. I don't think there's anything unique about right now. Southern California is closer to the US economy. Northern California has the ability to move aggressively, a little bit aggressively in both directions.

You're seeing part of that. Affordability is the concern about northern California, because demand growth so quickly and we have such great pricing power that rents were growing much faster than incomes and you can do that for some period of time, but at some point rents and incomes have to reconcile with one another over the long haul.

Thanks.

Thank you.

Tayo Okusanya, Jefferies.

Good morning on your end. First of all, big congratulations on putting up such great numbers against the backdrop you are operating in. Just on northern California in general, again, you look at the Axio metrics data and it paints a very grim picture. We look at your results and you guys are still doing very, very well. Just trying to understand again how you're managing against all that pressure from aggressive developers trying to fill up their buildings, the concessions, the slower job growth? Is it just the quality of the portfolio in regards to owning a lot of assets not at the very high end of the market? What exactly are you guys doing that is creating this type of massive alpha?

Well, thank you, Tayo, for mentioning that. I would like to believe it's because we have the smartest operations team, led by Mr. Burkart. We will give him a shout out on that point. I think if you look at the Axio charts, what we saw this year was a pretty weak peak leasing season and so I think what John and his team did was anticipate and really understand and execute around that. I don't want to steal John's thunder. John, what did you do that was magical this quarter?

I prayed a lot. (laughter) as Mike said, we changed our strategy. Typically the software will do what I call is actually closing the leasing door, where it takes certain units and it holds them out above market, trying to identify top potential market rent. We made some changes to the settings to bring those units to market, which enabled us to gain occupancy during the peak demand period and positioned us very well going into the fourth quarter.

That strategic change plus the loss to lease that we had, taking advantage of that, as well as, quite frankly, nickels and dimes, executing in many different places, from collections to reducing models, et cetera. We worked very hard and I'm very proud of the team. They did a great job.

Kudos to them too. Well done.

Nick Yulico, UBS.

Couple questions. First, on the 2017 market forecast you gave on rent growth, are those numbers only for a new lease growth or is that some sort of blended rent growth?

Nick, it's Mike. This is supposed to be market rent. Not the Essex portfolio, but all the assets in the sub-markets in which we are invested, weighted as if it was our portfolio. Were not trying to make a comment at all about Essex or As versus Bs or anything else. Just broadly speaking, what do we expect the sub-market to do, taking market rents at the beginning of the year versus the end of the year.

Okay. I guess when we look care at Northern California at 2.5%, that's higher than I guess where the latest monthly Axiometrics data has been, which is no growth or slightly negative. Is there some sort of difference? Are you assuming that rents actually to start growing across the market next year? I'm trying to reconcile that.

I think the question that I would ask rhetorically back to you is, how many straight lines do you see on these rent graphs? Pretty much the answer is none. They don't act in a straight line. They move. So, yes, if you look at September alone you say, okay, that let's extrapolate and figure out where things are going from there. I think you end up with a bad answer, because I would say what impact, as of September, did seasonality have on the overall results?

We already know that we have affordability issues. We have too much supply in the form of these lease-ups to operate typically 16% off on your annual rent and then now we have this affordability factor layered on top of that. No one can disaggregate what each of those pieces mean, so by focusing exclusively on September, I think that you're making an implicit assumption, hey, this is the way it's going and it's going to continue that way.

We don't believe that. If you look at doesn't just look at the Axio chart for San Francisco, San Jose and even northern California markets. There was a point at which we were getting 2% to 3%, 2% to 4% rent growth and, again, trying to stagger leases so that you take advantage of that and make good decisions with respect to building occupancy during the right period of time allows you to have some ability to manage around that. I would not focus too much on the one September number but look more broadly at where rents have gone this year.

I would assume that next year, again, will be a little bit challenging in Q1 and Q2 because we will do with this issue of too much supply, big discounts because a lease-up operator is heavily incentivized. It's got a bunch of vacant units to discount and absorb apartments and he does so by stealing from the stabilized unit. I think that dynamic is not going to change and that will have the effect of dampening our results. However, we start building demand in February and March and we would expect that to happen and that will temper that. Again, we try to understand these relationships and how the rents vary throughout the year and try to make good decisions and execute well around what we expect to happen.

Okay. That's helpful, Mike. Just as a follow-up, I don't know if I missed this but could we get a sense for where new lease growth was in northern California for your portfolio in the quarter and how it's trending in the fourth quarter so far? Thanks.

Sure. This is John. Our new leases in the third quarter, SoCal were about 3.6%, Norcal, about 1% and Seattle about 5.6%. On average, about 3% year over year. Where it's trending, we're going into the lower demand period. I don't have the current numbers but it will trend typically a little bit lighter. One thing to remember is that last quarter, year-ago quarter, 2015, was a week quarter. That will help the year-over-year comps

Thanks, everyone.

Dennis McGill, Zelman & Associates.

Thanks for taking the question, guys. First one has to do with, I think people are tried to get their arms around whether the supply curve peaks in 2017, extends into 2018 and you brought up the point, I think others have as well, that you might get more of a smoothing effect as things get delayed and pushed out. I guess the question is as you guys look at it, do you feel like we end up in a different place in 2018, whether it bulks up into 2017 or gets smoothed out? Is there a preference in your market as far as one or the other and do you think it matters as far as the endgame?

It's Mike again. I think it does matter and I think that it's very difficult to look out too far out there because conditions change. Back to the point I was trying to make before, there are no straight lines in this industry. We react based on what we see happening on the market day in and day out. Again, what we see, and we see a lot of this with good visibility into what's going on in the development fields, because of our preferred equity program where we are coming in at that 55% to 85% loan-to-cost ratio on development deals and so we're seeing a lot of deals and we're originating these preferred equity loans on properties that we would -- that would be very consistent with the Essex portfolio.

I guess the point is that a number of those are ready-to-go development deals that don't hit yield thresholds that make them viable in the marketplace and, therefore, they are being pushed off and they don't qualify for our program. A lot of that is when you get into the discussion of reconciling cost, I think a lot of the land owners thing that the costs are much lower than they really are when they sit down and actually price things out. That process I don't think is what to change anytime soon. It's possible, for example, that the construction industry will have less, fewer projects and they will become a competitive from a cost standpoint and some of these land deals will start working, but we're certainly not seeing that at this point in time.

What we have before us is a number of, let's say, half the deals that were scheduled or could come to market are actually getting done because of, again, these constraints. The cost rising issue, the city delays from being -- having planning departments that are really busy and the impediments from conservative construction lenders. As long as those circumstances remain in place, I think we're going to see the development pipeline moderate as we model for 2017 and you would not expect it to get any better in 2018. I hope that answers the question.

Yes. I think so, but just to make sure I'm thinking about it right, so if it gets smoothed out, do you think that ultimately leads to more supply because it makes the underwriting a little bit less cautious?

No. I don't think it's a matter of the underwriting being cautious. I think that, again, we've never seen a pro forma that didn't have the right numbers on it and so we see lots of pro formas that have un-trended cap rate's for development deals in the 5% to 5.25%. When you actually sit down with someone to price that out, it is coming out to be somewhere in the 4.5% to 4.75% range. That pressures the numbers in terms of how much equity you need and some of the other constraints. Again, very conservative lenders, lenders that unless you have a huge balance sheet that are somewhere in the 55% to 65% loan-to-cost ratio, et cetera.

I don't see that changing. I don't see construction costs moderation happening in the very short-term. Again, if developers become less busy -- I'm sorry, contractors become less busy and costs go down, then maybe some of these deals will make it through. Again, right now I feel pretty confident in our forecast in terms of first half of 2017 being a bit heavy and then abating each quarter throughout 2017 and the second half of the year being much better. I feel very confident in that although, again, like we've seen before, there could be some movement of projects from quarter to quarter as delays and other things happen.

Okay. That's helpful. You did mention a preferred equity program. Can you just given an update on how you see that pipeline? It seems this quarter was a good origination quarter and heavy relative to the outlook that you gave last quarter. Are you seeing more opportunity or that opportunity expand?

I think what I would say about that, were at $186 million outstanding and we did two deals that funded a few million dollars this quarter. We have a pipeline of around $50 million. In talking to our team there, they are, again, seeing a lot of deals they can't make work. It is not like we have 30 deals and we're picking the best of them. It's more like we're looking at a lot of deals and somewhere around half of them are making sense and the other half are, again, not producing the returns one would normally expect if you're going to take development risk.

But that's against the context of looking at an acquisition. On an acquisition you can lock in somewhere around a 4.5% cap rate with a seven-year loan and around 3% range. You have huge amount of positive leverage. I guess I would say, why would you take all the development risk when there's so much positive leverage on existing acquisitions, all things being equal? I think the alternative with respect to where capital gets allocated are pretty interesting and it means that development deals, money can't flow into development deals at lower yields because there's another alternative out there that is better economically. It's certainly risk reward.

I appreciate the perspective. Have a good weekend, guys.

Thank you.

Tom Lesnick, Capital One.

Thanks for taking my questions. Most have been answered already but I just wanted to address the subject of buybacks since your share price still looks relatively discounted. Any update or thoughts on that?

As you may recall, we have $250 million program in place and we've always been opportunistic when it comes to capital allocation. We plan to continue to do so. We had a small purchase, but not enough as it relates to subsequent events. It's just a very small amount. Like I said, we will continue to be opportunistic on that front.

I guess where the stock is traded today, how do you evaluate that as an opportunity against her overall investment set?

I think we liked it better yesterday. (laughter) It's interesting, the one thing I would add that is a continual conversation between Angela and me is that it isn't like we can sell our whole portfolio, primarily because of prop 13, tax planning, et cetera. We have somewhere around $1 billion that we can sell relatively easily and either pay a special dividend and/or by shares back. We don't really care about which of those we might want to do.

I guess the point is there are some assets that are -- many assets, that we've had huge gains on that there's a large prop 13 difference between what we pay as property taxes and what the buyer pays as property taxes and the buyer will cap out that difference and get a lower value. There's something -- there is a headwind in California to large-scale dispositions and repurchase transactions and so we have essentially gone through our portfolio and categorized them by type, and so we have a list of assets that we know we can sell. We have a culling portfolio. We have a opportunistic sale portfolio and, again, we're just trying to get the relationships right.

We're not going to do it if it has a very small impact. We'd much rather wait for opportunities to see meaningful differences between the value of the real estate portfolio and the value of the share, and so we're going to be patient on that. As Angela said, we did execute on the repurchase and so that'll give you some idea that we are interested in it and following through.

That's really helpful. Just one last one for me. I think you mentioned the aggregate loss lease figure earlier in the call, but I was wondering if you could provide that between your three portfolio segments?

Yes. Sure. This is John Burkart. The aggregate, as we said, was about 1.9%. That breaks down with southern Cal at about 3.4%, the Bay Area with a slight gain to lease at this point time of about 40 basis points, and then Seattle at about 2.6%.

All right. Perfect. Thanks very much, guys.

Thank you.

Rich Hightower, Evercore ISI.

Good afternoon, everyone. Another twist on the loss to lease question. I don't know if you can answer this readily on this call, but I'm trying to get a sense of what loss to lease has represented in terms of Essex's out performance in terms of your rent growth versus the market's rent growth or your competitors rent growth over the past couple of years. If you could attribute that out performance to loss to lease. If you could attribute part of it to better revenue management. Just trying to get a sense of a split there. Again, attribution of out performance, I guess.

This is John. I'll take a shot at it and Mike wants to follow-up. Ultimately lost to lease is the product of rent growth, right? It's asset by asset in the marketplace and are we investing in the right locations? What's the rent growth look like? Then the loss to lease is derived by what we actually rent at versus where the market is that.

At Essex, we've had very strong markets. As Mike has said many times on the calls, we had a self-imposed rent cap that we put in that was basically 10%, that has -- plus of the market strength has led to loss-to-lease growth over time and over the last year as we said earlier, about a year ago we were about 7.2% loss to lease. Now were about 1.9% loss to lease. You can see that a big portion of that has a rolled through to the bottom line. Does that basically answer your question?

Yes, John, that's very helpful. I will certainly follow up for more details. I don't waste everybody's time of the call here, but that was helpful. My second and final question is just on Seattle. I think you guys quoted renewals running around 6% and change in the Pacific Northwest earlier in the prepared comments and then when I compare that to the market forecast for next year of around 4.5% and then also measuring that against around 8%, which is what you guys have done so far in 2016, I'm just wondering what all that implies in terms of new lease growth in Seattle for next year. It sounds like it should be pretty low to get to those numbers when you tie it all together.

We've laid out, in our supplement, what we see as rental growth rates there at 4.6% for next year for the marketplace. As it relates to the renewals for the fourth quarter, what we're sending out at this point in time, that's going to be a function of the leases in place that are there. As you get to the fourth quarter, you're going to pull back a little bit but were sending out 90 days in advance or 60 to 90 days in advance. The renewals are very strong. I wouldn't look at that as saying the market is not strong.

Let me add something quickly to that. In Seattle, we have a couple things that are happening. We have supply in 2016 estimated at 9,800 units. That is multifamily. We have that increasing to about 10,900 units and we have job growth decelerating from 3.5% to 2.7%.

Now, will that happen exactly like that? I'm not sure but, again, our market forecast is based on a scenario and those of the two key inputs in the scenario so we have some moderation of market rent growth in Seattle. Again, this is just market rent growth on S16. It's not include loss to lease.

Okay. Great. Thanks, guys.

John Kim, BMO Capital Markets.

Thank you. I think John mentioned in his prepared remarks a pickup in office net absorption and some of your markets. I realize there is different supply in leasing dynamics, but I'm just wondering if you view office leasing as the leading or lagging indicator in your markets?

This is John. From our perspective, we look at that. We try to look at a variety of pieces and that's one of them, to understand A, do we have enough office space that is going to be available, which is why I often we will mention construction because we've gotten such a strong job growth, do we have enough space for the people? Then B, is that space being leased up? In other words, are the companies making decisions, real capital decisions preparing for the people. That's why we bring that up as somewhat as a leading indicator, confirmation of our jobs numbers.

Okay. On page S 8, you had an increase sequentially and both turnover and financial occupancy? I'm wondering how we should read that.

Turn over, I look at it from a yearly perspective. If you look at year to date, our turnover for the portfolio is about 55%. That's up about 1% from last year, year to date. It's pretty consistent there.

But are you leasing up vacant units faster or turning over units quicker?

We are. We are and it gets back to the change of strategy where the software would typically hold units vacant at above market rent, trying to find the peak of the market, so to speak. With making that modification and a few others, we've reduced our vacant days down.

Okay. Great. Thank you.

Rich Anderson, Mizuho Securities.

Thanks and still good morning. Mike, to use a weird analogy, if you were to wear a mood ring and you were wearing that last year, it would be kind of a nice shade of blue and now it's kind of brownish. I don't know if you wear a mood ring but if you did, that would probably be the right analogy. You're talking about a soft landing scenario in 2017, but so often, our expectations of whatever happens in the future it's hard to identify until they actually happen.

The point is, I know you've mentioned behaviors of municipalities and the behaviors of lenders to cut off the supply chain to some degree, but is that all that's hinging on what could either pivot from being a soft landing to something materially worse than that? Because if you were to plot how your view has changed over the past year, it would suggest that it's going to be something worse than a soft landing in 2017.

Well, Rich, only you could phrase a question like that. I appreciate it. I guess I would say, I'm not sure what color this would translate into, I would say it's we are cautiously optimistic.

Well, green is jealous just to give you (laugher) --

Okay. You need to send me that wheel. The motion wheel. I think were cautiously optimistic. We think we're -- it feels kind of like it's starting to be late cycle and so that is one element of caution. The recent GDP report looked great, but the jobs are decelerating so we see a lot of inconsistencies out there in the marketplace and that caused us a great deal of concern.

We feel pretty good about the supply projections. We spend a lot of time on them. If we miss that, it's our bad. The broader issue, I think, is what goes on in the economy. we're always concerned about that and especially the last several years where we just, every time it seems like we're getting a little bit of a momentum, something comes out of the woodwork to knock it down. I guess cautious optimism is what I would get.

As a relates back to supply, just look back. If you get, what's it been, 7% to 12% rent growth in northern California for four years, guess what's going to happen? Every piece of land that's available that you could put some apartments on is going to be built. That is predictable. The current pipeline deliveries is really a function of the extraordinary rent growth we had of the last several years. Normally, half of those sites or some portion of those sites would not have been buildable. This is what always seems to happen is they get delivered in a different economic environment and soften conditions further.

This is what causes the greater volatility of northern California and Seattle, again, with better long-term growth rates over time. I think it's really a function of what's happened with a function of history. Again, huge rent growths making every deal work and having all of that hit the development pipeline at the same time and then delivered at the same time. As you, again, as you're looking at a development deal today versus looking at it two or three years ago, it's a completely different world out there.

You don't had the expectation of rent growth that you had a couple years ago. You don't have the financial infrastructure from the banks, especially. They're becoming much more conservative. You have got a backlog in the cities and a variety of other constraints. We feel very comfortable that we are not materially off as it relates to the current conditions and what's going to be built that comes out of this for those reasons. Again, from our perspective, it's all about the economy.

Okay. I guess it just seems to me that if you get 12% rent growth then you're destined to get, have these wide swings as you describe. I guess it may be different this time. I don't know. Can you recall back to when, a year or two before northern California went to hack and if you guys saw that coming as clearly or do you think it's just there's so much more information flow now that you are at more of an advantage to see these things coming a little bit more clearly?

Well, I think to comment, we saw the supply coming, definitely. What we missed is what's going on with the economy when the economy tanked. We did not see how crappy the mortgages became in 2007 and 2008. We did not know that. Then the impact of that was something that clearly we didn't see. We had, I think, a very good idea of what the supply was going to be but I don't really -- and again, this is where asset bubbles are something to keep you awake at night, because we just didn't see that asset bubble develop and we didn't see it blow it up as it did.

When you go back into the Internet boom/bust period, we were becoming a lot more conservative. We were moving our portfolio pretty dramatically from northern California to southern California because we didn't believe in the rent and we didn't believe in sustainability. I actually think we played that one pretty well but, again, did we see the magnitude of the economic sort of disaster that happened when the Internet companies imploded? No, I don't agree got that one right either.

Okay. Cool. I appreciate the honesty. Thanks. Good call.

Conor Wagner, Green Street Advisors.

Good morning.

Morning, Conor.

You mentioned the developments leasing up and the aggressive pace or rapid pace they had to do that. How do you guys anticipate things going when most of these lease ups turn within a year of the development? Do you have any idea of what impact it will have a market or are you trying to position yourself for that in any way?

Conor, it's a great question. I was trying to figure out how to put that into my call comments, because I think it remains to be seen. It's an enormous question. Developers, there is a limit on which they can offer concessions and that limit, in effect, what it does is it pressures the first renewal to a huge extent. In essence, it becomes something that fills up their buildings quickly, sometimes with the wrong tenants and so when their first lease renewal comes, you end up with either another concession or people that have to leave in fairly large numbers.

I'm not sure exactly how that's going to play out. I think that, that has been a big problem. A lot of people that are moving into San Francisco, for example, or San Jose because they can now afford it, and even though they are relying on that 16% concession in order to make those numbers work, I think you're going to see change because each of those newly developed apartment communities go from being a lease up with their very unique financial equation to being a stabilized owner and when they do, I think there's going to be a lot of people that are going to be shocked within their resident pool.

In our experience, at one month, it's no problem. At two months it begins to be a problem as it relates to your tenant base cannot generally pay market rent and so you end up with this problem on the renewal. When you start getting above two months, you end up with a real problem. I think that we're starting to see that, as John noted in his comments. There are some two-plus month concessions for the time you add in free parking and a variety of other things. I think that's going to make for a very ugly first renewal on those buildings.

And the impact it will have on your pricing power? That sounds like a net negative for owners of stabilized assets.

No, I don't think so. I think you go back into normal supply and demand. People that can't afford it have to move into more affordable housing, which means longer commutes for them and /or double ups. I think it's a good thing for us because, again, they become a stabilize owner. Right now they are disconnected from the stabilized ownership.

You've got two different constituency with dramatically different financial objectives. As soon as they become a stabilized owner, they're interested in generating the most rent they can. They're going to have a messy situation in dealing with the people that they let in that can't afford to pay market rent and you're just going to see and other transition within the renter pool. I think it's all better because net-net the places that have the properties, the best locations in the best properties, will go back to having the pricing power that they normally have, whereas the secondary or tertiary areas are going to have people move into them that will probably, they will underperform and the better areas will recover these 16% rent that they lost or some portion of it. It's good for the (inaudible).

Thank you, that's helpful. With the diminished outlook for rent growth in the Bay Area in 2017, does that change your ability to do revenue enhancing CapEx in the region? Yes, just the economics there?

I'm afraid it does because, again, if you're going to offer on your A product a 16% discount, you're going to compress As and Bs and the rehab premium is somewhere between the difference between the A rent and the B rent. Your premiums that you're going to achieve on your rehab properties will likely change a little bit and be lower. From our perspective, I would expect the volume of turns in our rehab program to moderate or decline and as we become more selective and find the markets that we can get the premiums that we need in order to make the numbers work

Thank you very much.

Thank you.

Drew Babin, Robert W. Baird.

Thanks for taking my question. A quick question on the expense growth side. Given the market forecast for the deceleration next year, is there anything you might do differently next year relative to this year in terms of maybe running leaner then you normally do, or anything you are doing specifically there?

This is John. There's a couple of comments there. To the extent markets get slower, there's commonly you end up spending a little bit more on marketing, so cutting back doesn't necessarily work on that spend. We are pretty focused on procurement at Essex and refining some of our pricing and taking advantage of our larger scale here. That's working for us at this point in time. I think the two will work together and we will end up at a reasonable spot.

Normally when the markets slow down you end up spending a little bit more on marketing and that often pushes those expenses up a little bit. The other thing just to note, in California we have the minimum wage growth so that is affecting lower-waged positions, the turnover, the landscape security, effectively it's going up about a 7% rate per year. It's not the same each year but effectively that's what's happening for several years. That is putting pressure, upward pressure on those different areas and we are working to offset that in various ways.

Okay. That's helpful. Secondly, Alameda County had close to -- it wasn't the worst but it had a decent amount of sequential revenue growth deceleration. Is that a product of Alameda County just having the most robust growth last year or is that an indication that the new supply in downtown San Francisco, San Jose, that the concessions are aggressive enough to draw from lower price points further out in the suburbs?

Yes. It's more of the latter. It benefited from people moving out there for affordability and now you can see the reverse of that as people start to move back, as there's not as much rent pressure in San Francisco and San Jose.

Okay. That's helpful. Thank you.

Thank you.

Michael Kaddish, Canaccord.

Thanks for taking my question. I just have one quick one. I'm sorry if you answered this previously, but in your developments at 500 Folsom, I believe costs went up about $35 million. It didn't seem like any of the other underlying assumptions changed. Do you know what drove that cost increase?

I do. This is Mike Schall again. The same things that we've been talking about it a relates to the broader issues in development. It was driven by delays, number one, in terms of getting through the city process growing at double-digit rates which outstripped our expectation for that property. Again, back to these conditions that are leading to lower supply, obviously we're not immune from those conditions and that 500 Folsom deal is a good example of that.

Is the same thing happening with the Galloway Hacienda in Pleasanton? Is that part of the -- under the same issues there?

No. It really isn't, because that was started a couple years ago. Again, 500 Folsom, we just signed the contract with the general contractor, finished up the city requirements. We hoped to have done that several months ago and, again, the delays and movement of cost increases are really the reason for that cost bust. Hacienda was fortunately done before that.

Again, this is one of the reasons we've tried to decelerate the development pipeline. At the bottom of the cycle you end up with really good crews because there's not that much going on. Cities are helpful trying to push deals through. At the top of the cycle, it's the opposite. The cities are trying to increase fees, increase affordability requirements, have greater say in the product that is being built. They're less motivated to actually get the construction workers back working because the construction workers are really busy. This is why we tailback development at the top of the cycle.

Thanks. That's really helpful. One follow-up on that. With costs up and pricing power down, how has that affected your yield assumptions on 500 Folsom?

It certainly had an impact. I think we're in the 4.75% expected cap rate un-trended on 500 Folsom where it was somewhere around a 5% before.

Great. That's really helpful. That's all for me. Thanks.

Thank you.

Jordan Sadler, KeyBanc Capital Markets.

Is Austin Wurschmidt here. Mike, you mentioned early in the call that the concentration of supply is contributing to the heavy concessions by developers and I was just wondering if that concentration spreads further out and if so, could we see that concession start to abate before overall supply actually abates?

That's a good question. We do have some increase in Oakland, for example, in terms of development but, again, off a very small base and so we don't see that as a major issue. I think it has more to do with California's Global Warming Solutions Act of 2006 where California is trying to create a residential model that is going vertical as opposed horizontal and trying to eliminate urban sprawl. The way to do that is to have high-density projects on all the major transit hubs.

What you're seeing is greater concentrations of apartment buildings and actually condos and other housing in an effort to become more efficient from an environmental perspective and I don't think that, that changes. I think that, again, in the Bay Area we need to go through a massive upgrade of our public transit system, but I think you're going to see more and more residential construction that's on the main transit lines or in the urban core. I do not think that's going to change anytime in the next several years and I think that, that acts as a further supply constraint that is a more recent phenomena.

Thanks for that. Lastly, on the investment side, you mentioned last quarter you were previously working on some acquisitions. Did those just get pushed further out or did anything change with the deals you were previously looking at?

No. We do have some acquisitions that remain in the process. We are trying to 10-31 exchange, which has caused us to push out some of the closing dates and again, we will be more active in the fourth quarter, so you will start seeing a few deals close. Again, funded with disposition proceeds.

Great. Thanks for the time.

Thank you.

Thank you. I'd now like to the floor back over to Management for any closing comments.

Thank you. Well, in closing, we appreciate your participation on the call and look forward to continuing the conversation with many of you at the NAREIT conference in a couple weeks. Have a great weekend. Take care. Thank you.

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