Essex Property Trust Inc (ESS) 2017 Q2 法說會逐字稿

Good day, and welcome to the Essex Property Trust Second Quarter 2017 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 risks 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. (Operator Instructions)

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 second quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments, and John Eudy is here for Q&A.

This morning, I will comment on our quarterly results, market conditions, changes to our market outlook and investment activities.

On to the first topic. We're pleased with our second quarter results, which benefited from outperformance in Seattle, along with continued improvement in Northern California. Results in Southern California were mixed, impacted to varying degrees by supply-related disruption and slowing job growth. John Burkart will comment on each Essex market in a moment.

Overall, the West Coast continues to outpace the slow-growth national economy, although the level of outperformance has narrowed. As noted previously, pricing power is disrupted when large rental concessions are introduced to the market, usually occurring when several lease-up communities compete directly with aggressive absorption targets. In our experience, 6 to 8 weeks of free rent, equivalent to [12% -- 16%] of annual rents, provides sufficient incentive to draw residents out of stabilized communities. Fortunately, these large concessions generally represent only a short-term disruption in pricing power, while long-term fundamentals remain intact and California's persistent housing shortage continues.

This year's strong recovery in Northern California confirms that the pricing disruption we experienced in 2016 was directly attributable to high levels of rental concessions. As soon as these concessions abated in early 2017, market rents recovered and pricing firmed. Accordingly, we have experienced recent concession-related pricing power erosion at certain of our properties in Downtown Los Angeles, West L.A. and the Tri-Cities. We expect pricing power to rebound when concessions abate.

I would like to recognize the operations team for reacting quickly and thoughtfully to changing market conditions.

As noted on our last call, an important part of our expectations are that tight labor markets in California push incomes higher, [hiring] workers from other parts of the U.S. and world. For the Essex markets, 2017 personal incomes are expected to grow 4.9%, led by San Francisco at 5.9% and compared to the U.S. average of 3.2%.

Further, over the past year, the ratio of rent to income has declined in both San Francisco and San Jose, 2 areas most affected by affordability constraints.

Median home prices are also growing faster than rent, Seattle leading the way, 14.8% year-over-year, and California up 7.2%, both outpacing rent growth over the past year. This is important for 2 reasons. First, higher home prices make the transition from a renter to a homeowner more difficult. And second, a significant part of the Essex portfolio is convertible into condos.

On to our revised 2017 outlook. We made a number of changes to our MSA-level forecast on Page S-16 of the supplement. First, we've reduced our job growth forecast for several metros, including Orange County, San Jose and San Diego.

Across the Essex portfolio, job growth peaked in 2015 and has slowed since. Tech markets continue to report strong yet decelerating job growth that has consistently outperformed the U.S. average. Southern California, however, is a more diversified economy and, therefore, performing more in line with the broader U.S. average.

Additionally, several factors have impacted our forecast as follows. First and most notably is the shortage of skilled workers and low unemployment rate, which are more acute on the West Coast. Unemployment rates in the Essex markets are now at or below the U.S. average of 4.5%, with San Francisco the lowest at 2.6%. Overall, the unemployment rate in the Essex portfolio has declined 50 basis points over the past year, with nearly 20,000 open positions at the large companies in California and Washington.

Second, demographic factors are also contributing to slower job growth. According to one study, there are now 8,000 baby boomers turning 65 each day, and that rate will continue to accelerate. At the same time, the number of millennials entering the workforce is now declining. [Growth] should continue to slow. The number of baby boomers reaching retirement age is expected to exceed the number of millennials entering the workforce. Fortunately, longer life spans and healthier senior workers will slow this impact because they often remain in the workforce past the age of 65.

Third is the housing or location preference of retirees. It is estimated that more than 70% of retirees want to "age in place," referring to the fact that they strongly prefer to remain in the same house and/or community with friends and family.

Given longer life spans and the preference to age in place, many will consume homes without requiring a job, thus creating housing demand that is not appropriately represented in the normal relationship where 2 jobs are needed to create one household.

Finally, the limited supply of skilled construction labor also appears to be an influence. The demanding physical requirements of construction result in earlier retirement compared to other industries, and studies indicate that many more construction workers are at the end of their career compared to those new workers entering the trade. This leads us to believe that construction labor will remain in short supply, which will help keep construction costs near current levels to prevent significant increases in housing buy.

These forces remain in place as we head into 2018, tight labor market conditions pushing incomes higher and hopefully attracting people from other areas, while higher wages will impact operating expenses, also make apartments more affordable and are necessary to push rents higher.

Summing this up, as long as the economy continues to expand, we see apartment rents growing at near their long-term averages for the foreseeable future.

Turning to investment activities. We modified our investment strategy during the quarter, driven by lower capital costs for both long-term debt and equity as well as improved expectations from rent growth in some areas. Previously, our 2017 plan relied primarily on dispositions to fund new investments. We now anticipate fewer dispositions, relying instead on stock issuance and long-term debt. As to dispositions, our strategy will focus on portfolio-culling activities, whereas previously we targeted partial sales of wholly owned properties to institutional co-investment entities. Thus, we are now targeting a range of 300 to 5 -- $350 million of -- for property sales in 2017, down from a range of $400 million to $700 million previously, of which $132 million has been completed year-to-date.

With respect to acquisitions, investment conditions remain highly competitive, with strong investor demand relative to a limited number of quality properties hitting the market. Thus, prices are being driven above our expectations, and we are often outbid. We have closed $270 million year-to-date. We currently have 2 properties in contract, getting approximately $230 million.

If these transactions close, cumulative 2017 acquisitions should be approximately $500 million, which is within our targeted $400 million to $600 million range.

Please note that the foregoing comments about acquisitions and dispositions refer to total property values, whereas many of these transactions will involve institutional co-investments. Angela will discuss the net impact on Essex' balance sheet in a moment.

Additionally, given the strong investor interest in apartments, especially for value-added opportunities and high-quality properties in the best locations, we have lowered our internal cap rate assumption for the Essex portfolio by 10 basis points.

Across our markets, A-quality property in the best locations are trading at around 4% cap rates, using the Essex methodology, and sometimes more, as the buyers will pay sub-4% cap rates.

Cap rates for B-quality property and location are generally 40 to 60 basis points higher than A-quality property, with upgrade costs and related rents assumed for value-add opportunities.

Switching over to our preferred equity and subordinated debt program. We've made good progress during the quarter. Significant transactions were detailed in the press release. And at quarter's end, we had a total outstanding of approximately $276 million, up about $26 million from last quarter.

Through Q2, we have funded approximately $34 million in new deals in 2017 against our guidance of the year -- for the year of $100 million. On the repayment side, we received $13 million in repayments during the quarter and converted 1 preferred equity investment into a common ownership position earlier this year. We have also approved 5 additional preferred equity deals involving around $100 million, most of which are expected to close by year-end. Therefore, we remain on track to equal or exceed our original guidance.

Finally, on the development front, we remain on schedule to commence construction on 2 new projects and the next phase of our Station Park Green project in 2017. In general, we continue to see headwinds to new development deals, and we believe that the overall trend for apartment supply is downward in 2018.

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

Thank you, Mike. Q2 was another solid quarter for Essex, with year-over-year same-store revenue growth of 3.9% and NOI growth of 4.7%.

Overall, the market performed at or slightly above our expectations. However, the market was stronger in April and May and a little weaker in June.

Specifically, in L.A. and Orange County, net effective rents were flat and/or declined in June. L.A. is negatively impacted by a very competitive lease-up environment, and Orange County is impacted by the combination of lower employment growth and increased supply.

In the Bay Area and Seattle, market rents grew significantly during the quarter. However, occupancy declined in both markets. [Reduction] in occupancy in the Bay Area and Seattle was mostly due to higher turnover, which is consistent with seasonal norms. However, in Seattle, we also saw a slight slowdown in the market in June.

We adjusted rental rates to meet the market in July, and we picked up 20 basis points of physical occupancy during the month of July, bringing occupancy this week to 96.4% and decreasing availability 30 days out from 5.3% at the end of June to 4.9% this week.

Lower rents appeared to have peaked in June, a month earlier than historical seasonal patterns. The strong leasing activity that we experienced in July gives us confidence that the markets are healthy. It is our expectation the markets will follow a normal seasonal pattern in the second half of the year.

Our loss to lease for the portfolio in June 2017 declined to 3.4% compared to 3.8% in May 2017. Similar, our market rent for the portfolio increased in June over May. Scheduled rent increased more, 57 basis points, which is a good thing, due to leases being renewed or units being re-leased [their] rents and, therefore, loss to lease declining.

We are spinning out renewals for the third quarter at an average of 4.8% for the portfolio. However, renewal rates may negotiate it down, as rents appear to have peaked for the portfolio.

In the third quarter, we expect that our occupancy will be roughly the same as the prior year's quarter or about 96.5%. And therefore, we will not receive the benefit of increased year-over-year revenue growth related to the increased occupancy that we have had in each of the last 4 quarters. It is our continued expectation that the third quarter will be the low point for the year-over-year revenue growth, between 2.5% and 3% over the prior year's quarter, in part due to a tougher occupancy comp from last year.

Turning to expenses. We continue to face strong headwinds, both from utilities and wage pressures, as I've noted on prior calls. However, we've been successful in partially offsetting the increases by strategically bidding out asset collections to service vendors. For example, our pool and landscape contract expenses are down 1% from the prior year's period despite the 10% increase in minimum wage, which directly impacts both services.

Moving on to update on our markets. In Seattle, job growth has slowed relative to prior quarters but remains the strongest job market within the Essex portfolio, with year-over-year growth of 2.6% for the second quarter.

Amazon continues to expand with their purchase of Austin-based Whole Foods for $13.7 billion. Currently, in the state of Washington, Amazon has 8,600 openings.

Microsoft announced a reorganization earlier this month that will result in thousands of worldwide company job cuts. However, only 400 to 500 layouts are expected in the Seattle region.

Multifamily supply remains high in the MD, and concessions are generally 1 month free for properties and lease-up. Interestingly, some of the lease-ups in the Seattle CBD have little to no concession.

We have seen move-outs to buy a home remain elevated in the Seattle market at approximately 20% compared to a historical average of around 14% to 16% for this market.

In office activity, Seattle has recorded the strongest year-to-date office absorption of any major metro in the U.S., at 2.9% of existing stock. Additionally, MD has nearly 6 million square feet of office under construction, almost half of which is preleased by Amazon, Facebook and Google.

On the east side, Vulcan, who's developed a substantial amount of office space for Amazon in Downtown Seattle, purchased 2 development sites in Downtown Bellevue, both of which are zoned for 450-foot tall towers.

Our same-store revenues in the Seattle MD grew by 6.6% year-over-year for this quarter, with the CBD at 6.7%, the east and south market -- submarkets achieving around 6.3% and the North Snohomish submarket achieving 7.8%.

In Northern California, job growth in the Bay Area averaged 1.8% year-over-year in the second quarter of 2017, with roughly 63,000 jobs added over the prior year's quarter.

San Francisco continued to lead the way, posting year-over-year job growth of 2.3%, while Oakland and San Jose were up 1.9% and 1.5%, respectively.

There is almost 19 million square feet of office space under construction in the Bay Area, roughly 44% of which is preleased.

In San Francisco, Salesforce and Amazon expanded their combined footprint by an additional 330,000 square feet. Across the Bay, WeWork plans to open its first office of 75,000 square feet in the open CBD at the end of the year. And in Pleasanton, construction has begun at Workday's 400,000-square-foot office building.

Finally, in Downtown San Jose, Adobe is in contract to purchase a site adjacent to their headquarters where they are planning an expansion that can house an additional 3,000 employees. Additionally, Google has started negotiations with the City of San Jose on the formation of a new campus in downtown, which could ultimately house up to 20,000 employees.

During the quarter, we continued our lease-up of Century Towers in Downtown San Jose and Galloway located in Pleasanton. Using 4 to 6 weeks of concessions on selected units for both lease-ups, we've averaged over 30 leases per month at each site.

Shifting to Southern California. In Los Angeles County, job growth has averaged 1.4% year-over-year for the second quarter of 2017 and is generally in line with the U.S. at 1.5%. Essex continues to perform well in this market led by Long Beach and Tri-City submarkets with 6.9% and 6.2% year-over-year growth, respectively, in the second quarter trailed by Woodland Hills submarket at 3.9% and the West L.A. and L.A. CBD submarkets at 2% and 0.4%, respectively.

The revenue in our L.A. region was negatively impacted in the second quarter by a dispute with a corporate tenant, which was resolved after the close of the quarter.

Concessions are still high in Downtown L.A. Often, 2 months free at new assets and lease-up encourage prospects to break their existing leases and move into the new building. Commonly, in California, leases allow tenants to move out prior to the end of the term by paying a 1-month lease-break fee.

As a result of the aggressive downtown lease-ups, we are now starting to see some stabilized assets offering $500 to 1 month free on new leases, which is similar to our experience last year in the Bay Area. Additionally, new lease-ups in Glendale and Hollywood are now commonly offering 2 months free.

Looking at office activity in the market. The television and entertainment industry continues to drive office demand in the West L.A. submarkets. Amazon Studios, HBO and Netflix expanded their footprints, with a combined total of over 170,000 square feet of new leases.

In Orange County, job growth continues to show signs of weakness, with 0.7% year-over-year growth for the second quarter of 2017. We achieved solid rents -- solid results in this market despite the weak job growth and supply. The South and North Orange submarkets grew at 5.2% and 4.6% year-over-year, respectively, in the second quarter of 2017. We are watching Orange County closely, as market rents are being negatively impacted by the supply/demand imbalance at this time.

Finally, in San Diego, job growth was 1.6% year-over-year in the quarter. Our North City and Oceanside submarkets achieved 4.5% and 4.1% year-over-year growth in the second quarter of 2017, while our Chula Vista submarket achieved 2.5% over the same period. Despite the lower job growth, the rental market in San Diego has remained strong.

Currently, our entire same-store portfolio is 96.4% occupied, and our availability 30 days out is 4.9%.

Thank you. And I will now turn the call over to our CFO, Angela Kleiman.

Thank you, John. I will start with a review of our second quarter results, followed by the full year guidance revisions and conclude with an update on the balance sheet.

In the second quarter, core FFO grew 8.4% and exceeded the midpoint of guidance by $0.10, of which $0.03 is related to timing of expenses and is expected to occur in the second half of the year.

The remaining $0.07 outperformance were driven by the following: $0.02 from revenue exceeding expectations, $0.02 from operating expense savings and $0.03 from lower property taxes, as we received final bills from several legacy BRE properties, which primarily relates to prior year period. Therefore, this is a nonsame-store item.

As a result of the second quarter performance, we have tightened the range of our same-property revenue growth, thereby raising the midpoint to 3.6%. Year-to-date, we have raised this midpoint by a total of 35 basis points compared to our original guidance of 3.25%.

Moving on to expenses. We are pleased to be able to decrease the midpoint of our same-property expense growth guidance by 30 basis points to 2.7%. This reduction is due to a combination of property tax refunds and savings realized from various initiatives implemented in operations, as described earlier by John Burkart. The resulting impact to same-property NOI growth is a 30 basis points increase to 4% at the midpoint. And year-to-date, the midpoint of our same-property NOI growth has been increased by a total of 62 basis points, as our original guidance was 3.38%.

On to FFO guidance. We raised our full year core FFO per share by $0.07, to $11.83 at the midpoint, which reflects a 7.2 year-over-year increase. We continue to drive operating results to the bottom line, as our core FFO per share growth is 315 basis points above the same-property NOI growth rate at the midpoint.

And for the third quarter, we are projecting core FFO per share of $2.93 at the midpoint. The $0.04 sequential decline is primarily due to the one-time property tax benefit mentioned earlier.

Lastly, on the balance sheet. At the end of the quarter, our net debt-to-EBITDA improved to 5.6x from 5.7x since last quarter. This is consistent with our expectations for this ratio to decrease from growth in EBITDA.

The continued downward trend in this metric over the past several years has enabled us to reduce the low end of our target range from 6x down to 5.5x.

During the second quarter, we issued $81 million of common stock through our ATM program, which substantially meets our equity needs to match fund our investment activities.

Since much of our acquisitions and dispositions will involve the co-investment program, the net effect is de minimis on our funding plan as it relates to future equity issuance.

We remain disciplined and well positioned to be opportunistic relative to our cost of capital in order to optimize opportunities in the marketplace.

With full availability on our $1 billion line of credit, a variety of capital forces and 0 debt maturities for the remainder of the year, the balance sheet remains flexible and strong.

That concludes my comments, and I will now turn the call back to the operator for questions.

(Operator Instructions) And our first question comes from Juan Sanabria from Bank of America.

I was just hoping you could speak to the new and renewal trends achieved in the second quarter by the major markets, if you wouldn't mind.

Sure. This is John, Juan. The -- so new in SoCal was about 3.1%, and renewals were about 4.6%. In NorCal, new was about 1.8% in the second quarter, and renewals were about 2.7%. And then in Seattle, new was about 8.7%, and renewals were about 5.9%. So overall for the portfolio, new coming in about 3.6% and renewals at about 4.1%. And to be clear, the way we're looking at that, that is versus comparable terms. So roughly a 12-month lease compared to a 12-month lease. Because as soon as you start changing the terms because of revenue management pricing, it'll change the -- move the numbers around a little.

And then I was just hoping you could talk to Southern California. You kind of mentioned some supply pressures. Kind of how you see that playing out in the second half of the year and if supply is skewed to the second half of the year in Southern California and thoughts into '18. And how -- like how should we think about like the duration of this supply pressure, maybe comparing it to what we saw in Northern California last year? And have you seen any improvement in the jobs? Or kind of should we expect this -- the same level to continue?

Juan, it's Mike. I'm going to try and attack that question, and maybe John will want to add on to that. We see supply continuing in L.A, actually increasing a little bit in 2018 relative to 2017. Orange County, however, seems to drop off pretty significantly in '18 relative to '17 but will remain pretty consistent for the rest of the year. And we have actually a pretty large increase expected in San Diego for '18 over '17. So that's how that plays out, and that compares to reductions, pretty big reductions, in Northern California in '18 around 40%, and around 10% in the Seattle marketplace. So that is one factor. And then, as you noted, the other factor is what's going on with jobs. And so we brought those numbers down pretty substantially from last quarter to this quarter in terms of the Southern California job growth. And -- but do a couple of months make the year or the quarter really fundamentally changed? I'm not sure we can answer that question. We tried to highlight some of the factors that are influencing or, we think, reducing job growth, which includes this issue of the shortage of skilled workers and overall low unemployment rates. So the availability of workers is not there, and I think that's probably the key factor that is limiting job growth. The answer to that, obvious -- the answer to that would probably be that wages go up, and people in other parts of the country relocate to the West Coast and take those open jobs. We haven't -- I'm not sure how we track that, but I think that is the key. And those forces, which will put pressure on wages and, hopefully, push them up and make it more attractive to make a move from the East Coast or the Midwest to the West Coast. We think that's ultimately the (inaudible).

I'm just going to add just a couple of comments. As Mike said, the -- for jobs overall, our April and May really reflected the nation as far as the level of weakness. And then June, it came back stronger. So just like the U.S., there's a little bit of a mixed message there. And then just a little bit more commentary on the marketplace. In NorCal, and I referenced earlier, the -- what we're seeing in L.A. with the concessions and now some of the stabilized assets giving concessions because of the 8 weeks free or 2 months free at the lease-ups, how that is similar to what we saw in NorCal. The one difference is in NorCal and Seattle the markets are more seasonal. So towards the second half of the year, they just seasonally drop pretty significantly. Whereas in Southern Cal, that tends to not happen. It comes down a little bit but not very much. So how this thing plays out, I suspect it plays out a little bit stronger than NorCal did last year.

Our next question comes from Nick Joseph from Citigroup.

In terms of the preferred equity and net debt opportunities, what sort of competition are you seeing in the market today?

This is Mike. I'll take that one again, Nick. We're seeing more competition, generally speaking. And at the same time, I think that we're seeing somewhat of a lower deal flow. So we're seeing both of those occurring. And that's pretty consistent with what we see on the development side. And John Eudy is here. He may want to add to this. But overall, we think fewer development deals are penciling, primarily because costs are growing faster -- construction costs are growing faster than NOIs, which is putting pressure on development deals. And so I think, generally speaking, the number of deals that make sense and that pencil are fewer than they were a year ago, let's say. And so that obviously cuts into the preferred equity and debt program as well.

And just in terms of rent control initiatives. Do you have any update on those, recognizing the market has been stopping and starting in terms of rent growth? But yes, any update there would be great.

Yes, it's Mike again. There are 100-plus bills that are in the state legislature right now, and many of them deal with housing. And actually, I was going to note that there's a really good summary of a lot of the activity in the -- in an LA Times article dated June 1 of this year. I guess, the big question is what, if anything, hits the ballot in 2018. There have been discussions about Costa-Hawkins, which is a statewide rent control measure that basically limits the extent to which local governments can enact rent control. That is the big discussion here. But there's a lot of activity out there. I don't think at this point in time -- and the reason why I didn't include it in my script, I don't think at this point in time we can conclude much from all the activity. I'll give you some of the -- maybe the areas that some of these bills are dealing with. Certainly, affordable housing production is one of the key areas. One, for example, allowing smaller units as low as -- as small as 150 units -- 150 square feet per unit, more housing of all types. A bill, for example, that will expand the area around a BART station that can be developed as housing from 0.5 miles radius to 1 mile radius; raising money for housing of all different types from bonds and other types of things, transaction fees on real estate, eliminating the mortgage interest reduction on second homes and doubling the tax credit for low and mid-income renters. So there's lots of activity. That's just at the state level. The local level there's activity as well. So there's a lot of things happening in California and a lot of discussion, but it's probably not the right time to conclude anything from all of this.

Our next question comes from Gaurav Mehta from Cantor Fitzgerald.

So early in the call, you talked about median home prices going up in Seattle and Northern California. And you also mentioned that a significant part of Essex portfolio is convertible into condos. First, wondering if you could provide some more color on that. Is that something on your radar?

Yes, it's Mike. This is definitely on our radar. And we have somewhere around 8,000 to 9,000 apartments that can be converted into condominiums. Some require some additional work in order to perfect that process. Virtually, everything we build, we have some kind of condo map at some -- in some stage and so -- including a couple of the deals that we have recently started or can start in the near future. And so I know John Eudy has spent a fair amount of time looking at that. But just to remind you what our overall metric is there. We need to see a substantial premium of condo values or the value of our property as a condo, considering all the cost involved, relative to its value as an apartment building. And so obviously, apartment values have done really well over the last several years. And so we are starting to see some of those premiums for for-sale housing relative to apartments, but it's -- I think we have a ways to go. It certainly helps. For example, in San Francisco we had 9.2% increase in the median home price, and we didn't see anywhere near 9.2% rent growth in the last year. Therefore, that is starting to build this premium. But I'd say as a general statement it's not quite there, but we're definitely monitoring it and focusing on it.

Okay, great. And as a follow-up, I think you talked about how difficult it's getting to develop more assets because they're at higher costs. I was wondering when you think about your pipeline over the next few years should we expect you to do any more developments outside of 2 starts that you mentioned earlier in the call?

Yes, John, do you want to...

Yes, this is John Eudy. We -- I think we mentioned in a previous call we've got up to 3 deals that we anticipate starting between now and year-end. All 3 have legacy owner land costs and don't have some of the exactions that are being asked for in approvals being granted today. So you could expect those 3 to occur late Q3 to early Q4. Beyond that, the pipeline is very, very skinny. We are looking at a couple of other opportunities and trying to be opportunistic where we can. But clearly, a year from now, if you look at our pipeline in process, it'll be significantly less than it is now.

Our next question is from Nick Yulico from UBS.

This is Trent Trujillo on with Nick. Just wanted to follow up on some detail on your guidance range. You tightened and increased the same-store revenue guide for the year. So can you maybe talk about your forecasted second half San Francisco rent growth expectations? And along similar lines, earlier in the year you provided some additional detail on same-store rev expectations by region. Do you happen to have an update on those underlying ranges, if you amended the aggregate range?

I would point you to -- as far as the region-by-region basis, I would point you to our S-16 that has the outline for what our expectation is for the year specifically. And for the year, for the portfolio total, the second half of the year, our range would imply on the low end; second half is at about 2%. And on the high end, to achieve the high end, it's closer to, say, 4%, to get us to the average of -- the 3.6% average.

Okay, that's helpful. And just maybe to get into the same-store expense side,. You provided some -- a lot of color in your prepared comments. Just wanted to go back to something that you had mentioned earlier in the year about second quarter expenses projecting to about 4.5%, and they ended up well below those expectations. So just a little bit more color on what you did to improve expenses and if there's anything that we can expect going forward as additional expense savings?

Sure, happy to. As far as our first quarter call, we had announced the 4.5% expense growth. And at that point, we had not contemplated the property tax benefit. But also, we had expected that in Q1 -- due to the storm activities in Q1, we had expected to incur the normal painting, tree trimming, et cetera, those activities occur in the second quarter. But it made sense to not do that during peak leasing season. And so that's the $0.03 that still will occur in the second half of the year. And then, of course, the combination of the various operations and initiatives that John Burkart mentioned earlier that led us to our confidence to lower the overall expense guidance. But we're not expecting more than what we are -- what we talked about earlier.

Our next question is from Austin Wurschmidt from KeyBanc Capital Markets.

Just a quick one. You talked about you lowered your internal cap rate about 10 basis points. And I was just curious if you could talk about what you're seeing in the transaction market in terms of volume as well as the number of bidders and who the bidders are.

Yes, Austin, it's Mike. Thanks for the call. Yes, we lowered our portfolio NAV, as noted, by about 10 basis points. And really, that was the culmination of looking at all the transactions that we've done over the last, let's say, 6 months or so and realizing that we basically outperformed what we expected per NAV model. And so we lowered it. I think that was probably done back in June, I'm -- May-June time frame, something like that. So it was just simply we're outperforming what our NAV model said, and so we know we need to tighten it. In terms of the things that are -- the properties that are most attractive and the types of bidders, generally, the REITs are not in the market. Obviously, you saw the -- Monogram take private transaction and an [NCO] JV buyout and that type of thing. But for the most part, we're not seeing a big REIT bid. But we are seeing many institutions that like apartments and want to invest in apartments. And so I'd say the institutional side has been very, very strong. And they are most focused on one of 2 things. It's very well located and high-quality properties generally within -- not necessarily just CBD but, say, the top areas, high-quality properties and then the value-add component with a partner that can execute that. So those 2 specific types of things are seeing multiple bidders. They're seeing a few rounds of best in finals and that type of thing that are -- normally go along with those and prices that are generally, once again, exceeding our expectations. Hence, my comment in my prepared remarks that we are often out bid.

And then just curious, when you think about same-store revenue growth expected to bottom in the third quarter and occupancy going to be flattish in the back half of the year, should we expect that blended lease rates for the portfolio to turn positive on a year-over-year basis sometime in the back half of the year? Or has any of that changed, given some of the supply dynamic getting pushed out?

Yes. So you're saying blended lease -- new lease rates. We do expect that our -- the rates right now are above a year ago, and we expect that to continue. Last year, we had quite a falloff in the second half. Our expectations are to be more -- this year to be more consistent with the normal year. And so that'll ultimately create a greater spread. So in the end of the year, if you look year-over-year lease rates, say, December over prior year's December, that would mean closer to a 4% year-over-year rate that we would end on is what we're looking at.

Great. And then just last one for me. Just with all the moving pieces within the Northern California portfolio in terms of jobs being added in San Jose, you talked about Adobe and Google, any plans or thoughts on changing any submarket exposure within the Northern California region?

This is Mike. I think that within the Northern California region, we still like San Jose a lot. And it has, we think, some of the better parts -- the rent-to-income ratio makes more sense. And it seems like just it's the area that's receiving the most activity. It's also the jobs and locating apartments near the jobs. It seems like that is a logical place to be, so we're certainly interested there. But I'd say that we would consider properties in other parts of the Bay Area. Part of this is a function of cap rate and a function of what it is and what kind of value we can add. So I'd say we're not going to rule out different parts of the Bay Area, but San Jose would be one of the areas that we like a lot.

Our next question is from Rich Hill from Morgan Stanley.

You've discussed this in various different parts throughout the call, but maybe want to just take a step back and think about guidance in terms of supply versus demand. So obviously, you've taken guidance up at midpoint. From a high-level standpoint, maybe then drilling down to some of the individual MSAs, what's driving that higher guidance at midpoint? Is it supply getting pushed out in some of your markets? Or is it maybe stronger demand than you would have thought? How are you thinking about the supply versus demand balance?

Yes, this is Mike. Honestly, we don't know exactly what it is. I mean, the enemy here is 6 weeks to 2 months free rent, which draws people out of the stabilized community and softens pricing power throughout the portfolio wherever it occurs. And so I think the essence of what you're asking is where are we going to see 6 weeks to 2 months of concessions within the markets up and down, from Seattle to San Diego. Because that will be the place the pricing is impacted to the greatest extent. Because typically in California, we offer a lease-break fee, given the way the laws work out here, that's equal to 1 month free. So if you get 2 months free, basically, the lease-up is going to pay the lease-break fee, and they're going to pocket -- the resident's going to pocket the other month. And so that's a lot of incentive really to move out of the building. So I guess, anecdotally, when we say some of the supply is being pushed out, what we mean is when we start seeing that 6 to 8 weeks, that means that there's 2 or 3 or more lease-ups competing directly against one another in a local marketplace, and that is causing the pricing disruption within that location. Generally, that will always clear the market at some point in time. And when that clears, we will start seeing much greater pricing power. And again, it's exactly what happened in Northern California, and we suspect it will happen in other parts. But this isn't like we go out and count every quarter the number of lease-ups that are coming into the market because, candidly, we can't because you can't see within a building -- let's say, a building contains 200 units. We can't go within that 200 units and figure out exactly how many units are going to come to market that are going to be completed. So you have to use the anecdotal process of how -- what are lease concessions in the market and how is that affecting price within the local markets. So that is the way we do it. We look to overall supply and demand for a pretty good indication of where we think the biggest risks of that are. And anywhere that has very significant supply, so Seattle, we're concerned about; Downtown L.A., concerned about. Supply goes up a little bit projected in Downtown L.A. Downtown San Diego, supply goes up. But pretty much everywhere else, supply is expected to go down. And actually, let me correct Seattle. Seattle actually is expected to go down in 2018 by a little bit but still remain at a pretty high level.

Got it. And then I just want to ask quickly about San Francisco only because we've, I think, heard some different data points as to whether or not supply is getting pushed out or not. And I know you're not explicitly focused on that. But what are you seeing in San Francisco? Is the supply going down in the near term? How are you thinking about that?

Yes, San Francisco is interesting. We have San Francisco at 5 weeks free right now, but that's down from 6 weeks free recently. So again, back to my anecdotal evidence, we'd say that it's concerning, but it's bouncing along at that acceptable range. Generally, at 4 to 5 weeks free, it's not enough incentive to draw people out of the East Bay, for example, into San Francisco. You get up to 8 weeks free, guess what, people that are living in Oakland are going to now live in San Francisco. And so the other point, I guess, I'd make as it relates to the Bay Area in general is that there were 25 active lease-ups in the Bay Area, some of them in San Francisco. And 10 of those 25 are in -- at the final lease-up phase, so -- and that involves a couple of thousand units. And when they're gone, I think it'll continue to be tighter. So again, we see the projection for the Bay Area to become a tighter market with less lease-up velocity, which should help us with price.

Got it. And just to -- I'm sorry for being redundant here. The way you look at it it's difficult, or you don't want to state whether that's demand or supply. But you do know it's a better market for you.

Well, San Francisco is -- again, I mentioned the unemployment rate, which at 2.6%, a pretty good indicator that demand is very strong there. And that's -- I don't think that's the issue. I think -- on the pricing issue, I think plenty of people want to live in San Francisco. The reason why they don't is because of price. That has been true of San Francisco for a long period of time. So I mean it's kind of like in -- take Manhattan as the ultimate example. If Manhattan prices go down, you're going to have a flood of people that move into Manhattan. Well, San Francisco is the same way out here. So demand is generally not the problem. It's a matter of price. And that's why I focus on these concessions as being the critical key element of this.

Our next question comes from John Kim from BMO Capital Markets.

It sounds like in Seattle despite the increase in vacancy this quarter for you the characteristics are overwhelmingly positive. I'm wondering where you think we are in the cycle in Seattle and if that's changed at all in the last few months?

Yes, it's Mike. And John looks like he was dying to take that question, so I'll give him a chance to chime in. Again, Seattle's a little bit of an enigma for us. We expected it to be a little more muted over the last couple of years, and we've been wrong. It's turned out to lead the portfolio. And the thing that obviously concerns us is the supply. Although you have -- got to point to Amazon here, and look at what they've done in Seattle. And hate to focus on any single entity that has such a dramatic impact, but, certainly, that one does. And so we view Seattle, given the amount of supply it produces, as a little bit riskier market, which means we would seek a little bit higher cap rate if we were investing there. And we don't want to continue to add to the portfolio in Northern and Southern California and not sort of keep that pro rata share up. So we will look at acquisitions in Seattle, but we'd like to be pretty careful about buying in that market. Going forward, I guess, we're more or less jumping onboard with the Seattle train and saying, "It looks pretty darn good, and it looks like it's not enough end anytime soon." So I think that as we go into '18, we're going to view it as one of our best markets. John?

Yes. I would just add. I remember these calls years ago when people would ask us about Boeing. And you look at the changes that have gone on in Seattle, really fundamental changes, and they continue to this day. Yet, Seattle still has a rent-to-median income of like 20% compared to many of our markets in the mid-20s. And so there's still room to go. So it's a market that's under change -- undergoing change. It's a very positive change, and I think it still has legs.

But as far as weighting for your company, it's still going to remain around 18% or something?

I mean, we target 20%, but that can ebb and flow. Again, cap rates and deal flow and opportunity becomes part of that equation. We're not developing in Seattle right now because we don't want to be the one that is -- half completed when the cycle ends. And so -- again, we like Seattle. We're a believer and more optimistic about it today than we were a year ago but an area to be cautioned -- cautioned area with.

Okay. And then on your balance sheet, marketable securities went up $13 million this quarter to $152 million. Can you just remind us what this is mostly comprised of and if you own any shares in any public company?

Let's see. Marketable securities. That is primarily our insurance captive activities. And so there's not a meaningful change in investment activities there. And so we don't have any meaningful ownership of any of our peers.

Our next question is from Alexander Goldfarb from Sandler O'Neill.

Just a question -- 2 questions here. The first one is on Downtown L.A. Just -- that market has been transforming for over a decade, and there's always a lot of supply there. Do you have a concern that, that market just because it seems like a lot of -- there's a lot of push to have development there that, that will remain a market of imbalance where developers will never pull back just because of the political pushing to do development there? Or do you think that it really will pull back and finally allow you guys can have the landlords to gets pricing power there?

Yes, Alex, it's Mike. It's a good question. And obviously, we don't have a perfect answer to this one. We entered Downtown L.A. in the late '90s, and we had kind of 2 scenarios. One was it continues to be the place that everyone leaves at 6:00 at night, and no one's there for dinner, or no one lives there. And the other was it changes to be more like a 24-hour city. And I think that we now know where that's going. And I think the California Global Warming Solutions Act of 2006 helped it, where California is trying to get people out of the suburban sprawl type of program and into high-density residential in urban areas. And if there is a shining example of that occurring, it's probably Downtown Los Angeles. The amount of transit dollars that are going into that area and the amount of just development in general is really, I think, transforming Downtown L.A. And I think that our thought is that it will be choppy over a period of time. But remember, there is a constraint, a financial constraint, on new development. And so if rents disconnect too much from construction costs -- and construction costs, there's no evidence they're going up at a different rate in L.A. than they are in Northern California. Maybe there's a little bit of an advantage down there, but I think the rate is still the same. And therefore, there's an economic reason why you can't have unfettered development forever in Downtown L.A. So to sum this up, I would say we're a believer in Downtown L.A. We're not going all in, however. We think it's a market that can take some period of time to get to what it's ultimately going to be. Remember, all the jobs are already there. It has a huge downtown. And so what we're really saying is at what point in time will people choose Downtown L.A over a commute from, let's say, Pasadena, Glendale, Burbank, Westside L.A, et cetera. The other phenomena in -- well, really throughout California, again, emanating from Global Warming Solutions Act, is the investment in cars and highways is very -- very small relative to the demand. So I see traffic getting worse. I think that, that puts pressure on these commutes. It gets people out of their cars. And again, I think Downtown L.A is a winner in that scenario.

Okay. And then the second question is just going to John. John, you mentioned that there is -- I think you said softness in June versus earlier in the year. And then you sort of talked about the flat occupancy in the back of the year. Was that a comment portfolio-wide? Or that was more you talking about like Orange County and L.A.?

Sure. I mean, over the whole portfolio, our occupancy dipped a little bit in June. And if we go back to NAREIT, as I was saying, we had a really strong January through May. And we were not going to miss the market. So we pushed pretty hard on rents. And I think we found basically the top. But that's why I went into a little bit more depth in the comments to say that in July we then turned around and gained occupancy by just making a few adjustments with rents. So I don't see it as a market problem, but it really was across the whole market. It was most pronounced really in Seattle. And part of Seattle relates to turn, as I mentioned, and part of it relates to us really hitting the peak of the market as well as Orange County and some L.A.

Our next question is from Wes Golladay from RBC Capital Markets.

Looking at the supply next year in Seattle, are you more concerned about the CBD where you don't have exposure or more of the submarkets such as Bellevue, which is going to have an uptick?

Wes, it's Mike. Well, I have a chart somewhere that has the breakdown. But I think that we still see more supply in the downtown. And obviously, our portfolio is largely on the east side. And so we think we have a little bit of protection relative to that. Does anyone have that other chart? Because I don't have the exact breakdown of the supply in Seattle. Yes, so it looks like of next year's -- the breakdown this year versus next year, there's a slight increase in supply in the downtown that's roughly, let's say, 4,500 units. The east side, very similar to this year, at somewhere around 2,700 units. And to the north and the south, they are about 1,500 units. So the downtown gets a little bit more, and the east side and the north and south get a little bit less. And overall, supply is down a little bit in Seattle.

Okay. And then looking at your cap rates that you cited, the 4% for the As, is that a nominal or economic?

Well, that's why I say that it's using the Essex definition because I think our definition is a little bit different than the way the market looks at it. And let me just summarize because I can't translate it immediately in my head. Our definition of a cap rate is using market rents today in the marketplace today with a market management fee or management costs and marking property taxes to market and assuming a 95% occupancy -- financial occupancy rate. Pre-capital. Pre-capital. No CapEx in that number.

Our next question is from Drew Babin from Robert W. Baird.

Just on the macro comments, Mike, that you made in the prepared remarks about less millennials entering the workforce. Well, that might be the case. Are you seeing more millennials kind of hitting an age range maybe closer to where your average tenant is? Because I assume your average tenant is not 22, 23 years old. Any comments on that?

Well, I think the markets -- we're talking about the market in general. And so we will not necessarily reflect the market because if you have A product versus B product, you'll say the millennials are more likely to rent the Bs. However, puts pressure on the pool, and that moves people around within the pool. So I'm not sure that our actual performance is going to be reflective of exactly this. I think what we're saying with respect to that -- and just to put this into -- make sense out of it, we're starting to look at demographics as part of the overall supply-and-demand relationship. And I look back and think that had a rough -- relatively easy time over the last 30 years because this business came down to a few factors: supply, demand, the affordability between apartments and for-sale housing and maybe commute patterns. And now we have to deal with rent income, demographics and maybe regulatory issues. So it's a little bit more complicated. But I'll throw it back to John. John, within our portfolio, do we see any notable changes in who our renters are?

No. And we -- I think it would surprise people. I think people tend to think that our portfolio is going to be full of millennials or something of that nature. We really have a diverse group of people across our portfolio. Some people tend to be renters for the long term, and they're phenomenal people. And others kind of come and go, and that's more or less the millennial group.

Okay, that's helpful. And John, one last question. Could you provide loss to lease by region?

Sure. So as we go to SoCal, our loss to lease for June was 2.3%; in NorCal, 2.8%; in Seattle, 7.2%. And then, as I said in the opening, that brings the average to 3.4%.

Our next question is from Michael Kodesch from Canaccord Genuity.

Actually, just a follow-up on Drew's question there. For Seattle, what was that trending at on loss to lease? What's that trending at for the past few quarters? Would've elevated from 7.2?

Sure. So if we go back a year ago, it's probably the easiest. So if you go back to June '16, it was 9.5. And then if we go to December '16 -- this is a wild ride. So December '16, it goes to a gain to lease of 1.6. So very big reversal. The market is very seasonal. And then we come back to May of '17. It was 7.4. And now in June of '17, as I said, it's 7.2. Seattle has a huge level of seasonality in that market. It's our most seasonal market. The Bay Area is less and then SoCal much less.

Great, that's really helpful. And then -- most of my questions have been answered, but just kind of one more general one. In terms of move-outs, are you guys hearing at all any more -- or more move-outs due to moving to single-family rentals by any chance? And how do you guys kind of factor that into your supply outlook? Do you guys include the single-family rental market in there at all?

Yes. Actually -- this is Mike. We do, but indirectly. We do supply and demand as a -- looking at all housing. So if someone goes from -- if someone moves out of their house and rents it out, we don't track that per se because what we try to do is we've tried to look at the entire housing stock: what's the net change in the housing stock, what's the net change in demand represented by job growth and maybe now demographic factors. And how do those 2 relate to the market? Is the market becoming -- is there an excess of demand over supply or not as to the market? In terms of what people actually choose to do, it's a function of, again, price point, affordability, et cetera. But again, we try to look at supply and demand very much for the whole organization. Actually, one of the interesting -- I'm going to segue into something else. Interesting numbers is -- someone may ask or be concerned about the level of multifamily permits, which remain pretty high in our markets. And so we looked at that recently, and we would agree that if you look at trailing 12-month multifamily permits, they hung in there pretty well. However, if you look at total permits so -- part of this is that the single-family permitting is way down. And therefore, if you look at total permits for housing, it's either near or well below -- all of our markets, near or well below the long-term average. And again, the long-term average is not a huge number. So the fact that permitting is somewhere near the long-term average, and we continue to do a little bit better on the job growth side, should mean that we will continue to have a little bit of wind to our back as it relates to supply and demand. And by the way, there are very few single-family rentals in the city of Palo Alto because the cap rate would be like 3% or something like that. So the single-family rentals tend to be on periphery of the Bay Area and where the cost to housing is much lower. And that's the way it is. That's why we love this place.

Sure. But I guess maybe just a little bit more anecdotally. Are you hearing about any more -- with the single-family rental pool becoming a little bit more institutionalized, are you hearing more move-outs as a result of that or heading towards that? Are you seeing any trends that way?

No, not at all. Again, as Mike said, the single families, as it relates to the institutional ownership, those are really outside our market. You -- they may have literally 1 house in our Bay Area market, I think, in Pleasanton. They just don't have penetration in our markets. They're outside, and they're going to be Fairfield or other markets that are considered the Bay Area, but when you map it out, it's not reflective of our locations and our tenant base.

Our next question is from [Artie Cole] from Zelman & Associates.

Just wondering about Seattle here. If I look at your June deck, right, you guys were doing 7% in Seattle in April and May. And then you reported 6.6 for the quarter, which kind of tells me that June was a lot weaker around the 5.8%, 6% range. Is there something specific that happened in Seattle in June? I know you guys mentioned it's seasonal, but what's pricing like there today versus earlier in the quarter?

Sure. Sure, this is John. So June for Seattle was 5.5%. And that is really, again, a combination of, as I mentioned, our occupancy declining. So the occupancy in Seattle declined 90 basis points from where it was at the start of the month. And that is a function of the number of units turned, again Seattle being highly seasonal. So a lot of units turned, and that's a big part of it as well as us pushing rents very hard. But I wouldn't say it's reflective of the market having trouble. And as we've said all along, we expect the trajectory of our year-over-year to continue to decline and the third quarter to be our low point. So it was not a surprise to us that the year-over-years continue to decline like this. This is as expected, as we said from the end of last year. But we've since picked up some occupancy in Seattle, again, as expected, as we planned management and will finish up the quarter with solid occupancy looking into the fourth quarter. So that's kind of our management plan there. But does that help?

Sure, perfect.

And our last question comes from Conor Wagner from Green Street Advisors.

John, what was new lease growth for July, thus far in July?

Yes. So new lease growth for July is -- I don't actually have it directly in front of me, but it's less. Year-over-year, it's going to be about, say, 2.5% versus the 3.6% in June because we pulled rents down some and gained occupancy. I mean, overall, we moved rents down in July about 1% and then took 40 basis points or decreased availability by 40 basis points, which is huge. So we're sitting now at 95.1%. So where I'm going with that is we pulled it down a little bit more. Then it's not really reflective of the market. It's more strategic in management. We pulled it down a little bit more and filled up the portfolio and now pushing the numbers back up. So does that help?

Okay. Yes. Just to be clear, you said 96.1% I thought. Is it -- or is it 96.5% you're at for the quarter, your expectation?

For the -- right now, where we sit, occupancy is 96.4%, and our availability is actually 4.9%.

Okay. Okay. Great. And then what's the opportunity on the BRE portfolio and continued redevelopment there, even just -- not full scale, but even just kind of lighter CapEx and upgrade and getting that up to speed with the rest of the portfolio? How has that played out this year? And is there any further opportunity there next year?

Wow, we don't even separate out the assets like that anymore. The -- I would say across the board at our portfolio it's like all of us in this room here; every year, we get a year older. And so we're on a pretty steady path right now. So if you look at renovation and, say, if we renovate 5% of our units, that would imply a 20-year life for the, say, kitchen and bath. That's kind of where we tend to be at. And I think that will continue that way. And the BRE portfolio is largely getting rolled in or has been rolled in as it relates to most of those things. But what I mentioned on the call also earlier was we are now taking a little bit more advantage of some of the strategic locations and finding some opportunities on expenses and other areas there that are out -- are opportunities at this point in time.

Great. The last one. Do you -- so San Francisco showed a slight acceleration versus last year. And it's obviously very small for you guys, but it's big in terms of how it impacts the East Bay. Do -- when do you expect -- I mean, you said -- I think, Mike, earlier you said that people aren't being drawn back into the city from the East Bay yet. But at what point do you think San Francisco starts to begin to push people back out into Alameda?

I think it's -- to answer your question, it's Mike. I think it's happening. This has been an ebb and flow, an interesting ebb and flow. When San Francisco has 6 to 8 weeks of concessions, again, people start flowing from the East Bay into San Francisco. And when those concessions abate, it actually goes the other way because people are very price sensitive. And let's face it, somewhere between 12% and 16% of annual rents, it's a big incentive. And I think that's the key to what we're trying to communicate. And so that flow will, I think, directly relate to the amount of concessions and the overall relationship between Oakland rents and San Francisco rents. So Oakland underperformed last year. It's doing a little bit better this year. And I would expect that back and forth activity to continue depending upon the concessionary environment.

But just again, on the direction of San Francisco, that if the concessions stay low, that should begin to reflect more in your Oakland portfolio in the second half of the year or early next year?

That's what I think is happening. Yes, I think people now can't afford San Francisco. And so they're staying in the East Bay.

This concludes the question-and-answer session. I'd like to turn the floor back over to Mr. Schall for any closing comments.

Yes. Thank you, operator. Hey, we really greatly appreciate your participation on the call, and we hope to see many of you at the BofA Merrill Lynch conference next month. Have a good day. Thank you.

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