Essex Property Trust Inc (ESS) 2017 Q4 法說會逐字稿

Good day, and welcome to the Essex Property Trust Fourth Quarter 2017 Earnings Call. As a reminder, today's conference is being recorded.

Statements made in 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 on current expectations, assumptions and beliefs as well as information available to the company at this time. A number of factors could cause these 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 fourth quarter earnings conference call. John Burkart, Angela Kleiman and I will make brief comments, and John Eudy is here for Q&A. Today, I will discuss 3 topics: our fourth quarter results and expectations for 2018; recent regulatory activities; and an update on investment markets.

Onto the first topic. 2017 was another successful year for Essex with core FFO per share growth of 7.9%, exceeding the high end of our initial guidance range and mostly driven by the same property portfolio, accretive investments and opportunistic capital market activity.

As always, we focus on driving growth to the bottom line, which allows us to have one of the best track records in the industry for dividend growth. To that end, later this month, we expect our Board of Directors to approve our 24th consecutive annual increase on the common dividend, positioning us nicely to become a dividend aristocrat a year from now. Since the IPO in 1994, we have paid about $85 in dividend, roughly 4x the IPO price.

On the Q3 conference call, we expressed concerns about slowing job growth for both the nation and on the West Coast, noting that unadjusted total non-farm employment declined sequentially in most of the Essex markets in Q3 2017. In Q4, job growth improved in the Essex markets with the 3-month trailing average job growth at 1.6%, better than the 1.4% estimate reflected on last quarter's S-16. The significant volatility of job growth in the Essex markets and the improvement in Q4 is graphed on Page S-16.1 of the supplemental, along with historical information to provide context.

Turning to our outlook for 2018. We published our key economic assumptions for the year on S-16 of the supplemental. In 2017, the U.S. economy experienced significant improvement in GDP relative to previous years, and we believe the recently enacted tax reform bill will further stimulate economic growth into 2018. Thus, we've increased our GDP growth expectations in 2018 to 2.7%.

Turning to job growth. We expect U.S. job growth to remain relatively flat in 2018 at 1.4%, primarily due to the tight labor markets and low unemployment rate, both nationally and on the West Coast.

Job growth in the Essex markets is expected to be 1.6%, consistent with 2017, which should create about 201,000 jobs across our footprint. This should be sufficient to drive housing demand above the 67,000 total housing units expected for delivery, both rental and for-sale, thus continuing Costa California's chronic housing shortage. Office construction, which often precedes job growth, continues at a robust pace in the tech market, representing around 6% of stock in the Bay area and 5% in Seattle.

For several years, virtually all of the apartment supply has been focused on the luxury segment, creating shortages at lower price points and stretching rental affordability.

When wages grow faster than rent, as is expected in 2018, the affordability issue for apartments abates. Thus, while wage inflation may negatively impact interest rate, it improves affordability and often, rent growth. In 2017, personal income growth has been estimated at 4.5% in the Essex markets compared to 2.8% for the nation. In 2018, both the U.S. average and Essex markets are expected to accelerate to 4.3% for the U.S. and 5.3% in the Essex markets. As you might expect, rent-to-income ratios fell or remain unchanged in 6 of the 8 metros in which we operate, including those in Northern California. Improving economic conditions, overall lower supply level and better affordability underlie our expectation for better market rent growth in 2018 versus 2017.

Onto my second topic, regulatory matters. I've commented on prior conference calls about California bill 1506 proposing to repeal the Costa-Hawkins Rental Housing Act, which limits the scope of rent control enacted by local government. As in 2017, AB 1506 recently failed to obtain the required support to move out of committee, making it unlikely it will be enacted at least in 2018. The bill analysis available online references a 2016 study by the Legislative Analyst's Office. It states that "expanding rent control protections would not increase the supply of housing and likely would discourage new construction." While we concur with this view, it misses other important issues.

A recent study of San Francisco's rent control by faculty at Stanford Business School found that longer tenancies and reduced supply drove citywide rents upward, as apartment hunters had to compete for fewer available units. As noted last quarter, there is also a referendum to repeal Costa-Hawkins, which is currently in the qualification process for the November 2018 ballot.

In response to this effort, a coalition named Californians for Responsible Housing was organized to oppose the effort. The coalition has strong support from owners, industry associations and other impacted groups. We will provide an update on future calls as warranted.

Similar to AB 1506 in California, there is a bill in the Washington State legislature to repeal the state's ban on rent control, and it seems likely that other states will follow California's lead. We are monitoring the situation and will provide an update on future calls.

Turning to the federal tax bill that passed late last year. While there has been a lot of attention on deduction limits related to state and local taxes, it's important to distinguish between renters and homeowners. For renters who don't deduct property taxes or mortgage interest, the lower tax rates are a clear boost to after-tax income. These new limits also reduce the tax incentive to buy a home, likely resulting in greater demand for rental housing. The tech market in Northern California and Seattle should also benefit from the repatriation of cash held overseas by large tech firms amounting to hundreds of billions of dollars. Apple has already announced plans to repatriate cash and expand domestically. Overall, there has been a lot of negative press related to the tax law changes and its effect on California, which generally appear to be overstated, certainly from the perspective of apartment ownership. Finally, my third topic, investments.

Regarding asset values, recent transaction activity indicates that cap rates remain stable. A quality property and locations continued to transact around a 4% to 4.25% cap rate using the Essex methodology. B quality assets and locations are generally 25 to 50 basis points higher, although often contemplate upside from redevelopment and/or value-add activities. With the REITs mostly on the sideline due to the cost of capital and a meaningful increase in apartment mortgage rates, there are fewer motivated apartment investors in the market as compared to a year ago.

Recent increases in interest rates have caused some noise in negotiations, but ultimately, cap rates have not changed at this point. In December, one of our co-investment entities completed the sale of 2 properties, each about 28 years old, at about a 4.1% cap rate, which represents a lower cap rate and higher valuation relative to my previous comments about cap rates.

During the quarter, we started one development in Hollywood, which is the legacy project where we have a very low land basis. As previously noticed -- noted, it has become very difficult to make new deals pencil given double-digit increases in construction costs, coupled with slower rent growth in the recent past. Therefore, we have not assumed any new starts as part of our 2018 guidance. Overall, we're seeing a general pullback in development starts in our markets, which we believe will lead to lower levels of new supply in most of our markets over the next several years.

Finally, we originated 3 preferred equity investments during the quarter for $65 million as outlined in the press release, bringing our total commitment at year-end to $394 million. We expect to bifurcate the program into 2 parts going forward. The first part will be for under construction apartment properties, which will be capped at $400 million. The second part will represent investments involving completed apartment properties, which will generally have a lower preferred return and will be subject to an aggregate cap of $500 billion. We're currently seeing a slowdown in our pipeline of opportunities to originate preferred equity deals, confirming our belief that apartment development starts are moderating. That concludes my comments. Thank you for joining our call today.

I'll now turn the call over to John.

Thank you, Mike. Essex finished the year with another good quarter. Our fourth quarter year-over-year same-store revenue and NOI growth was 3% and 3.4%, respectively. Our same-store results were slightly better than our expectations due to higher occupancy, a greater growth in other income and RUBS. These results are evidence of another strong year for the company, and I want to thank the Essex team for their continued dedication to our success. As we mentioned on the third quarter conference call, market rent growth peaked earlier than normal due to elevated supply and slower-than-expected job growth. The negative impact of the early market rent peak will continue as a headwind for revenue into growth in 2018, due to the volume of leases that we signed during the summer leasing months, with little to no increase over the expiring leases. Concessions in the fourth quarter of 2017 were approximately $700,000, consistent with the fourth quarter of 2016. However, geographically, the allocation was very different. In the fourth quarter of 2017, 70% of the concessions were related to Southern California assets compared to the fourth quarter of 2016, where 90% of the concessions were related to Northern California assets. As the concentration of new highly competitive lease-ups has decreased in Northern California, the concessions are declining for the new lease-ups and disappearing in the stabilized communities as expected. Moving forward, we expect to see a more typical seasonal pattern in rent growth, which is assumed as part of our 2018 forecast. Therefore, we expect our loss to lease to rebound quickly as we enter the peak leasing season.

Regarding the executive order signed by Governor Brown as a result of the devastating California wildfires, which effectively limits rent increases on all housing to 10% of -- above the price in place when the order was signed in October 2017, it has been extended for all of California until mid-April 2018 and for selected counties in Southern California through June 2018.

Although the market rents are not increasing at that rate, the application of the law leads to selected challenges such as pricing short-term premium, selected renovation, et cetera. We do not expect that the temporary law as currently applied to materially impact our earnings in 2018; however, we are watching the situation closely. Our full year expenses came in below our original guidance at 2.7% over the prior year as a result of the various cost-saving initiatives that we've been working on. We were able to hold our controllable expenses to about 50 basis points year over prior year, which helps offset the impact of the 7.3% increase in utilities.

Now, I'll provide an update on our markets. In Seattle, job growth remains strongest in the Essex portfolio, posting year-over-year growth of 2.5% for the fourth quarter of 2017. Amazon continued to expand their Seattle footprint in Q4, adding over 300,000 square feet of space and bringing the total expansion for all of 2017 to just under 2 million square feet. Additionally, Microsoft announced a multibillion-dollar campus renovation and expansion in Redmond that will occur over the next 5 to 7 years and add up to 1.3 million square feet of new space. Office absorption in Seattle continues to be robust. In 2017, net absorption totaled 4.2% of existing stock, the highest percentage of any Metro in the U.S. Seattle's median home prices grew at 14% -- 14.6% year-over-year for the month of December, making it the third fastest-growing market in the Essex portfolio, only surpassed by San Francisco and San Jose.

Our year-over-year same-store revenues for the fourth quarter of 2017 were led by the CBD and North submarket at 4.8% and 4.9%, respectively, while the East side and South submarkets grew by 3.6% and 4.2%, respectively.

Turning to Northern California. For the fourth quarter, job growth in the Bay Area averaged 1.7% year-over-year. In San Francisco, Okta and Airbnb signed new leases, which added over 300,000 square feet to the Downtown tech footprint. In San Mateo, next door to our development, Station Park Green, Guidewire Software fully leased an under-construction office project that is scheduled to be completed in the first half of this year.

Moving south. Facebook extended their footprint across the Bay into Fremont, a market where Essex owns just over 3,000 units with a new 190,000 square-foot lease. Tesla also announced that they were expanding their Fremont offices to accommodate 1,500 employees in addition to the 10,000 employees already in the market. And in the South Bay, We Work and Synopsis signed leases totaling over 800,000 square feet.

Over 13 million square feet of office space is under construction in the Bay Area, with San Francisco accounting for nearly half the pipeline and more than 70% of which is preleased. Home prices in the Bay Area continue to soar, as San Jose leads our portfolio with 24% year-over-year growth in December with median home prices at $1 million, over 4x the national average. Essex continued to perform well in the Bay Area during the fourth quarter of 2017, with year-over-year same-store revenue growth led by our Fremont submarket at 5.4%.

Moving down to Southern California. In Los Angeles, job growth lagged the U.S. with 1% year-over-year growth in the fourth quarter. L.A.'s tech footprint continued to expand during the quarter as evidenced by several noteworthy leases throughout the region. Tesla, Facebook and Apple all signed new leases in L.A. during the quarter, totaling 425,000 square feet from West L.A. to Culver City. Coworking companies, WeWork and Spaces leased an additional 150,000 square feet of office space in Downtown and West L.A.

Our L.A. year-over-year same-store revenues for the fourth quarter grew at 4.6% in Long Beach, 3.7% in Tri-City, 3.3% in Woodland Hills and 1.7% in West L.A. We saw a decline of 2.2% in the L.A. CBD due to elevated levels of new supply, which is leading to highly concessionary market. Looking forward, roughly 77% of the projected L.A. market 2018 supply is concentrated in the West L.A. and Downtown submarkets, where 2/3 of Essex's L.A. portfolio is located. In Orange County, year-over-year job growth improved in the fourth quarter to 1%, a 70 basis point increase from Q3. Almost half of the 550,000 square feet of office absorption for the full year occurred in the fourth quarter of 2017, which is consistent with the pickup in job growth noted above.

In the fourth quarter, our North and South submarkets grew at 5% and 3.3% year-over-year.

Finally, San Diego posted 1.3% year-over-year job growth for the fourth quarter. Similar to Orange County, almost half of the total full year's office absorption occurred in the fourth quarter of 2017. Although supply is expected to increase in San Diego in 2018, over 50% of the supply is coming in the Downtown submarket where we only have one asset. San Diego's supply outside of the Downtown is actually projected to be lower in 2018 compared to 2017.

Currently, our portfolio is at 96.7% occupancy and our availability 30 days out is at 4.7%. Our renewals are being sent out at about 3.3% for the first quarter overall. Thank you.

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

Thank you, John. Today, I'll focus on our 2018 guidance, followed by capital markets and balance sheet activity. Starting with our 2018 market outlook. Page S-16 of the supplemental provides an overview of the key housing supply and demand assumptions supporting our market rent growth expectations. In our West Coast markets overall, we expect similar total multifamily supply deliveries this year versus last year, although differences within each major region are more pronounced. For example, we expect Southern California supply to increase by 11% due to L.A. and San Diego. In contrast, Northern California supply is expected to decrease by 28%, primarily attributed to San Francisco and San Jose. We notice that our key vendor, AXIOMetrics, has significantly higher supply numbers than us in 2018. In addition, their 2017 supply was also higher than ours and higher than what was actually delivered.

From reconciling with them, we learned that AXIO moved all of the delayed 2017 supply into 2018, but they have not yet made any adjustments for the expected delays in 2018.

Just a quick review of our process. We approach our supply research with both a top-down and bottoms-up due diligence, which includes driving individual sites to verify the construction progress, and we also phase the deliveries consistent with how we would approach delivering our own projects.

Turning to demand. Historically, job growth in our markets outperformed the U.S., as Mike commented earlier. We expect that trend to continue in 2018 with a forecast of 1.6% for our market compared to 1.4% nationally. Given this economic backdrop, we expect market rent growth of 3%, which is in line with the long-term average, as multifamily fundamentals remain steady. We expect revenue growth to lag market rent growth, which led to our 2018 guidance for same property revenue and NOI growth of 2.5% at the midpoint.

Our forecast assumes lower revenue growth in the first half compared to the second half of the year, as we rebuild loss to lease. There is one reporting change to highlight. Starting in 2018, we are moving property management expenses out of same property operating expenses to be consistent with the peer group reporting. Going forward, property management expense will be reported on a separate line item on our income statement. This change has no impact to FFO or same property expense growth as the prior period will be restated to conform to the new reporting method.

Moving on to core FFO guidance. I'm pleased to report that we plan to continue our long track record of driving operating results to the bottom line. We expect core FFO to grow at 4.5% at the midpoint, which is 200 basis points higher than our expected same property NOI growth. Other key assumptions supporting our 2018 guidance starts on Page 4 of this press release.

Turning to investment activity. In 2017, we match-funded our external activities using a combination of disposition proceeds, joint venture capital and common equity, accessing the most attractive capital source at the time. As for 2018, our only required funding needs are $200 million of debt maturities and $250 million of unfunded development commitment, which is only about 1% of our total market cap.

So far this year, we have repurchased approximately $3.8 million of common stock under our $250 million stock buyback program. We continue to be mindful of current market conditions in order to thoughtfully approach capital allocation. And we plan to continue match-funding our investment activities with most attractive cost of capital and on a leverage-neutral basis.

On to capital markets and the balance sheet. Last month, we amended and increased our line of credit by $200 million to $1.2 billion, which is extendable to 2023. The upsize is primarily a function of the company's growth as it's been over 4 years since we last increased the line. We have also improved our unsecured debt from 58% last year to 65% today. Our balance sheet remains strong with 26% leverage and 5.6x debt to EBITDA. With light debt maturities on the horizon and ample liquidity, we are starting the New Year in a solid financial position.

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

(Operator Instructions) And our first question is from Austin Wurschmidt from KeyBanc Capital Markets.

The midpoint of your same-store revenue guidance assumes deceleration versus what you achieved in the fourth quarter. And Angela mentioned that you expect revenue growth to be lower in the first half of the year, which would imply pretty significant deceleration, I guess, early in the year versus the fourth quarter figure. What's driving that sizable decel given the fact that you expect the market rent growth in 2018 will be similar to 2017?

Yes, Austin. I'll make a couple of comments and then maybe John Burkart would want to follow up. It goes back to what happened in Q3 of 2017, in that we had a period of very weak job growth, which led to a low demand period, significant supply coming in, we signed leases at little or no increase, and we carry those leases, obviously, for typically about a year. And so we're going to carry that -- those leases into the New Year and it's going to compress our growth a little bit. So -- and then that changes as we did get into 2018. We expect a more normal peak leasing season in 2018. And -- but again, jobs can change pretty abruptly anywhere in the United States, and therefore, subject to how the demand curve looks versus how many units of supply come on throughout the year. John, do you have anything else to add?

Yes. No. I'll just add that, again, we feel good. We feel optimistic about this year going forward. But part of it is a starting point issue, as Mike said, and to put some numbers around that. In December '16, our gain to lease was 50 basis points. In December '17, our gain to lease was 200 basis points. So we're, in a sense, starting in a little bit more of a hole. But the outlook is very positive going forward.

And so what does that assume in terms of what's earned in, I guess, going into 2018 from a revenue growth perspective?

Well, if you -- the gain to lease means that our rent in place are 2% below -- the market, I'm sorry, is 2% below where our rents in place are, so it means we're upside down. But again, there's a seasonality to it. So I'm quoting you at the low demand point. But I'm just trying to give -- compare '16 versus '17. But in reality, to answer your question, yes, rents in place at December were lower. As you go forward into January, that 200 basis points gain to lease moved to 130 basis points gain to lease. So it improved. And that's what will happen. Seasonally, rents will move up. We expect them to peak in midsummer and to have a solid year. But my point is the reason why we can have stronger revenue growth overall expected for '18 over '17 when we're looking at this really relates to our starting point. Did that make sense?

Yes. No. That's helpful. I appreciate the commentary there. And then just secondly, it's focused, I guess, specifically on Seattle, which was a market last year that surprised to the upside. It has the most or biggest magnitude of deceleration assumed in your 2018 guidance. And, I guess, I was just hoping you could provide some detail on the range of outcome there and what's really driving the magnitude of that deceleration as well.

We've mentioned for some time that Seattle has, in a certain sense, the highest risk associated to it related to the supply that's out there and then jobs. And clearly, jobs had slowed down some. What we saw at the end of last year is that in a low demand period -- and Seattle is the most seasonal market that we have. It can move up as much as 10-plus percent at the peak and then back down. So Seattle at the low point moved down to a gain-to-lease situation where it was at 490, almost 5%, and then we're pulling out of that. So Seattle market has slowed down in part because of the supply -- or the demand slowed down, but we are seeing a pickup in demand as we had mentioned and expect Seattle to have a strong year, but it doesn't have the same tailwind that we've had in the past.

Our next question is from Nick Joseph from Citi.

Appreciate the regulatory overview. Just in terms of the referendum movement on Costa-Hawkins. What's the process of getting it on the ballot and then theoretically, if it does make the ballot and passes, is Costa-Hawkins immediately repealed or are there additional steps after that?

Yes. It's Mike here. And John Eudy is also here, and he's spending a fair amount of time on this issue for Essex. There is a qualification process, which includes signature gathering, which is the current -- currently occurring, and will go on for another month or two. And at that point in time, we will know whether it would be qualified or not. The industry is assuming that it will be qualified, and so we have mounted pretty strong support opposing the effort. But I want to make sure everyone understands that the repeal of Costa-Hawkins does not immediately mean rent control is enacted. That requires cities or local governments to pass different rent control ordinances. And I think on the last ballot, somewhere around half of them passed, John, and several had not passed?

Less than a quarter.

Less than a quarter. Yes, I know San Mateo, Burlingame, Alameda were defeated and then 1 or 2 passed. So it's -- there's a process here. This is not an immediate thing, but there's a process here. And we feel pretty good about the effort to oppose the proposal.

But if it is on the ballot, still in pipe, so putting aside the municipalities, if it does pass that, is it repealed from a state perspective? Or there are additional steps at the legislature or anything else that has to occur before it actually is repealed?

Yes. It would effectively repeal. It's a referendum, so that would effectively repeal it. Keep in mind, my comments I talked about 1506, which was a legislative proposal to repeal Costa-Hawkins, which did not get out of committee either in 2017 or 2018. And previously, on the Q3 call, I talked about these 15 bills that were passed in California related to housing, creating more affordable housing, developers -- requiring developers to produce more affordable housing and process reforms involving cities and that type of thing. So none of those things involved Costa-Hawkins and -- except for 1506, which was -- which didn't get out of committee in either year. So I mean, we feel pretty good that the legislature is not fully behind this idea of repealing Costa-Hawkins. Because obviously, they would have taken actions if they did support it. And -- but the ballot proposition is a completely different thing.

And then what was the average price for the $4 million of share buybacks?

Well, we bought some heading into the blackout, but it's -- the pricing is in kind of in that low 220-ish range. I'd rather not give out specific numbers, as you probably can understand why.

And then just if you were to continue to execute on a larger scale, how do you think about the timing of buybacks versus asset sales?

I think, ultimately, our plan is to have this -- the buyback on a leverage-neutral basis. And so it's a little bit harder to exactly match the timing of the stock buyback and the asset sale. But we do have asset sale planned. And so it's going to be match-funded just like any of our other investment activities. And I think -- and you guys put odds on that piece about what we're trading close to that 5% implied cap rate. It makes the buyback very attractive, especially when we're selling assets at close to a low 4% cap rate.

Are you comfortable buying back shares before and taking on the execution risk of selling assets later? Or do you need to sell the assets before executing?

No. No. We don't need to sell the assets before executing. We're comfortable bridging it with our lines. We have ample amount of capacity there.

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

It sounds like you're accounting for a lot of the 2018 deliveries to be delayed to 2019. But can you provide us some color as where you see '19 new supply versus '18 in your market?

Yes, John. It's Mike. And again, others may pitch in here. I have to say the visibility about supply is problematic. So we compare our information with AXIO and some of the other sources. It could be pretty confusing. So we sympathize with all of you out there. As Angela noted on her comments, we go and drive the properties. We have a little bit different methodology than AXIO, and so we may come to a little bit different conclusion. But the market that we're most concerned about is Downtown L.A. or L.A., let's say. When we started 2017, we had around 10,700 units expected to be delivered in L.A. It's now -- by the end of the '17, it was 8,700, so there's about 2,000 units that were moved. I think AXIO had a much more larger number moved. I think they went from -- they had 18,000 units, 19,000 units in 2018, which is a huge number, but they moved a lot more units. And this is pretty confusing because trying to track what's moved and what's not moved and the different assumptions that we understand is very confusing to everyone.

So having said all that, our view is that '18 supply will ultimately be somewhere around 4% -- 3% to 4% reduction from '17. And there are some variations by geography there, but a little bit less supply. The regional differences will be pretty significant, L.A. primarily because of the moving of units from -- the 2,000 units from '17 to '18, we'll have a increased supply. It will go from about 8,700 units to about 11,000 units. So -- and that's the biggest -- the most significant increase, I think, across the portfolio. And -- but again, we understand it's a challenge to get your arms around these numbers.

So is '18 the peak in Southern California or could it pass into '19?

Well, we -- and again, I think what will happen, it depends, for example, on how many units get moved from '18 into '19, assuming these construction delays continue, because I don't think AXIO, for example, in fact, certainly have not moved any of the units from the end of '18 into '19. And so this is what has caused, I think, the confusion because these construction delays are more significant than anyone expected. And therefore, it's moving these numbers in significant amounts and is obscuring the picture. I know in our case, we think '19 will be a little bit less than '18, but not substantially. I think when we kind of hit the peak, or let's say, we are leveling out is in Northern California. So we -- it looks like the peak is in the past there. Southern California depends a little bit by market but -- and it appears that L.A. will continue to have significant supply going into '19.

So -- and Seattle will slow down over the next couple of years as well. But again, I think -- so I think there will be some challenges in Southern California, but Northern California, Seattle, probably get better over the next couple of years.

And then as part of your guidance, you were mentioning that you're not going to have any development starts this year. Why not deliver into the 2020, 2021 year? It's related to the Costa-Hawkins or...

No. It relates more to having a risk premium for development deals. And it goes back to what is the would be multiyear effect of the things we've been talking about, mainly that construction costs are going up somewhere around 10% and rents are not going up anywhere near that. So your cap rates are compressing and lot of cap rates out there that are in the 4.5 plus or minus range measured today. And so you just don't get there. I mean, all things being equal, we'd rather acquire and not take the development risk unless there is a risk premium for development. So, John Eudy is here. He underwrites a lot of development deals. Even deals -- what's interesting is even deals that appear to have attractive land bases and have decent agreements to the city as to affordable units, which we obviously lose money on every affordable unit, and therefore, it increases the cost relative to the returns on these assets. And as a result, we're just not seeing the yields that we need to make -- to make a significant investment in development.

Our next question is from Nick Yulico from UBS.

Mike, you talked about cap rates not having moved higher yet. But with interest rates up sharply, do you think it's reasonable cap rates increased this year? And, I guess, going back to the development question, is that also shaping your decision-making in not starting more development projects this year?

Not really. I mean, interest rates are going up a little bit, and I think as long as -- on the longer terms, obviously, a lot in the short end of the curve. But as long as there's positive leverage, I think it's a good thing for real estate. And so we're still seeing 5- to 7-year mortgages somewhere in the 4% range. So there's still a little bit of a positive leverage. And I remember back to periods of time where we had significant negative leverage and real estate did pretty well then as well. So I don't think it's necessarily interest rates that is causing the problem here. Anyone want to follow up with that? Yes.

Okay. Just one other question. When you give on S-16, where you give the market forecast for economic rent growth, can you just remind me, does that -- is that a number that's not just new lease growth? Like for example, if you look at the recent AXIO data on Seattle, it's showing new lease growth for the whole market in sort of a 1% to 2% range and your number here is higher than that. So I just want to make sure I understand that. And then also if you could sort of explain how you're thinking about new lease pricing in Seattle, where it's at right now, and whether it improves or it gets worse as the year goes on.

Yes. I'll have John handle the second part of that. The first part, S-16, that is meant to be a broad measure of the marketplace, really based on a scenario. The scenario is how many jobs did we produce, how many units of supply both for-sale and rental did we produce during that period of time, and what does that mean for rents. So as you saw last year, we can -- these numbers can be wrong. They represent a scenario of what we think is going to happen, and then we mid-course correct throughout the year. So based on 201,000 jobs being produced, 1.6%, we cover the supply about 3:1 on jobs. The long-term relationship is typically 2:1. And as a result of that, we feel pretty good about supply and demand. We feel good that California is going to continue to have a pretty significant housing shortage. And therefore, we think the economic rent growth will improve in 2018. And that is what is reflected here. So it's not meant to be us. It's meant to be the broad measure of the marketplace based on how we see supply and demand for the market. And what we do may vary a little bit by that, but that goes back into the budgets. And John, you want to kind of reconcile from the market forecast to what we budgeted?

Sure. Let me step back for a second and comment on the AXIO, the data that you're seeing. The information we see right now is relatively consistent. In Seattle, our year-over-year, I think, was probably close to 70 basis points year-over-year in December. But realize that, that market is the most seasonal market. So as I said before, it will move up over 10% at the peak and then back down again. So we really are sampling it at the wrong time, because what happens with supply deliveries is, property management operating companies tend to stay pretty focused on the absorption amount the number of units they want. And when you deliver units into the slow demand period, you end up having to push pricing down.

And so that's largely what has occurred there, and we -- our expectations are as we move through the season, things will improve pretty dramatically. But going on to what we see happening for Essex in Seattle going forward, again, we're starting in a hole. I'd say, I'd mention 4.9 or 490 basis points gain to lease right now. So even though we have an optimistic outlook, our expectations are more in line -- well, they're exactly in line with our guidance that we have -- that we laid out for Seattle on revenue. So it won't be as strong as it has been in the past, but still another good year.

So if I could just sum it up, it sounds like what you're saying is that overall, you think Seattle as a market it's going to put up a little over 3% rent growth this year. And don't worry about the recent numbers from January, December, which are more seasonal that are showing new lease growth below that.

Absolutely. Correct. As the demand picks up, you'll see the rents start to move pretty dramatically. I think what we saw in the fourth quarter was the supply have an exceptional impact on pricing. But as demand picks up, things will come closer to equilibrium and the rents will move pretty dramatically.

Again, as they always do. I mean, I said last year, we were up in Seattle from the beginning of the year about 12%.

12% in peak and the same thing in '16...

These numbers moved significantly. And when we talk about seasonality, what we're really seeing is jobs are not ratable throughout the year. They're very seasonal. You get into the fourth quarter and the colder markets are -- Seattle is worse. For this reason, jobs slip to a trickle. And if you end up with a bunch of apartments delivering during that period, you have a period of zero demand, delivering apartments. So you're trying as a landlord to pull people out of the stabilized communities, which is where concessions pickup both on the lease-ups and in the stabilized portfolio. So this is the way that the rental markets work. And so pricing can move around pretty significantly, certainly more as job growth slows and the amount of apartment deliveries increases. When those don't connect timing-wise, you end up with pretty significant swings in rents, as you would imagine. And then as soon as the apartments deliver or stabilize, the lease-ups are stabilized, then you go back to a period of no concession.

So this is what's driving these markets. That's what causing the volatility of pricing. That's what limits our visibility or anyone's visibility in the marketplace because you don't know exactly how many units are coming and exactly when they're coming. And so there's a certain amount of just trying to understand the market as best we can, and then reacting appropriately when things occur. So this is a forecast -- big picture forecast. And when you get into the markets, it'll depend on exactly who is delivering and what types of concessions they're offering and how we react to that.

Our next question is from Juan Sanabria from Bank of America Merrill Lynch.

Just talk -- you could talk to where you see the best potential uses of capital, including a buyback with all the different options you have: preferred redevelopment, development, et cetera, acquisitions. Kind of highlighted that feelings on potential preferred investments, kind of above where you are today. So hope you could kind of outline where you see the best opportunities.

Juan, it's Mike. It's a good question, and the scenario has changed pretty rapidly over the last quarter in terms of stock price. So obviously, we -- as Angela said, we completed some stock buyback. So we found that attractive relative to acquisitions that we're seeing. And we also like the preferred equity program. And then it becomes how do you fund that. Obviously, issuing common stock at current prices doesn't make sense to us and -- because we'd rather be on the other side of that equation. And so, I think the disposition process is one that's kind of in full swing here. And I think that's the way the year's going to play out. It's interesting, we had almost exact same comments about cap rates, interest rates a year ago. We had a plan that was much the same -- a conference call that was much the same and it changed throughout the year because the stock recovered. I think it was -- it started the year at somewhere around the 225 level and went back to 270. And so if these things are fluid discussions, again, reacting to changing conditions in a thoughtful way. And I think there's a good chance that 2018 will be one of those years.

And just on the preferred breaking out now 2 kind of separate buckets. What's the strategy behind that? What drove that new line of thinking?

Yes. The strategy is that trying to really separate the preferred because there's a different risk element with respect to an under construction project in which you get a higher return for that. But we also think that, let's say that you're in the 8% to 9% range for a stabilized community, yes, we think that, that is an attractive program. And in fact, we had at least one deal last year that converted from an under construction to a stabilized community at a lower preferred returns. We just want to acknowledge that that's an attractive business to -- again relative to the opportunities that we're seeing in the marketplace, and we wanted to create a bucket for the lower risk and bit lower preferred return properties that are in that area. We also -- depending upon what happens with rent growth, some of the refinances of the development deals maybe a little bit short and that creates a bucket to continue to be involved in those transactions.

And then you kind of talked about Seattle a bit in terms of your loss to lease. Would you mind kind of hitting on the other 2 major markets?

Sure. So this is John. So in December '17, SoCal, we had a gain to lease of 90 basis points and that, obviously, improved in January. So now it's 30 basis points. In NorCal, it was about 190 basis points gain to lease and now it also improved to 130 basis points. I mentioned Seattle, which was 490 basis points in December and has improved to 420 now. So overall, the company went from about 200 basis points gain to lease to 130 basis points gain to lease in January. Again, right as planned, things are improving. The December numbers at the low point, but things are going in the right direction as we've planned.

Our next question is from Rich Hill from Morgan Stanley.

Just following up on a couple of comments that you made previously. Just want to make sure I understand, why are we seeing these construction delays at this point? You mentioned rising construction cost. There's also lack of available skilled labor. Why are these projects being -- getting pushed out at this point in time? Or the delivery, should I say. Sorry about that.

This is John Eudy. You hit it on the head. Lack of skilled labor is the main reason and short of that no other answer.

Okay. Great. Easy enough answer then. And then just another follow-up question. You guys have seemed to have a really good handle on job growth. So 2 parts here. I'm reminded about what happened in 2016 when job growth maybe slowed to more than what the market was expecting. What gives you confidence that, that's not going to happen this time? And then secondly, I've heard a lot of discussions about job growth, but not a lot of discussions about income growth. And I'm wondering, as income growth starts to pick up, is that more of a tailwind that it's been previously to rent inflation, particularly if household formations start to increase as people don't double up anymore, people move out of their parents' houses? How are you thinking about income growth going forward and is it more or less important than it's been in the past?

Great questions. So having a good handle on job growth, I don't think anyone in the room professes to have a good handle on jobs up here. It bounces around like crazy. We attached a schedule 16.1 to demonstrate the volatility of job growth. And the problem that we talked about on last quarter call, which I think surprised everyone. But jobs are going to do what they're going to do. We don't have any particular insight into what jobs are going to -- whether they're going to go up or down. And so I'll have to distance myself from that one. We're just going to be cog in the wheel. We do look at some of the broader indicators. I mentioned, for example, having 5% to 6% office construction or 5% to 6% of the office stock under construction for delivery in the future. I mean, presumably those landlords are not building the buildings unless they're going to be occupied by workers. And therefore, we think that, that's an interesting forward indicator as it's interesting to look at 5% to 6% of the office buildings under construction versus 1.4% job growth and 0.8% overall supply growth. So again, we try to determine whether we have a supply or demand in balance, which we think is in favor of California, ultimately. However, it can be kind of messy in terms of how all that plays out. So that's kind of the job growth picture. We're going to have to wait and see. But again what we -- Essex team is our planning mechanism. So we're trying to understand the world in which we live. And because some of these decisions that we have to make about, asset sales, which markets to select, et cetera, they require some template of what you think is going to happen. So that's what Essex team really is useful for us. It will change and we expect it to change. But again, to have a good planning process, you need to have a pretty good starting point. And as to the second point, income growth, we totally agree with you. We think that is the key metric. And in my comments, I mentioned that wage inflation is ultimately a very good thing for apartments. And we think that, that is a pretty significant potential tailwind for us, again, subject to supply and demand.

And these personal income numbers and the slow mending of the rent-to-income ratios are positive signs for us. And those are really the things that we're pointing to give us the confidence that we're going to hit these economic rent growth numbers in 2018.

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

Mike, just a quick question on the peak-leasing season. Last year, you guys mentioned that it peaked earlier because of supply and jobs. What are some of the things that you would look for this year? It sounds like you think this year should be more of a normal one. But what would give you pause that this year could end up being similar to last, especially if supply is being pushed into this year and so far it's -- employers are having a tough time finding people to fill the spots?

Alex, welcome to call. It's a good question. Again, I think it's all about jobs. I mean, we have pretty good idea what's happening on the supply front. We send our people out to walk the buildings and try to understand as well as anyone what's happening. We keep track of each year's production of housing, how many units got delivered in each year. And -- so the good thing is, we don't have any confusion about what is going on, on the supply side here. Again, we look at where we started last year, where we ended and that type of thing. The real issue comes back to jobs. And as we said on last quarter's call, which is affecting the shape of the curve this year and how our rents grow and why we can -- we will decelerate into Q2 and then turn the corner this year. I mean, all of that is related to what happened last year in the third quarter, which to remind everyone, it was basically a job drop. We ended up with fewer nonfarm jobs at the end of the third quarter than we had at the end of the second quarter. I think that was incredibly unusual and not something that we could anticipate. There was nothing in the numbers. If you look at open positions that various tech companies had or whatever data that we might have, there's nothing that really indicated that, that was going to happen. And so, again, we don't have any great insight into the jobs during the quarter.

And so like everyone else, we're waiting for those statistics. So I can't help you more than that, outline our process what it means to us. And again, we'll adjust to the world as we experience it.

Okay. And then the second question is on the rent control, just a few things here. One, it almost sounds like the governor or whoever the governor ends up being next election could almost buy Fiat, invoke sort of a rent control by capping price increase. But if they do repeal Costa-Hawkins, is there any sense that they would impose income limits on who can have rent control? And would vacancy decontrol be eliminated as well, so you'd be sort of locked in? You couldn't bring that unit to market. You'd be capped in how much you could increase the price of a vacant unit.

Yes, Alex. I mean, you're way down the road ahead of us on that. I mean, I think that we are following up with respect to what's happening now. John, do you have something to add?

Yes. Just one follow-on, Alex. If Costa-Hawkins did get repealed, it just enables local jurisdictions to enact rent control. And yes, it would not protect, if you will, the vacancy decontrol issue. But one important aspect in rent control ordinance that are in place, it does have a provision that requires a fair rate of return to the owner, which basically if you took away vacancy decontrol, you just took fair rate of return away. So even if individual cities decided to enact that control, there would be other measures we could look to, to keep vacancy decontrol. But that's speculative in the future. Right now, we think we have a good shot. The industry has organized at pushing back, assuming that the ballot measure does go forward in November. So we'll monitor it closely in every quarter. We'll have a better update for you.

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

Quick question on East Bay, which we haven't talked about a whole lot. It looked like there was a big sequential kind of pickup in both Alameda and Contra Costa counties in the fourth quarter. I was curious what specifically is happening there, if anything, in those markets?

This is a combination of a few things. As I mentioned in the comments in the call, there is clearly a pickup in -- as it relates to some jobs. We noted Facebook and Tesla and others that are out there, which is clearly a positive thing for that portfolio. There's also a year-over-year benefit in the sense that -- which makes the comp easier in the Alameda area. Due to last year's movement in pricing, we ended up with more vacancy a year ago. So we had a benefit from year-over-year. But it's really both of those combined, the positive jobs that we're seeing out there, high gain jobs out there as well as the benefit from the easier comp.

Okay. And then on, I guess, taking the other end of the wage growth equation, as it pertains to your own portfolio. I guess, what's in there for your same-store expense guidance for '18 in terms of payroll at the property level? And is it becoming harder and harder to retain quality leasing personnel in this environment?

Yes. It is overall. We struggle and we are working hard to pay all of our team fairly, and we had increased wages. The wage rate goes up somewhat significantly. But we have been able to find offsets in other areas by operating more efficiently. One of the areas we mentioned previously was our asset collections. And so we found opportunities to reduce labor and vendor cost by bidding out the collected assets as groups and whatnot. And so that's enabled us to keep the expenses under control while we continue to push our wages and meet the market there. I think last year we -- our wages were probably up 5% for our staff on the sites. But again, it is a struggle. No doubt.

That's helpful. And one last one, just on kind of bread and butter acquisitions, whether they occur in JVs or wholly owned. It seemed from some of the commentary that, I guess, there's potential -- acquisition cap rates could potentially exceed kind of the average disposition cap rate. Should they be in the low 4s, kind of some of the recent transactions illustrated? I guess, can you talk about what's being assumed in guidance as far as acquisition and disposition cap rates a little more specifically?

Let's see, Drew. We're assuming that we'll be in the 4% to 4.5% range on acquisitions. Dispositions, it depends on how we execute the dispositions. You may recall a year ago that we did a -- we took several assets and contributed them into a joint venture entity and put some loans on it, and took some capital out that way. That would be one of the things we're thinking about. But we're working on it, and I don't want to give you more specific guidance because we have a variety of strategies that we'll work on and pick the best one. And we just don't have -- we're not at the level -- we're not ready to give that type of guidance at that level of detail.

Our next question is from Dennis McGill from Zelman & Associates.

First question just, Mike, your tone, I would say, sounds much more positive today than it did 3 months ago and you walked through kind of the job shift and the uptick in the government data there. But then you also acknowledged that, that data can bounce around and it can be pretty volatile and sometimes doesn't tie the things in the market. So is it fair to call you more optimistic today? And if so, is there anything else you'd point to besides the job data that leads you there?

Dennis, that's a good question. Yes. 16.1 supplement really outlines why we're so much more optimistic and it really is all about jobs. So we feel like we have a good handle on supply, and we have a good handle on affordability and we need these jobs. I mean, that -- it really comes down to that. Our -- when we saw Q3 essentially not produced any jobs, which is very unusual, and started thinking about, well, is this a trend or is this a data point? That was a distressing discussion. And obviously, we didn't know. And so when Q4 came back and came back pretty darn strong when you look at the December-over-December numbers, it gave us a lot more confidence.

Okay. And then earlier comment as well about the shift in or the difference in first half versus second half revenue growth. How much variation is there around that 2.5% midpoint?

Not a whole lot. I mean, we're talking about somewhere in the low 2s in the first half versus somewhere in the higher -- high 2s in the second half. So between, say, 25 to 50 basis points for the range.

Okay. And then just one last technical question. When you guys do your supply work on year-end, do you draw a line in the sand as far as how big the development needs to be before you consider to be competitive?

50 units is our -- yes. That was the -- we tried to conform because there were so many different assumptions out there that we're trying to simplify the data and we're trying to conform to AXIO. We had that comment on a conference call in the past year at some point in time. But again, we tried to take out senior student, et cetera, and then focused on 50 and above. And I think the other difference that different people have is the denominator. We're using, I think, everything -- I think it's -- the entire stock, especially because California has so much older housing, that if you eliminate the smaller units out of the denominator in this calculation, you get something pretty wacko. So anyway, that's how we do it and that was conforming to AXIO. And again, the active numbers have moved so substantially that we're still trying to reconcile, as Angela said, our numbers to their numbers.

Our next question is from Tayo Okusanya from Jefferies.

I just wanted to go back to the question on same-store OpEx. And again, with everyone really talking about big increases in payroll and taxes, trying to understand what assumptions you're making about other payroll expenses to kind of get to this 2% to 3% same-store OpEx for '18.

The -- our pay -- we do expect our payroll for our site level people to continue to move, and I don't have -- I'm not going to give out the details of the numbers, but it will move. It's an aggressive area. We're meeting the market as it relates to the compensation there. But what we are finding, again, is offsets and opportunity. So our controllable expenses, we expect, next year to also be down. We did a very good job this year. The team did an outstanding job as a matter of fact along the lines of controllables and we expect that same thing to happen in the next year. So at the end of the day, even though we're increasing our compensation for the site level people at market and market is moving rather aggressively, we're finding opportunities. We've done various things from restructuring our call center to making adjustments in marketing and elsewhere to offset cost. So we expect to control that. The areas that costs are moving more that's harder to control relate to utilities. There's a lot of work that's being done in California certainly on utilities. It relates to infrastructure. It relates to accomplishing the objectives for the green requirements, which require the utilities to buy certain amounts of energy from solar and other renewable sources, which is increasing cost. And we've also done work there in the sense of installing PV panels and other things. But that -- utilities are the higher growth area on expenses.

So what other things that can come down? Is it like more of the office expenses, advertising? I'm just kind of curious like what those big offsets can be after -- let's say, after how much you kind of controlled it last year.

Well, I don't want to necessarily give away all of our playbook to our peers. But again, we are doing what we can to leverage technology. I've mentioned the call center, we've made recent restructures there over the last 5, 6 months. And we continue to find opportunities to make win-win environment. I mean, interestingly on the asset collections, it was really a win-win. It's not us grinding down vendors. It's a matter of us providing a package that reduces their commuting from asset to asset and ultimately saves them labor cost. And then that was driven through -- that came back to us. So again, I don't want to go in extreme amount of detail, but we do expect to maintain a stronghold of controllables and keep them down to about 1% year-over-year.

Okay. That's helpful. And then are you -- I don't know if you answered this before and I may have missed this. But the big increase in same-store OpEx for, I think, was it Seattle for the quarter and then the big decline in Northern California. Could you kind of talk a little bit what kind of happened in the quarter?

Well, actually, I'll let Angela go ahead with that. Is this...

Yes. In Seattle, it's really property-tax driven. No surprise there. And it's consistent with what we had expected and budgeted. So we ended up coming in -- the year coming in line with that 2.7% as planned.

Okay. And then Northern California, the decrease.

There's timing issues. I mean, with expenses, they don't follow rents. We look at them closely, of course, monthly, daily. Expenses are better looked at over the course of the year. There ends up being timing issues there. So the numbers move around a little bit, but nothing that indicates a change in the future.

Yes. And keep in mind, something like repairs and maintenance, we have control as far as when those get implemented. But we don't specifically say, they're going to be done in second quarter or third quarter. We plan that we're going to do it over the year. And it's really depend on what the focus for the operation team is at the time. And so they're really focused on their leasing activities. We're not going to distract them by saying, they're going to also have to get the repairs and maintenance done.

Our next question is from John Guinee from Stifel.

John Guinee here. I guess, Mike or maybe John, your Station Park Green Phase 3 and then Hollywood, looks like you're $721,000 a unit and $500,000 a unit. Can you talk about, I guess, three things? One is, what exactly you're building for $721,000 and $500,000 a unit, what kind of property type? Two, what that cost would be, if it was fair market land? And then three, what sort of yield are you expecting on these developments at your basis and then also at a fair-market-land basis?

This is John Eudy. I'll try to answer all of those questions. But to start off with Station Park Green is core Peninsula, top of San Francisco. And the building type, it's a high-density type 3 rapid. That means anything to you meaning expansion to build. Our land basis is just over 100 a door. It has 10% affordable requirement. We just opened up our leasing office about 10 days ago. And I can tell you, we're having a very good reaction. And there's a lot of construction around it, obviously, with Phase 2 and 3 right next door. The difference between that $720,000 versus Hollywood is rent-driven. Rents in Northern California are in the high $3 square foot range and Southern California, it's obviously less. And in Southern California, we have a much lower land basis as Mike mentioned. The legacy land basis of Hollywood is about $68,000 a door versus over 100 in Northern California and the fees are much higher up here as well. If we mark them to market on what the land would have sold for in both cases, it would be about $50,000 to $70,000 a door more in both San Mateo and Hollywood. Cap rates, we expect both to be right at about 5%. And if we market to market, they'd be under 4.5%. Those are the round numbers for it, if that helps you.

Okay. Perfect. So what you're saying, Mike, is that the reason you're not developing is that at market rate land, the yield on development is sub-4.5%?

Okay. You asked a question on -- this is John Eudy, again, on marking the land market. What's happened on both cases since then is the cost of production has gone up. So there's another quarter to have cap rates if we rebuild those with the mark-to-market on the land and today's construction cost.

The next question is from Conor Wagner from Green Street Advisors.

Maybe, Angela or John, could you give us some insight on the other income in the fourth quarter? It seemed like it grew around 6% versus 2.8% for the rental revenue.

It's a combination of rents performing better than expected. We had anticipated kind of in that high 2s range, and it came in the 3s on the rental and the scheduled rent piece of it. And other income also performed better than expected. So the...

What was the other income though? Is there anything -- were there any onetime items there, and maybe as you segue into what your expectations for other income is in the '18 guidance?

Yes. It's mostly driven by RUBS. And as you can see, our utility costs have gone up. So correspondingly, the RUBS income have also increased. And so we expect a similar relationship in 2018.

Okay. And then I think you had bad debt payback in 1Q '17. Is there anything like that in terms of the headwinds on the other income side or just again anything we should -- that we don't necessarily have visibility on outside of just the organic demand?

Yes. To your point, that was a onetime item and we don't see that reoccurring in 2018.

Okay. Great. And then Mike, on the regulatory front, it seems like things are moving more and more towards greater housing production or some sort of reaction to the chronic housing shortage, which you spoke about in the call. Could you give us some comments on first maybe -- or John, the impact of SB 35? I think they released that most cities in California can now be subject to a streamlined process on any development that has 10% affordable. And then if you could give us your thoughts on SB 827, the one that would allow -- reduce cities' ability to enact zoning ordinances around mass transit developments?

Yes. It's Mike, Conor. Our experience and -- over many years and the recent activity and you may want to add Measure JJJ in L.A. County to that. All of these things that require prevailing wage or affordable unit mandates or density bonus in San Francisco has density bonus for more 30% affordable units. All these things have the effect generally of increasing cost. And when you increase cost, again, you know what's happening with rents. When you're increasing cost to a greater extent, it just puts more pressure on the cap rate. And the number of deals that pencil are fewer, which is -- I think part of these measures have been -- had the effect of actually having less housing being produced, which is why we are confident that when you look at starts that they are trending down, not that they're going to zero. We're not saying that. And as you look at Northern California, which has gone from somewhere around 10,500 units in '17, and it'll be probably 7,500 in '18 and about the same in '19, that's a pace that, I think, probably level off at, let's say. And one of the factors here is, again, the construction cost increases. These additional mandates from the cities, they produce more housing, some of which as you point out come back to the developer. And what that means for the overall economics of the deal. I think it just continues to pressure the deals. Again, we all know that there's a housing shortage here, and we're Californians first and we want there to be affordable housing. Unfortunately, most of these laws and rules and propositions have an unintended consequence of driving cost up and reducing our yield, which makes development difficult to pencil, hence my comments.

And do you see 827 as likely to get through the assembly?

I think it will, but it doesn't really -- it does, you're talking about the TOD high-density residential state control?

Yes.

Yes. It -- clearly, I think it will. That doesn't change the economics, again, getting to Mike's comment. And I don't believe that there are that many barriers to those transactions going residential to be honest with you at a practical level when you get to TOD station to TOD station. There has been encouragement to develop residential. So that's one more step to help make it easier, but it doesn't make it happen.

Yes. I mean, they all do the same thing ultimately. So -- and again -- so I wouldn't -- I don't think you should focus on anyone per se because it's really the collection of all of them and that's what's given us part of our confidence with respect to supply not going crazy in California. The one -- the area that we have the most concern is really L.A. and really downtown L.A., which we also think is probably the long-term beneficiary of it as well because it basically transforms the downtown into more and more of a 24-hour city. And right now, I recently took my wife down there for a romantic evening, visiting Essex apartment communities at night. And it's amazing, the amount of construction and just general activity there, basically the downtown is not really arrived yet. And -- but it's going to be, I think, a pretty special place when all is said and done a few years from now.

But maybe just to kind of follow up again, knowing that these bills specifically aren't going to do much. But it seems like the overall direction in California is towards trying to address this housing crisis and it seems the major gap right now is the funding. What is your concern about the state enacting some changes to get the funding either through increased tax from landlords or again there's a proposal for the ballot to repeal Prop. 13 on nonresidential commercial buildings? What is your guys' concern maybe over a multiyear period that the state is going to come after you in some way for more money?

Yes. So it's a good question. And yes, as you point out, there is a ballot proposition underway to create a split role. And -- but fortunately, it's clear in that case that multifamily is on the side of residential, therefore, would maintain the same rules. And that bill was pretty -- filed pretty late in terms of the process. And so, we're not sure exactly where it's going to go. But we're keeping an eye on it and we'll continue to watch it as time goes on. You do have -- on this development side, you do have other things to come into play. John mentioned one of them earlier, which is we have the right to a fair return on our property, and so there is a limitation. There are also core cases that restrict cities' ability to just change the rules and require density unless they give something. So in other words, if you require a zoning change or more density or any number of things from the cities, that triggers a variety of requirements, which could include prevailing wage, could include other items that will affect your cost. So it probably isn't as simple as the governments can enact whatever they want and we're just going to have to live with it. There are some boundaries out there that I think are important here and will prevent it from getting completely out of whack. I guess, maybe the final comment I'd make, which I commented on earlier is, the 15 bills that were passed in California in September that I commented on the Q3 call, again, they were trying to come up with process reforms, penalizing cities that didn't produce housing, for cities to produce more housing and funding more affordable housing programs with a bond issue and other things. So those were pretty constructive from our perspective. And we think those are the right direction with respect to trying to address the affordable housing issue and the chronic shortage we have here in California as to affordable housing. So I think the good progress had been made. And we just hope for kind of more of the same thing.

Yes. But those bills though, that there's -- the funding isn't there to do it and the bond issuance is just a drop in the bucket compared to what's needed, right? I mean, that issues unless they force land to reprice, most of these things don't pencil due to the affordability requirements or union wages. So it seems like the first step is getting these cities to rezone to streamline projects, but the economics still aren't there. And so, I guess, my concern would just be when the state takes the next step to tackle the economics, they're either going to -- can they mandate land prices or are they are going to try and find the funding to build the housing through some other means?

Connor, we're spending our effort on what is right in front of us. So we have the repeal of Costa-Hawkins. We have a number of issues that are here. We're pretty focused on remaining -- targeting our efforts towards opposing those proposals. And we'll see what happens down the road. Again, almost all of these things have unintended consequences, which are put the burden back on the developer, which is going to compress their yield and actually you're going to make the problem worse. So I don't know what's going to happen. I've seen a lot of proposals come and go. And at the end of the day, you have to believe that there will be reason and/or something will get passed and then they'll realize the unintended consequence and then they'll have to change it. So I mean, we have to assume that reason will prevail at the end of the day.

The next question is from Karin Ford from MUFG Securities.

Just a couple of quick questions. First, on your 2018 disposition plans, do you expect to sell any properties to condo converters this year?

Karin, it's Mike. I don't know. I mean, that is out there. It's part of the opportunity set. And I commented on this before. There were -- we've looked at several properties. And when you look at the for-sale-price activity in California, there were some very large numbers there. California in total was up 9.5%, and there were some bay area cities or areas that were up in the 15% to 20% median price home increase year-over-year. And that would be positive for the spread between condo values and apartment values. However, as I mentioned on the call, we also have the new tax law, which is probably part of the reason for pushing up prices in the fourth quarter as people were trying to lock in the deductibility of their mortgage. And so, we may see that turnaround, because actually we think that it'll be a headwind to homeownership going into 2018, given the new tax law.

Great. And my second question is just on the preferred equity program. If memory serves, I think, you talked on the last call that you might want to reduce the program as it was hitting sort of the $400 million level. And know it appears you're pushing your caps up to about $900 million. Just talk about your decision to do that and is it just because you're taking risk level down on the program a little bit?

Yes. No. We took apart the program and looked at it. And we realized it really does have two very different components. And so we like the return on it. The question is what is the risk relative to that return and how does that compare to the other options that we have to invest money. And we decided in the current environment that both pieces of that business are important and attractive to us. Both the under construction piece. But then we should be separating as really a separate piece the financing on apartment buildings that are completed where essentially the risk is mostly out of the equation. So we find them both attractive and we wanted to have that ability. And so we went to the board and they approved the program as submitted in terms of can we get to the $500 million on the completed apartments. I'm not sure we're going to get there. Certainly, not going to get there anytime soon. So I think practically speaking, we're going to -- the program will be probably in the $500 million plus-or-minus range. Although we'll see what happens because we wanted to have the ability to increase it from there if we saw the opportunity.

And we'll take our last question from Juan Sanabria from Bank of America Merrill Lynch.

Sorry. Just a quick modeling question. Can you guys give us a sense of the new and renewal spreads you guys got in the fourth quarter January as well as what's embedded in guidance?

Yes. Let me give you just kind of the summary here. So in the going forward Q3 -- I'm sorry, Q1, we were extended out renewals at about 3.3%. If you go back to Q4, our renewals were at about 3.4%, so they're down a little bit. Our new leases in Q4 averaged at about 1.4%, so below the renewals.

Okay. And do you guys expect any occupancy gains or declines or steady in '18 as part of guidance?

Steady in '18 as part of guidance. And we are laser focused on how we can optimize revenues. So the plan is steady and our occupancy is relatively high for the markets. But as you know, we see opportunities, we'll make adjustments -- strategic adjustments to optimize the returns on a market-by-market basis.

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

Thank you, operator, and thanks, everyone. Really appreciate your participation on the call. Sorry for its length. And we look forward to seeing many of you at the Citi conference in March. Have a good day. Thanks.

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