Essex Property Trust Inc (ESS) 2003 Q2 法說會逐字稿

Please stand by. Good day, everyone and welcome to the Essex Property Trust, Incorporated, second quarter Earnings results Conference Call. Today's call is being recorded. With us are Mr. Keith Guericke, CEO and Mr. Michael Schall CFO. For opening remarks I would like to turn the call over to Mr. Guericke. Please go ahead sir.

Thank you. Welcome to our second quarter call. As usual we need to do some housekeeping. We'll be making some comments in the call which are not historical facts such as our expectations regarding markets, financial results and real estate projects. These statements are forward-looking statements, which involve risks and uncertainty which could cause actual results to differ materially. Many of these risks are detailed in the company's filings with the SEC and we encourage you to review them. The economy has bumped along the second quarter; however, it hasn't translated into any significant job growth yet.

Our outlook for 2003 was based on a better second half during which time the impact of these recent fiscal and monetary cumulus policies should be felt. We remain cautiously optimistic that many of our growth expectations will be met for our specific West Coast markets and I'm going to go into that a little bit more specifically later in my comments. But like as the whole -- the U.S. as a whole, the performance across our West Coast markets has varied during the first half. Some areas have improved a little, some declined since our last call, and I'll update you on those changes and the outlook on each of these. We've added some economic data on the supplement on our Web site so you can more easily follow the discussions of each market's economic condition. To find this information go to the Web site and then a tab called" job supply". This data sheet displays our forecast for residential deliveries during the year and the performance of labor markets versus our expectations. We have previously posted the residential permit data for our markets and some of the larger U.S. metros. This time we've added another column of data which is essentially shows our estimates of single-family affordability for each metro. As always we believe low-home affordability is fundamental to the strength of an apartment market and that will lead to stronger apartment absorption as job growth returns to our markets, especially given the increase mortgage rates that we expect to see. Now, let me address the three major markets starting with the Northwest, which represents 23% of the portfolio.

In Seattle, we expect to see new supply to remain at low levels essentially no change from our last first forecast, 3000 units of multifamily, being delivered for the year which is 8-tenths of a percent of the stock and multifamily single-family delivering 7900 units for the year or 1.2% of stock. We maintain our expectation of moderate job growth of approximately 6000 jobs or four-tenths of 1% as of June, Seattle was actually ahead of these projections by 1900 jobs. We felt confident that Seattle can attain this growth despite the recent Boeing announcements, where they anticipate losing 5000 more commercial airline workers and by the way they also announced four or 500 new jobs being created in the defense sector, so there is job losses and gains going both ways at that company. This rate of job loss is actually matches the rate that we had in our first six months projections. The rest of the Seattle labor market has shown a strong recovery from the disastrous year in 2002. All the major industry sectors, accept manufacturing and construction have posted year-over-year job gains as of June. These results were unexpected. The labor force continues to grow and the unemployment is up slightly from last year from 6.9% to 7.2%. This result is fairly consistent with our expectations.

The office market stabilized in the second quarter as did the sharp increase in vacancy rates seemed to have abated for now. Microsoft recently announced it expects to continue its pace of hiring of an additional 2500 workers in the second half of the year. We expect a majority of those hires to occur on our east side sub market. Going to Portland, economic conditions continue to deteriorate. We have actually revised our expectations for job growth down from 4800 jobs to a loss of 5000 jobs for the year now. The labor market continues to shrink and the unemployment rate is 8.8% or an increase of 1.1% from last year. The office and industrial market conditions continue to weaken in the second quarter. The bright spot is multifamily deliveries are down about 1300 units or eight tenths of 1%, new single-family deliveries are still quite strong at about 10,000 units or 1.2% of stock. In the Bay Area where we have 17% of our portfolio, our forecast of new supply is very manageable and virtually unchanged from last quarter. Quickly going through the numbers in San Jose, new multifamily supply of 2400 units or 1.2% of stock and single-family, 1700 units or four-tenths of a percent of stock. Oakland, 1700 units of new -- multifamily supply for the year, which is six tenths of 1%, and 6000 new single family homes or 1% of stock. Finally, San Francisco, 1700 units of multifamily, 0.5% of stock, and 1000 single-family units or 1000 -- of a thousand -- three-tenths of 1% of stock. We're maintaining our job forecast for San Francisco and Oakland. We're behind our forecast by 2300 and 6100 jobs respectively through June but since we expect a better second half, we think that we will actually achieve our projections in both of those markets. In San Francisco, the unemployment rate is down from June from 6.2% to 6%; however, labor forces actually shrunk by 1.2% for the trailing three months over last year. The unemployment rate in Oakland at the end of June was up slightly from 6.1% to 6.2; however, labor forces have grown significantly by 1.9% for the trailing three months indicating increased employment.

San Francisco office markets stabilized in the second quarter with the vacancy rate unchanged from the first quarter. In Oakland, office vacancy rates remain flat as new demand roughly equaled new supply. The industrial market also stabilized in the second quarter as positive absorption led to a slight improvement in market occupancy. Economic conditions in San Jose continued to deteriorate causing us to revise our expectations for job growth down from 4100 jobs to a loss of 12,000 jobs. Unemployment rate from June was 8.5%, a decrease from 8.6% last year, however, the labor force declined by 3.8% over the trailing three-month period, which is an indication of a loss of employment. On the positive note in San Jose, job levels were flat in June, during the second quarter office absorption was positive with almost 400,000 square feet absorbed. Vacancy rates were down 23% to 21.5%; however, the industrial market continues to weaken with negative absorption and increasing vacancy rates. Southern California has 58% of the portfolio and we expect it to produce the best operating results for 2003. Again I want to go through the levels of new supply by market quickly. And these are essentially the same as last quarter. Inventory we have got 350 units of new multifamily supply and single-family supply is 2400 units. L.A. County, 7700 units of multifamily which is 0.5% of stock and about 8000 new single-family units for the year, which is four-tenths of 1%. Orange County, 3200 units of multifamily units being delivered, which is less than 1% of stock, and 6500 units of single-family which is about 1% of stock. San Diego, multifamily supply about 4700 units, 1.2% of stock and 8300 single-family units, 1.3% of stock. The employment picture in Southern California is much more positive than our other markets.

We have lowered our expectations of job growth in venture from 2400 jobs to flat but maintain our expectations for the rest of that market with an overall forecast of about 58,000 jobs or about eight-tenths of 1% of improvement. Looking at our industry job growth data, unemployment data and residential supply remain very confident in Southern California apartment market will meet our year are year-end expectations for occupancy and rental growth. The market overall are tracking slightly behind our forecast on a straight-line basis, and those expectations -- well, for Ventura we're 5100 jobs behind the expectation, LA county 2900 jobs, Orange county 9400 and San Diego, 3800. However, as I said these are on a straight- line basis. We expect second half will be stronger and we expect to hit the projection at year-end. The overall unemployment rate for Southern California markets fell from 6% to 5.8% year-over-year in June. At the same time, the labor force grew by 1.5% during the trailing three-month period indicating fairly strong increases in employment. In Orange county, there is a discrepancy between the unemployment figures and the industry job data.

The current industry job numbers indicate that Orange County market is behind by 9400 jobs as I mentioned earlier on a year-end forecast of 14,000. However, unemployment rate fell from 4.3% to 3.9% year-over-year in June, while the labor forces down by 1%. We believe the actual results are somewhere in between these two surveys an given the performance of the Orange County apartment market in the first half, we're fairly bullish there. In Ventura County, the apartment market outperformed expectations in the first half of the year given the jobs and unemployment statistics. We attribute this result to the opening of the new Cal state channel island campus in Camero which currently has 2200 students opened in the fall of 2002. Also looking at the office absorption data job growth in the San Fernando Valley in LA County has been stronger than expected and this job note is very accessible from the Ventura eastern city area. Finally our expectations in the San Diego market have been exceeded at the beginning of the year we warned that military employment could impact the market by increasing market vacancies from five to as high as 8% for several quarters. By the end of the second quarter, virtually all the military stationed in San Diego had returned home. The estimated market vacancy at the end of the second quarter was just above 5%.

And the same level as at the end of the first quarter. We have seen the vacancies in our buildings at high risk from the military which were about 11.5% mid-March are currently at about 4.1%. Given the relatively strong numbers reflected in the survey of industry jobs and the unemployment statistics in the market, we're more confident about the future of this specific market. As we always said, we believe that the single-family homes have a significant impact on operations of a multifamily market. We've chosen to operate in markets with relatively expenses of single-family homes. The following data demonstrates the relationship between the single-family affordability and the turnover resulting from residents buy go ahead a home across our portfolio. And this data represents six months data year-to-date. Let me start with Seattle which approximately 19.9% of our turnover was attributable to home purchases; Portland, 24.1%;Bay Area, 11.9%; Los Angeles 14.2%; Ventura, 17.7%; Orange County, 13.4%; and San Diego, 12%. These results track affordability very closely with Seattle and Portland being the most affordable single-family markets we're operating in. Overall, for the first six months we lost 691 residents to home purchases or 13.7% of our turnover. Now I'd like to turn the call over to Bob Talbott who is going to talk about operations and give you more color on specific markets.

Thank you, Keith, good morning. Today I'm going to update you on the current conditions in each of our major sub markets. Before I do it let me just mention again that our operating strategies and objects are market driven. We work to maximize our revenues by focusing on occupancy Lease exploration management and resident retention. As an example, we target our resident leases to expire during periods that are historically higher demand which is typically the late second quarter and third quarter. This allows us to minimize marketing costs and the affect of vacancy risks in traditional slower time of the year. To that end our managers have executed well. Between June and September, we expect between 50 and 60% of our leases to expire. Further, we'll expect to renew 60% of those expire leases. In response to this exposure, we have an intensive management team in place designed to maximize our renewal conversion. Myself and other members of our management team monitor the results weekly to make sure we achieve our renewal goals; nevertheless, given current economic situation and the trainsient nature of an apartment living, we expect higher turnover in the third quarter. So while the turnover is clearly more manageable this time of year, you will find that our occupancy figures I share with you today have fallen slightly in some of the our markets compared where we stood at the end of the second quarter.

We see this as a function of it being that time of year rather than an indication of any major problems. Also just as a reminder, the net occupancy numbers I'm giving you are for a point in time as opposed to the financial occupancy numbers we provide you in the earnings release, that's a representation of the average for the quarter. So let's turn to the portfolio. As of this week, actually Monday or Sunday, June -- judge 27th, portfolio is 95% occupied and first major market we'll discuss is Seattle. This market is still feeling the effects of supply and the weak job conditions, but we are seeing a little better stability than a year ago. Nonetheless, it continues to be concessionary with the use of one month free still being pretty common. We're -- we estimate market occupancy at 93%. This information comes from third-party data provided by our economists and these are broad MSA level figures and they are at of the quarter. We're expecting market declines between 2% and 4%. As of this week our occupancy is 95% and our net availability, which is the sum of un leased vacant units and unpreleased units that are on notice

expressed as a ratio of the total portfolio is 8%. Our traffic is up 14% from the first quarter right now. Portland's job situation continues to be a challenge and the difficulty is further compounded by the healthy single-family home market. Consequently, we're competing in a concessionary market of one month free still very common. We estimate market occupancy at 92%, a decline of 1% from the last quarter. Given the difficult job environment, we believe rents could decline 4 to 6% for the year. As of this week, our occupancy is 93% and our net availability is 10%. Traffic is up about 3% from the first quarter. We still think the key strategy in this market is to aggressively manage occupancy and pricing the market and buying occupancy as necessary to maximize cash flow. Looking at the Bay area, although our occupancy has stabilized, we continue to see some soft spots, particularly at the high-end in the south bay. Concessions are more common at the high-end of the market and they have not been completely eliminated in the middle; however, typically we're seeing a range of two weeks to a month. We estimate market occupancy for the San Francisco Oakland MSA to be between 93 and 95% and 93% in the San Jose metro.

Our previous rent projections contemplate a job recovery and as Keith mentioned earlier, jobs haven't returned and we reduced our job forecast. To date, market rents are down 5%. Best case we see them staying flat for the rest of the year or they could drop another 2% for a total annual decline of 7%. As of this week, our occupancy in the San Francisco Oakland MSA is 93% with 8% net availability and in San Jose we're currently 97% with 5% net available. You know, with the occupancies in the south bay, one could suggest this is an opportunity for us to raise rents; however, we don't see this occur go ahead until we see some real job growth in the market. Again, you strategy in this environment is defensive and we're seeking to maximize cash flow. Traffic is down about 2% from the first quarter.

Let's look at Southern California now. In the L.A. Ventura sub market it continues to be stable with minimal concession activity except in a few pockets such as Glendale and Pamoana were receiving between $500 and a month free. We estimate market occupancy at 95.5% and expect rent growth between 2% and 3% for the year. As of this week our occupancy is 96% with availability of 4%. Traffic is up about 24% from the first quarter. Orange County, this market is also relatively stable, concession activity is minimal; however in a few areas such as ton Beach and Newport Beach we're seeing a month free. Market Occupancy is up 95.5% and we're expecting rent growth of 2 to 3% for the year. As of this week, our occupancy is 95% and net availability is 7%. Traffic is up 21% for the first quarter. As was discussed earlier, San Diego had experienced some softness due to military deployment and that does seem to be behind us. Also as mentioned our occupancy in our three buildings that are affected by the military the most in mid March had fallen to 89% and today they're 97% occupied with availability of 5%. We estimate total market occupancy to be 94.5% and expect -- continue to expect rent growth of between 2 and 3%. We continue to see little to no concession activity if at all we're seeing $200 to $300 off the first month. Just also a comment on the Sacks Portfolio transition, that first phase seems to be affectively behind us, cash in that portfolio is 96% and 5% available and for the total San Diego ethics portfolio in San Diego is 96% occupied and 5% available. Our traffic in San Diego from the first quarter was flat. At that point I'll turn the call over to Mike Schall.

Thank you, Bob. And I just want to indicate that we appreciate everyone's participation on the call this morning. Please note that the press release in our supplemental reporting package is available on our Web site or you may call the company Investor Relations at our offices in Palo Alto. I'll discuss the following four topics on the call. First, the quarterly financial results; second, loss to lease; third, balance sheet; and fourth, estimates of FFO going forward. So as usual, we'll start with the quarterly operating results, financial results, and specifically talking about FFO.

As expected, FFO per-share for the quarter declined 6.8% to $1.09 per-share from $1.17 in the second quarter of 2002. Virtually the entire difference can be attributed to the decline in miscellaneous non recurring income which I'll discuss in further detail in a moment. The bright spot continues to be the various Southern California markets where we generated 4.1% revenue and 3.9% NOI growth. We've added a new page to our supplemental package which is again on the Web site that provides a detail of the change in same Property revenue by County, both on a year-over-year basis and sequentially verse the first quarter of this year. That page indicates that all counties in Southern California contributed to the revenue growth, except for San Diego; however, we should note that the same property pool in San Diego only includes one property, the Blutfs, which was hampered by increased concessions during the second quarter, again tied to the military employment issue.

Southern California led the portfolio on a sequential basis as well generating a 0.4% increase in revenue as compared to the March, 2003 quarter. The rate of decline in Northern California revenue was lower than last quarter. It was minus 7.9% for the quarter as compared to 10.2% decline last quarter and an 11.4% decline in the fourth quarter of 2002. Much of that reduction, however, is attributable to easier prior year comparisons as opposed to significant improvement during the current quarter.

As with last several quarters, the Northwest revenue trends generally followed a similar pattern to Northern California. Although the magnitude of the reductions in the Northwest are not as large. I have several comments about some of the details in the quarterly results. We'll start with internal growth. Overall sequential revenues declined .9% and strength of the Southern California portfolio was not sufficient to offset the declines in Northern California in the Northwest. Based on these trends and assuming that we don't have another lay down on the economic and jobs front, we'll continue to believe that the same-store revenue declines will abate at the end of 2003. I have several comments about the components of the quarterly same-store -- same property revenue decline at 1.9%. The first component is occupancy which on the same-store portfolio increase marginally

is 94.3% to 95.5%. The increased occupancy in Q2 of 2003 versus 2002 added approximately 626,000 to same-store revenue. Occupancy alone was at 1.5% positive offset to the same-store revenue decline. As noticed - as noted previously and by Bob during difficult economic conditions our strategy has been to focus on leasing occupancy and the timing of lease expirations which we believe is still the right strategy to employ. Second component of the decrease in same property revenue is the decline in scheduled rent of 4.2%. As reflected, loss to lease numbers I'll comment on later, market rent by the end of the second quarter had dropped 3% on average relative to June 30th, 2002. And this 3% drop was broken down further into a 7.2% reduction in Northern California, a 6.1% reduction in the Northwest, and being essentially flat in Southern California.

Third component of the drop in same-store revenues is concession. The amount of same property concessions recognized during the quarter decreased by 263,000 relative to the quarter ended June 30th, 2002, and was a .7% positive offset to the same-store revenue decline. It also increased by 128,000 on a -- on a sequential basis from the first quarter, 2003. As reported previously, we expensed free rent in the initial period of the lease rather than reporting leases on a net affective basis. The increase in concession in absolute dollars as compared to the first quarter of 2003 is not surprising when you consider that we planned to turn more units during the summer months historically our best leasing environment. Concessions per turn, which is now -- it was added to the report property operations page of the supplemeant on the the property portfolio were $358 per turn for the quarter ended June 30th, '03, versus 350 for the quarter ended March, 2003 and 480 per turn for the June, 2002 quarter.

Turnover percentage also in the supplement for the quarter was an analyzed 63% essentially flat from a year ago and increased from 53% from the March, 2003 quarter. Again, it's attributable to the fact that we try to time our leases to expire in the stronger summer months. Next I'd like to talk about operating expenses which increased by 5.7% for the quarter. In general, second quarter same property operating expenses have increased at a greater rate than our guidance which is assumed a 2.5 to 3% increase due to improvements in how we -- how we accrue our expenses overall. Overall, we expect to hit our targeted expense increase for the year so we expect the year-over-year expense increase to be lower in the second half of the year. Accordingly, we rear in rating in our guidance the same property operating expenses will increase approximately 3% in 2003. I want to make a couple of additional comments specifically related to Southern California and our portfolio there. Just to go through the components of the increase in same property revenue in Southern California. As you know, for the second quarter of 2003, occupancies were 95.9%, up from 95.2% and in the last quarter and 94.4% in the second quarter of 2002. A break out of 4.1% increase is as follows. First scheduled rent increase were 1.3%.

The increase in occupancy accounted for 1.4% of the4.1% overall increase And decrease in concessions was .6% and the balance of the change was relatively small increase in other property and decrease in delinquency. Brief update on the results of the Sacks Portfolio which as you know we acquired by a merger in December 2002. For the quarter we are slightly ahead of our acquisition budgets for the portfolio. As indicated previously we started significantly behind at the end of the first quarter on three properties that were located near military basis and were impacted by the troop deployments to Iraq. It now appears that the troop deployment issue is behind us, going forward. Interest and other income has become a significantly larger component of our results over the years as we've increased our co-investment program. Interest and other income, including the add back for joint venture depreciation decreased by 4.3 million to 5.4 million.

The nonrecurring portion of these fees in the second quarter of 2003 was 284,000 and actually that is broken down in the supplement versus 1,880,000 a year ago. So that decrease alone was most of the change in FFO per share. Interest and amortization expense increased by one point -- 1.88 million to 10,500,000 during the quarter. There were three factors affecting the change. The first is the weighted average debt balance increased by 167 million. Most of that is due to the Sacks merger in December of 2002. The average interest rate on long-term debt was 6.5%. A decrease of -- further decrease in our line of credit rate from approximately 3% in the prior year quarter to approximately 2.5% in the current quarter, the quarter ended June 30th of '03 contributed to approximately 165,000 in FFO for the quarter. And finally G&A increased by 127,000 to just below 1,700,000. And the components of G&A are broken down in the supplement. On to the second topic, loss to lease, actually I'm not going to talk a lot about loss to lease because there were very minimal changes from last quarter. But in any event, loss to lease is detailed in the supplemental disclosure package and for those of you aren't familiar with us we define loss to lease as a difference between market rents per price sheets and scheduled our inplaced rents. Loss to lease for the portfolio June 30th was 6.3 million or 3% of scheduled rent. Again, essentially unchanged as with previous quarters, the negative loss to lease in Northern California, the Pacific Northwest, is now under $1 million and continues to decline. Southern California loss to lease was 7.2 million or 5.9% of scheduled rent as of June 30th, '03 and finally as I'd mentioned before, since we expense free rent up-front than amortizing it and doing an affective rent amount, we do not include concessions in the loss to lease numbers in that calculation.

Third topic, development and actually the balance sheet. A couple of comments. We again have adjusted upward moderately the cost of two development transactions on San Marcos, estimated cost of 1.4 million and on the funds River Terrace project cost increased by 1.8 million, contributed factors included insurance costs, capitalized cost, calculations and there were some hard cost increases as well. CapEx is expected to be approximately at $375 per weighted unit, which we expect to grow near inflation in the foreseeable future. We have again for those of you that want more information about capitalized costs, please see our 10-K because we are breaking down in further detail the additions to real estate line item. Interest coverage remains strong at 3.7 times EBITDA, deb-to-market capital was approximately just under 35% as of June 30th. Now, I would like to update you on the activity of Essex activity value fund. The fund became very active during the quarter. The fund continued to focus on Southern California, although it had large transaction in Northern California that we chose not to disclose at a sub six cap rate. The fund closed three direct acquisitions in Southern California totaling 1156 units and a total contract price of $168.8 million. The fund also obtained $115.2 million in seven to ten year mortgage debt -- fixed rate mortgage debt with interest rates approximately -- of approximately 4.65%.

The fund also acquired a 49% interest in Coronado at Newport for approximately $33.7 million. The fund acquired this interest directly from an unrelated institutional investor. Coronoda at Newport at 1447 units and encumbered by $105 million fixed rate mortgage bearing interest at approximately 5.3%. The fund became more active in the second quarter for really four reasons. First the relationship between cap rates and underlying debt cost was as attractive as we have seen in our careers, essentially market cap rates in the mid six range and seven to ten year financing of approximately 4.75 to - about 4.75%. Given that the fund you the utilizes approximately 65% debt, the return on equity was very attractive.

Second, our belief that the economy is improving and job growth will follow. Given the supply constraint nature of the West Coast markets, we believe that job gross growth will lead to a tight housing market which will significantly improve property financial results. Third, we believe that the debt, which is assumable, will add considerable value if and when we sell these properties. And forth and finally, we believe that the advantages indicate above, in other words, locking in the strong return on equity given the financial situation, the prospects for stronger future operating performance given a recovery in the economy, and the potential value represented by the debt outweigh the risk of inceasing (inaudible) in the future. The fund is approximately 90% invested which does not include capital that was previously distributed from the sale of the more recent apartment in May of 2002.

That capital is subject to be go ahead recalled. Our expectation is to complete the fund investment program this year. The final topic, FFO expectations, we are moderately -- modestly lower go ahead and tightening our range for expected FFO outcomes for 2003. The new estimates are for FFO to range from 428 to 434. Our FFO guidance announced at the beginning of the year was a range of 433 to 445. You may recall that we assumed that the economy and multifamily fundamentals would improve in the second half of the year. That expectation now appears to be too optimistic. While the economy is improving, job growth has continued to be weak, lowed go ahead demand for rental housing. Thus far, businesses have been reluctant to make the investments in people and infrastructure to trigger the creation of jobs.

However, we believe that this is just a matter of time before this environment changes. And the difficulty is always -- has been to try to predict exactly when that change in business sentiment will occur. You may recall the bottom end of our FFO guidance range was 433, which was comprised of 0% revenue growth and a 3.5% increase in operating expenses. Through June of this year, same property well revenue has declined by 1.7% and we do not expect revenues to improve much for the remainder of 2003. Buffering the impact of lower revenues which is approximately $3 million. Interest expense savings of approximately $1.3 million and the positive contribution of our investment activity to date. Combining these various factors leads to our new FFO estimates for 2003 again a range from 428 to 434. We're also in the process of preparing our 2004 budget and we'll provide guidance for 2004 in subsequent meetings. That concludes my comments. Again, we appreciate your participation and we thank you for joining us. Now we'd like to give you an opportunity to ask any questions you might have. Thank you

At this time if you have a question press the * key followed by the digit one on your Touchtone telephone. If you're using a speakerphone, please make sure your mute function is depressed to make sure your equipment reaches us. * one for a question. Take our first question from Jay Leupp (ph) of RBC Capital Market.

Hi, I'm here with David Ronko. A follow go ahead question on your comments on concessions and saw that they started to fall at least this quarter. Do you expect this trend to continue and when you're talking about two to four months of rent concession, are you doing primarily six month leases, 12 month leases or some other time period and then just after that, are you seeing much rent retrading on the part of your tenants' mid lease term?

Jay, could you clarify for me, I may have confused you with my statements. What did I say rent concessions? Did you say three months?

No, two to four weeks. You said early on.

Right, right. Okay. Well, I mean, if that will be -- I don't necessarily have a prediction where I think rent concessions are going to go at this point.

Right.

Bob Talbott They will be the first to be eliminated though when we start to see occupancies tighten up and the market get better. We're not at this point seeing -- you know, certainly in these concessionary markets our prospects know that there is concessions available and they come in the door looking for them and, you know, you're almost forced to have some sort of concession available if you want to be in the game and get a lease. So I don't necessarily of any big prediction on the trend and, yes, it will be -- you know, I also think part of this concessions we're seeing right now, you know, is a reaction of where our turnover goes. It is totally occupancy driven for us.

Hi, Jay. Let me add something to that.

Sure.

I think the psychology of the renter has changed somewhat in that a year or two ago they didn't really know what might be available and now they have been in and environment where rents have gone down and concessions have generally been available and they have become much more aggressive at trying to negotiate for it.

Right.

As opposed to renewing their lease at what might be, you know, a good rate for us they do a lot more homework now. I think they're much better educated and as a result of that they're able to push a bit harder so I think that is actually been a factor, you know, in terms of what we have seen happen sequentially with rents.

What is your most popular lease term at the moment at least in Northern California?

Right now we would be looking at one year leases.

So the -

We're still targeting for leases to turn in the stronger times of the year so we would not be doing anything that would expire in either the fourth quarter or the first part of the second quarter. We operate on a sliding expiration schedule based on the time of year that we have. Each of our managers works off of a gold board, if you will, or gold book that maps out how many leases we want to expire in any given month and they work to try and operate within those guidelines based on how they are priced and the guidance they give the leasing stuff.

Okay and given the twelve month terms, that when you were talking about how your attempts are more educated or you see much more mid-term re-trading where they're walking in at the six month mark or the seven month mark and asking for their rent to be mark to market?

No. We saw that early on when the market first turned. And once we adopted a practice of marking them to market when the lease expired, you know, came to accept that.

Okay. And then, Mike just to follow-up a question on your value fund activity. Given where you are in terms of filling that fund, when is the earliest we could expect to see some asset sales and profits booked out of the fund and, you know, in your estimation, how long does this six cap rate environment continue on the West Coast?

As to the first question, I mean, there are a couple of assets that we have actually attempted to sell and we didn't get the price that we expected. I guess the general comment I would say when we talk about cap rates, we're talking about an unleveraged transaction.

Right.

And so there is, you know I think a much different cap rate associated with properties that are levered with debt, that is you know, it was a 7% debt. Obviously that banks for a reduction in price. So, I think you'll start seeing we're not -- we're trying to maximize proceeds at this point in time and we think conditions in general will improve so we're not under a huge -- hugely motivated right now to sell assets. However, I think you'll start seeing some asset sales over the next year or two. In terms of the cap rate environment, as implied in the call, we obviously are concerned about cap rates and we're concerned about cap rates adjusting upward which we think will happen over time; however, we also think that, you know, we see even modest or moderate job growth, we think that concessions will go away. We think you'll start seeing, you know, rents increase. So you're kind of weighing those two against one another.

And you know, our belief is, you know, both sort of the cash-on-cash return that we received, plus the, you know, our expectation, that conditions will improve essentially will offset cap rate increases. But I think that they'll happen. I think they'll happen both with interest rates increasing on a -- I think on the delayed impact but obviously 120 basis points increase on the ten year is going to have an impact on cap rates even though it may not be manifested immediately, there may be somewhat of a delayed reaction to that, but I think that will be, you know, priced in, you know, over the next couple of quarters. And I certainly think that is one factor. And then as rental conditions moderate, you know, I think there is a lot of people that believe that especially in certain markets that are pretty well beat up like Northern California and Seattle, that you know, there is a significant potential, you know, pop in earnings in occupancy, reduction in concession and, you know, better rent pricing that may be available as soon as conditions tighten up and sort of the supply/demand equation looks a little bit better and the good news is, you know, in various supply line constraint markets, it doesn't take that many units of demand to sort of tighten things up and move in that direction. So when will that happen? That sort of begs the question of, gee, when are we going to start buy -- stop bumping along the bottom and when are we going to see some real direction in the economy? I'm not sure when that's going to happen. Certainly, you know, we think things are getting better and we are hoping for, you know, a good start to '04 for sure.

Thanks.

And moving on to Andrew Rosivach of Piper Jaffrey.

Hi, guys. I wanted to start with a couple of questions for Mike. Just back on the variable income kind of working off of Jay's question, you don't have any of those kind of promote in sale on your '03 numbers? That would be above and beyond your current guidance?

No, we don't.

Okay.

We had miscellaneous non recurring in '03 of one million and we're basically on that pace and we expect to be for the rest of the year.

Got it. And then for the rest of the year, do you plan to fix out any of the fully rate that you have both inside and outside of the fund?

We have actually, you know, just the line in the fund. Basically just the line on ethics, actually, we have some tax-exempt variables as well that are capped and we're going to probably leave those. You know, I think that we'll probably wait until early '04 to have any significant, you know, increase in fixed rate debt into -- to pay down the line so I don't expect it this year, no.

Got you. And some of that really low-debt that you managed to get in last quarter, is that assumable if you sell those assets?

Yeah, all those are assumable.

Terrific. And last for Keith, I just wanted to talk to you about this San Francisco portfolio deal. I want to know how big was it, why you walked away and if it might come back again?

Hang on a second, okay? I'm sorry, I missed that, you're talking about the deal, the six cap deal we had in contract in Northern California?

Yeah.

The reason we walked away from it was because a couple of reasons. One was on a land lease and there was -- it was a prepaid land lease for 50 years so there was a potential to buy the land but there was no guarantee. Second reason was therents, it was a relatively new property an rents were expensive relative to the marketplace and as we were in contract, rents continued to tick down almost $100 during that period of time. So what we thought was a six cap going in really was probably about a five -- three or five, four cap. And then it is in a marketplace that has significant new supply. So the combination of all those things was the result for passing on it.

Got you.

Not to say that we would love to -- we would love to make some acquisitions in Northern California because we absolutely believe in this market and things are beat up so badly here that we think there will be some opportunities. Just that particular deal wasn't the one.

Catch you Last on your guidance what you anticipate to do, it sounds like there are a couple of acquisitions left to make the fund full. How big would that be and when do you anticipate to get that done?

Well, we need about -- depends if we call back the initial equity that was released but given what we have now, we do about $40 million the deal is done and we expect to get it done, you know, within -- I don't have -- we have got a couple of deals we're looking at real hard now. I don't know if they're going to make it or not. If they make, we'll be done in 30 days; if they don't, we clearly believe we'll be done by year-end.

Got you thanks guys

Moving next to Bill crow of Raymond James.

Good afternoon, guys. Just a couple of quick questions. Going back to the acquisition outlook, if you are done with the fund this year at some point, what does that say for ''04 do you turn to your own balance sheet which is the one of the best in the industry and look for a more aggressive balance sheet or do you look for new partners and form another fund? What is your thought processes as we look ahead to next year?

Well, we're keeping our options op obviously. You know, with our stock price where it is at today, we could almost go out and do equity that hasn't been very exciting for us in the past. If we did leverage up the balance sheet, we don't want to leverage it up a lot. That is not going to give us a lot of firepower so, you know, I would guess that maybe in the interim, we would maybe do a few deals on balance sheet but I think clearly we're going to look at another fund and so we're continuing to evaluate that and we haven't made a firm commitment one way or the other but obviously we're going to have to do that pretty quickly here.

Bill crow And then during the market discussion it sounded like traffic was up a little bit from the first quarter in just about every market How much of that is just seasonality and how much of that is real improvement from the first quarter to the second quarter.

Bob Talbott I would attribute almost all of it to the seasonal comments of the marketplace.

Okay, great, thanks, guys.

Move go ahead next to Tony Paolone from J.P. Morgan.

Just on the seasonality item, with respect to traffic you mentioned I think down in San Diego it being flat if I heard you right from 1Q to 2Q and it was up in a couple of markets in the portfolio. How does that compare to like normal levels?

I'm not sure by normal levels -

Or by more normal 1Q, 2Q, seems like 2Q is a seasonal up-tick but if traffic is flat, is that normal?

Well, let me just jump in for a second. I think San Diego is sort of an interesting anomaly because we took on the big portfolio down there and our numbers may not be perfect. I think that is more of it because we had several properties at the beginning of the year and then we took on several more at the end of -- toward the end of the quarter and we still haven't taken on the entire portfolio. Some of it is still with third-party management. So being flat Q1 to Q2, I don't think is necessarily perfect data. More or less it is -- but I would guess -- I would tell you is that our occupancies there are very strong and, you know, we're very optimistic about that particular marketplace.

Okay. I guess more typically what would it be usually?

In terms of the percentage increase?

Yes.

I don't have a long enough track record since we have been gathering this data to really tell you a good answer on that one.

Okay. Thank you.

And as a reminder, if you have a question, please press star one. Moving on to David Shulman of Lehman Brothers.

Hi, it's David Harris. Good afternoon. I know you guys keep a good tab on the details of your tenants. Is it possible to say whether you're seeing inward or how outward migration of Indian nationals in the Bay Area?

You know, David, you never cease to amaze us. That is a -- that is a pretty tough question. That is like Bob is here though, Bob is the expert on tough questions.

That is the one detail we don't keep as far as the nationality of our resident base. I'm afraid we don't have that information but anecdotally I'm not aware of any trains or changes in HB's activity or seeing anything in the job growth market at this point.

Okay. Maybe this is an easier question to ask or answer, I should say. On the fund, I think your investment period closes at the end of the year, you made reference to being fully invested by the year end or hope to be?

That's correct, David.

Could we expect for you guys to be pretty aggressive in terms of selling some of the assets you bought which presumably even if we assume cap rates to go up a little here, you're going to see some nice profitability on?

You know, obviously we've -- there was a lot of investment activity that was in the low to mid sevens' and those properties have done well and there are some pretty significant gains there. You know, again, we are pretty opportunistic. We don't feel a lot of pressure to sell at this point in time because we think that, you know, as market conditions improve, NOI will tend to go up and it will offset or, you know, substantially mitigate any increase in cap rates. So we're going to try to do -- do our best to maximize the returns on the fund and just so everyone knows, we have to - in order to get to a promoted position, we have to generate a 10% return on the investor's money and then we -- you know, our sharing percentage goes up pretty significantly from that point. What we're trying to do obviously is maximize our overall return and if -- we're not going to be motivated by trying to book gains early. I think that overall we view this as a long-term business and we're going to try to deal with it in the best interest over the long haul there. May be a few sales in the next year, but I don't think it's -- you're going to see any wholesale activity there.

If you were to sell assets early on, does that mean your fee for managing the investment declines? It is no longer fixed after your investment theories closes?

That is correct. That is not a huge - given what we're trying to accomplish that is not a huge obligation.

Sure. I know.

There are no further questions in the queue at this time.

Well, if there are no further questions, we appreciate everybody who joined us this quarter and hopefully the information was helpful. And we look forward to speaking with you next quarter. Thank you very much.

And this does conclude today's conference call. Thank you for your participation