Essex Property Trust Inc (ESS) 2005 Q1 法說會逐字稿

Good day and welcome to the Essex Property Trust Incorporated first quarter earnings results conference call. Today's call is being recorded. With us this morning is Mr. Keith Guericke, President and Chief Executive Officer. At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Guericke. Please go ahead.

Welcome to our first quarter earnings call. This morning on the call we will be making some comments which are not his historical facts such as our expectations regarding markets and 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.

Welcome. And today on the call, with me is going to be Mike Schall, Bob Talbott and Mike Dance. During the quarter, we announced the hiring of Mike Dance as the Company's CFO. Since February, Mike has assumed his new role as CFO while fulfilling his responsibilities as an adjunct professor at UC Berkeley. Beginning later this month, Mike will be working full-time at Essex and I'd like to welcome him as a participant on this call.

Since Mr. Dance was hired, it's led to the realignment of responsibilities within the organization. Let me go through them real quickly. Mike Schall is now going to be overseeing Bob Talbott's Property Operations Group as well as redevelopment, finance, and fund management. That's going to allow me to focus more time on development and acquisitions. Mark Mikl is now leading the Asset Management Group which will include disposition analysis and potential condo conversion activities. And finally, Jo Ann Petrie has moved from asset management to the Division Manager responsible for our northern California and northwest regions. Overall I think that these changes strengthen the organization in two primary ways. First, Mr. Dance brings 20-plus years of financial and accounting expertise and a new prospective to the organization. Second, several executives are taking on new areas of responsibility, preparing them for key roles in the organization's future.

Last night we reported EPS of $1.13 per share and FFO of $1.28 per share well ahead of consensus for the quarter. The majority of that outperformance came from one time fees. However, $0.02 came from same store property revenue. For the quarter, portfolio revenue grew 2.9% on the quarter over quarter basis and 1.1% on a sequential basis. This is the best performance we've seen since 2001. Generally, we're seeing job growth in our markets which is translating to market stability and rental growth. All of our markets continue to experience significant single family home price appreciation, coupled with new supply remaining at levels that will not flood any of our markets. As in the past, on the web site you're going to find our updated expectations for market rev performance for the year 2005. Also on the web site is a schedule titled new residential supply which includes a residential permit activity for the larger U.S. metros and includes price information on median homes and affordability as compared to our Essex markets. To get to those details, go to our web site under Analyst Resources.

In my comments as in prior calls, I will update you by sub market on significant developments including commercial absorption which we view as a gauge of business expectations and job formation in the future. When I'm referring to this activity, commercial activity, the absorption numbers are for the period specified and all of the absorption rates that I give you are analyzed values.

Let me start in Seattle. That market has continued to gain strength during the first quarter. As of March, job growth is on pace to produce 27,000 jobs or 2% growth in that market. The unemployment rate fell from 6% to 4.9 and the labor force growth was flat. Great news, Boeing over the last twelve months has added 4,000 jobs. Our 7.5% growth to its work force. New orders for the 787 Dream Liner are progressing well. We don't anticipate any job cuts at Boeing over the next several years. The office of market absorption for the quarter was 433,000 square feet. 2.2% on an annualized basis and the absorption in the industrial market was 1.1%.

In the Bay Area, where we have 24 % of our portfolio, our forecast for new supply is less than 1% of total stock and that's both single-family and multi-family. We saw signs of improvement in the job market during Q 1. Year over year job growth was slightly positive which puts growth ahead of expectations of 38,000 new jobs for the year or 1.3% growth. The labor force was down slightly, however, unemployment rates fell from 6.6 to 5.5% indicating increased employment.

Quickly to the sub markets, San Francisco, office market continued its strong recovery in the first quarter, absorbing almost 1.3 million square feet of space. The financial district was responsible for 69% of the absorption which translates to 7.1% absorption for that sub market. The industrial market was -- had a small positive absorption of 0.2% and absorption for the last six months was 1.2%.

Going to Oakland, the momentum in the office market continued to build in the first quarter, absorbing 224,000 square feet or 3.2% over the last six months absorption has totalled 2.3%. The industrial market also showed I improvement absorbing 315,000 square feet or about 0.8%.

San Jose, after a weak second half of last year, we ended up losing 54,000 jobs, excuse me, 5,400 jobs for the year. This -- you know, although last year we had a strong first quarter and then it fell apart in the second half, so this year you're going to see fairly tough comparisons for job growth this first half, so we we think that we're going to see jobs returning to a positive during this third quarter of this year. The office market in San Jose absorbed 592,000 square feet or 4.6% on a annualized basis. And the industrial market also showed some signs of improvement absorbing 240,000 square feet. By comparison, in 2002 and 2003, the industrial market lost 2.3 million square feet annually in the industrial area.

Going to Southern California, as of March, year over year job growth was 64,000 jobs or 0.9% on an annual basis. During the first quarter, year over year unemployment was down from 6% to 5.3 and during the period the labor force grew by 1.1%. The office market has continued its steady growth during the first quarter absorbing a total just under 2 million square feet. The strongest areas for that absorption over the last six months has been south Orange County, Ventura County and downtown Los Angeles. In the industrial after two real strong quarters, absorption in the first quarter was down -- or was at 2.7 million square feet. However, over the last three-quarters, there were 14.7 million square feet or 1.4% absorption. The strongest sub markets making those numbers up were Ventura County, central San Diego County, San Fernando Valley and north Orange County.

Now let me give you a quick update on acquisitions, dispositions and development. The goal for the year is to acquire $325 million of properties. In the first quarter, we closed $42 million. We currently have in contract approximately $180 million of which about $100 million could and should close in the second quarter.

In the disposition category, we currently have one property in contract to sell to a condo converter as sub 4 cap with a sales price of approximately $48 million. The condo market continues to be overheated in the West Coast. We are currently analyzing five properties that have condo maps. If we can obtain yields in the sub 4 range, there's a good possibility we would market those assets as well. These assets are ones that we've owned for for a while and have huge built-in gains. As a result, we'd need to find 1031 exchange properties to replace anything we sell. Given that requirement, we'd probably not sell more than $50 million per quarter.

And finally, in development, we've completed River Mark, Parker Ranch and San Marcos. Last quarter we announced the start of the Northwest Gateway property. We have several properties that have been under option for several years and we have not disclosed in the supplemental schedule. However, over the next several quarters, these transactions are going to be coming to fruition and get approved, and as that happens we'll be rebuilding the development pipeline. However, none of it will result in deliveries in 2005. I'd like to turn the call over to Mr. Talbott.

Thank you, Keith. Good morning, everyone. Welcome and thank you all for joining us. As I've done in the past, I will discuss current conditions in each of our major markets. Overall we're very pleased with the performance of the portfolio and with Seattle in particular. Just a quick reminder to everyone that the occupancy numbers I report here are as of this past Monday, a point in time, and may differ from the financial occupancies in the earnings release which are an average for the quarter. As of Monday, our stabilized portfolio was 9.5% occupied. And our net availability, which is the sum of vacant and unnoticed units available to rent expressed as a percentage of portfolio was 5% which is the lowest it's been in several years. As for move out activity, 17.5% of our first quarter move outs were due to home purchases which is consistent with our experience last quarter.

Now for individual markets, I'll start with see Seattle. Seattle showing significant strengths as evidenced by our continued I improvement in our sequential and quarter over quarter revenue growth. Our occupancies in see Seattle remain very strong. As of Monday our port portfolio is 96.5 % occupied and our net availability was only 4%. Concession activity continues to decline. While they've not been completely eliminated from the market, we're starting to see consumer expectations shift in response to a tightening market. Traffic for the first quarter was up 55% sequentially and for the same quarter one year ago traffic was up 35%. Now the magnitude of these traffic figures certainly give an indication of increased demand, but I also want to caution everyone that his historically, we've seen a lot of volatility in these traffic figures so I wouldn't read too much into them. Home purchases for the quarter accounted for 25% of our move up from the fours quarter's 19%. Cedar Terrace, which was acquired during the quarter is presently 93% occupied.

Let's look at Portland now. Portland also looks pretty good with reported occupy for the week of 95.5 %, and net availability of 4 .5 %. Concession activity has also declined, but it's still more persistent than what we're experiencing in Seattle. $300 to $500 off is still this typical. Traffic is up sequentially, 42% for the quarter and down 8% from the same quarter last year. During the fourth quarter, 25% of our move outs were due to home purchases which is down slightly from the 27% we experienced in the previous quarter.

Now turning to the Bay Area, in the Oakland, San Francisco MSA, we're 97% occupied and 5% available, and in San Jose MSA, occupancy is 98% and availability is 5%. Our occupancies are performing very well relative to market occupancy of 95%. Given these conditions, we're transitioning our operating strategy to be less defensive and more price opportunistic. However we realize the future pricing power will still be dependent on continued positive job growth. As you may recall our fourth quarter sequential revenues were down 2.5% which was attributed to higher vacancy and availability. Consequently, concession activity remained prevalent into the he early part of the first quarter as we responded to those occupancy issues. Conditions have since improved as evidenced by an over 50% reduction in March concession activity from February. Traffic was up 14% from last quarter and down 8% compared to a year ago. And 15% of our move outs for the quarter were due to home purchases which is down from 19% last quarter. As noted in the release, we added Regency Tower to the portfolio this quarter. It's presently 93% occupied as we're holding units vacant while we refine our scope for interior unit upgrades.

In LA Ventura, that market's also performing well with an occupancy of 96% and net availability of 6%. Traffic compared to the fourth quarter was up 22% and it was down 8% compared to the same quarter one year ago. Concessions are typically limited to isolated locations that are fixing in short-term occupy problems. In those cases we're seeing $500 to a month free. Move outs due to home purchases accounted for 15% of our move out activity during the quarter which was the same as the previous quarter.

Orange County has continued to look very strong with occupancy of 97% and net availability of only 4.5%. We're seeing minimal concession activity as well. Traffic is up 42% for the quarter was up 10% for the same quarter a year ago. 19% of our move outs this quarter are attribute to home purchases compared to 21% last quarter.

And finally in San Diego, San Diego is doing better and has recovered from a few pockets of softness during the early part of the quarter with occupancy of 96% and availabilities of 6%. Concession activity is limited to vacant apartments and is in the range of $100 to a half month on a twelve month lease. Traffic was up 27% compared to last quarter and was down 7% compared to the same period last year. 9% of our move outs in the quarter were due to home purchases compared to 11% in the previous quarter. Now let me turn the call over to Mike Dance.

Thanks, Bob. My comments this morning will focus on our quarterly operating results. As Keith highlighted, the Company generated funds from operations of $1.28 per share for the quarter, compared to the guidance published in December 2004, which had a midpoint of $1.03 per share. Approximately $0.19 per share of the difference is attributable to the timing and amount of promote distributions from Fund I. Our guidance assumed that the promote distribution would occur in the second quarter upon the sale of Coronado in at Newport South. Our redevelopment team was able to complete the project ahead of schedule with a favorable cost variance which enabled us to accelerate the close of Coronado South into the first quarter. The actual promote distribution from Fund I related to Coronado South was 4.9 million versus the projected 3.6 million. Another $0.03 per share is attributable to the $709,000 in revenue for asset management services from Fund II that we deferred from 2004. This deferral was discussed in the fourth quarter 2004 conference call.

Property revenues for the first quarter were $0.02 per share better than our guidance and property expenses added another $0.03 per share over expectations. We expect that the positive variance in property operating expense is due to seasonality and will be offset by higher property expenses for the remainder of the year. We believe that the operating results in northern California will continue to strengthen during 2005. Late in 2004, we responded to increased vacancies by aggressive pricing which increased our occupancy to targeted levels. This 2004 initiative led to $118,000 increase in the same property concessions for the March 2005 quarter as it is our accounting policy to record the concession in the first month of the tenant's move in. In fact, with the increased occupancies early in 2005, the same property revenues in northern California for the month of March 2005 were up 0.5% over the month of March 2004. Property operating expenses increased 3.6% over the prior year compared to 3% given in our 2005 guidance. Much of the difference for the quarter is due to the new accrual procedures that were adopted in the third quarter of 2004. Accordingly, we reaffirm our guidance on operating expenses for the year. A detailed breakdown of our property operating results by market is included in the press release and supplemental schedules.

Corporate, general and administrative expense was 4.5 million for the March 2005 quarter. This amount exceeded our guidance because of the costs associated with Sarbanes-Oxley compliance. Interest expense for the March 2005 quarter was in line with our guidance and is 3.8 million higher than the March 2004 quarter. The year over year increase was attributed to the following three factors: Approximately 1.6 million was due to an increase in our total debt. Another $1.3 million was caused by increased interest rates on our variable rate debt. And the remaining $900,000 is a result of a reduction to our capitalized interest on construction activity.

In conclusion, there have been no significant developments during the quarter related to the lawsuit brought by former employees discussed in our last conference call. Thank you for joining us and I will turn the call over to Mike Schall.

Thank you, Mike. And good morning everyone. Thanks for being with us this morning. Well, thanks to Mr. Dance's arrival, I will be discussing just one topic this morning and that is our guidance of FFO for the remainder of 2005. As you know, the primary assumptions for our 2005 FFO estimates were included in a press release that was issued last December. That press release indicated an FFO guidance range for 2005 of 4.37 to 4.45 per share for the year with a midpoint of the guidance range at 4.41 per share. Based on the activity for the first quarter, we are increasing and tightening our FFO guidance range for 2005 to a range of FFO per share of from 4.47 to 4.53. The midpoint of the range, now 4.50, has therefore increased $0.09 per share as compared to the original guidance.

The key assumptions leading to the new guidance are as follows. First, same property revenues are expected to be modestly better than the previous guidance range adding over the year $0.05 per share to FFO as compared to the original guidance. Going forward, that means that $0.01 per share of FFO for each remaining quarter in 2005. You may recall that each share is -- or each penny per share is roughly equal to $260,000. For the year, we now expect 2.8% increase in same property revenue versus the 2.5% in the original guidance.

Second, the operating expense situation referred to by Mike Dance, we expect our overall operating expenses to remain at 3%. We had a positive variance in the first quarter, but we think that will be eliminated over the next three quarters. So we are adding -- or we're subtracting $0.01 per share from FFO for each of the next three-quarters.

Third, our estimate of the promote distribution related to the previously announced sale of the Fund I properties will increase FFO for the year by $0.05 per share relative to the original guidance, including the portion recognized in the first quarter. What that means is for the rest of 2005, the only promote distribution remaining will be approximately 2.9 cents per share and that relates to the sale of River Mark, which is the final closing of the Fund I sale to UDR, which is now assumed in our Q3 guidance.

Fourth, you may recall that when we sold the Essex at Lake Merritt in 2004, we originated a participated loan in the entity -- to the entity converting the property to condos. We are increasing our FFO return expectations related to that loan by $0.05 per share which is net of the related tax effect. From a timing perspective, we expect the contribution to increase our previous Q3 guidance by $0.08 per share and reduce our Q4 guidance by $0.03 per share. This change is due to the sales of condos occurring faster than expected. So far 201 units out of a total of 270 units in the project have closed. And the average base price is also higher than expected having averaged $487,000 per unit so far.

The fifth factor in the guidance discussion is the current interest rate environment has led us to increase the fixed rate component of our overall debt capital structure. So we expect in Q3 and Q4, we expect to place an additional $80 million in fixed rate debt with the proceeds being used to repay the line of credit. This will cause interest expense to increase by approximately 1.6 cents per quarter beginning in Q3, so for Q3 and Q4. The refinance and pay down of the line from Fund sale proceeds and from the refinance transactions will reduce our variable rate debt exposure to approximately 25% of total debt.

Finally our estimates for G&A have increased $0.05 for the year due to the additional Sarbanes Sarbanes-Oxley costs and also due to the incentive comp impact of other changes we've made to the guidance. The quarterly G&A run rate for the rest of the year will average approximately 4.6 million per quarter. So as a result of these changes as indicated in the press release, Q2 FFO midpoint in the guidance range is $1.02 in Q3 it's $1.14 and in Q4, it's $1.06. I'd like to once again thank you for joining us on the call, and now I'd like to give you a chance to ask any questions that you might have. Operator?

Thank you. [Operator Instructions] We'll take Jay Leupp with RBC Capital Markets.

Hi, good morning. Here with David Ronco. Bob, just first on your comments about move outs and the reason for them, it looked like pretty much across the board purchasing a home, or the reason for move outs related to purchasing a home were dropping slightly. How do you attribute that when you have the competing forces of rising interest rates as well as job growth as well as home prices being much higher than they were last year?

Well, actually, we've had some rising interest rates, but mortgage interest rates haven't necessarily risen that much. In fact, most recently, they've continued to decline and so we haven't necessarily seen -- are you there, Jay?

I'm here.

Okay, sorry. We haven't necessarily seen demand decline, and if anything anticipation of rising rates is forcing people to be more proactive about getting out there and buying a home. They don't want to miss the window.

Okay. Well, Keith has talked in the past about , particularly in the Bay Area, the rapid rise in for sale housing and the delta between owning a home and renting an apartment being as big as it's been in ten years as a potential argument that occupancy and rent growth will start to accelerate sometime later in the year. Do you see that still as being the case?

This is Keith. Yes, as I said, last time I saw this kind of discrepancy was probably in the mid ' '80s. Its more than ten years ago. And renting is an all-time bargain today and I think that the only thing that's driving people to own or continuing to buy is is -- let's face it, in America, everybody wants to own their own home and if they can, they're going to, but I think it gets to a point where the economics, if you're rational about it, are so overwhelming that -- that people are going to settle down and rent versus buy. And the other thing as these prices continue on, interest rates -- I think Bob pointed out interest rates haven't risen all that much, but as they have risen, lenders have become very creative and there's lots of interest only product out there and very low down products and as a result people are still squeezing them selves in if they can. But you know what? People are also fairly rational in the long run. So I really do think that this is a opportunity -- that its going to create opportunity to push rents in and our occupancies are, thank God, about as good as they're going to get. We need the entire market to get to where we are so we can see that pricing power because if we're at 98 and the market's at 95, we still need the rest of the market to catch up to us to create that pricing power

And then just one follow-up. What do you expect to be the high end of the potential range of asset sales in your portfolio this year? What cap rates do you expect to realize and can you just give us some feel for a cap rate differential between San Diego to Seattle in your markets and if there is much one?

Well, the cap rate on sort of B plus product from San Diego to Seattle is probably, I would guess, in San San Diego, it's probably 5.25 and Seattle is 4.75 to 5 with growth anticipation pushing rates down a little bit there. The Bay Area is in that same kind of range, 4.75 to 5, and I would, you know, LA Ventura, Orange County, I would guess are more in the 5.25 range, 5 to 5.25 range, slightly better. As far as -- as I pointed out, the five properties, if you add the value of all five up is probably $250 million. As I said, we're only going to sell them if we think we can get better than a 4 cap and if we do, we're not going to do more than $50 million a quarter so that would cap it at 150 million. I frankly don't think you're going to see that much over and above the one deal that's in contract at $48 million, you might see max another hundred million. And the cap rate spread, if we can sell these things at better than 4 and we're going to be reinvesting about 5 we're looking for 100 basis of cap rate spread to create some a accretion.

Thanks, guys.

We'll go next to Craig Leupold of Green Street Advisors.

Keith, following on the condo question, how many assets in your portfolio have maps? You mentioned the one that's under contract, five others that you're looking at. How many remain beyond that with condo maps in place?

We don't have that many. Out of the California portfolio, I think we have a total of 10 or 11, so we're looking at five, so there would be another five or six above that.

What makes these five, you know, the ones that you're looking at today versus the other five?

Well, what we try to do is -- I think that where you can get the best spread is where you have the most expensive single-family homes, so we've taken taken -- these five are sort of in the best markets -- all of our markets are pretty darn good, but the best markets with the highest priced homes in trying to evaluate those because we think that's probably where we can get the biggest dollar a pop on a sale.

Okay. And then one question for Mike related to the guidance, you had had an expected gain on a land sale in the fourth quarter in your December guidance. Has that changed at all?

Yes, actually the timing -- the amount is the same. The timing of that sale is now in Q2, not Q4. And that went into -- that was a component I should have mentioned, but it was in a a component in the revised guidance.

Okay. Great. Thanks.

[Operator Instructions] We'll go next to Josh Bederman of JP Morgan.

Hey, guys, just a little bit of clarification on the one-time fees and stuff. Mike, can you go over the Lake Merritt stuff? I think you had assumed about $0.05 in the fourth quarter previously and just missed the change to that.

Sure. So now we are expecting -- well, the change in guidance would be for a Q3, we think it's $0.08 and Q4 will be reduced by $0.03.

Okay. So Q4 is $0.02 then?

So Q4 is $0.02, right

Okay, great. And then the final promote related to the Fund I sale is about $600,000?

About that, yes.

Okay. All right. Thank you.

We'll go now to David Rodgers of Key McDonald.

Yes, Keith on the condo sales, would you do outright sales or would you try to do something similar to what happened at Lake Merritt? Is there more opportunity doing the Lake Merritt type transaction?

You know, very honestly, it depends on who the buyer is. If the buyer is somebody that we think is a real rock solid performer and we feel comfortable participating with them, we would evaluate that because I think it's a way to take some additional money off the table. However, if we get somebody out there who is just willing to pay a very high price and we don't necessarily think they have a lot -- as long as they pay us, we don't care and if we don't think their ability to perform is that great, we would not get in bed with them, so the answer is, it depends who the -- it depends who the person is that's paying the highest price.

Would the -- would the sale -- or would the condo sales in the same form as Lake Merritt preclude you from the 10 31 exchanges?

No. No, they would not. Because what -- in the he Essex at Lake Merritt example, what we did is we originated a loan, a participating loan to the conversion entity so the conversion entity was made up of unaffiliated investors and companies doing the conversion and then our MEZ or our participating loans. So we believe that we still would qualify using 10 31 to sell the asset into the conversion group.

In the acquisition guidance you gave the 300 -- I think it's $325 million. Was that for the REIT and if so, what is the amount either of acquisitions or of Essex REIT, the REIT cash flow into the investment fund?

That $325 million, the presumption is that it is for the fund, however, to the extent that we have 10 31 needs, that would bite into that, so currently the goal would be to get $325 million into the fund. We think we can do $325 million. If we needed $50 million or 100 million of 10 31 exchanges, that would go into the REIT. The difference, the two and a quarter would go into the fund. And we own 28% of the fund, approximately, and, you know, again, depend -- go through the accretion model and we're going to get -- it's not going to be significant in the current year. From a guidance standpoint, I don't think.

Thanks.

That is our final question for today. I'd like to turn the conference back over to Mr. Guericke for any additional or closing remarks.

Well, thank you for joining us. We appreciate your interest in the Company and hope to have all of you on the call against next quarter. Thank you.

Once again, this will include today's presentation. We appreciate your participation in today's presentation. We appreciate your participation in today's presentation. You may disconnect at this time.