Essex Property Trust Inc (ESS) 2005 Q2 法說會逐字稿

[ OPERATOR INSTRUCTIONS ] Good day everyone, and welcome to the Essex Property Trust, Inc. second quarter earnings results conference call. Today's call is being recorded. With us are Mr. Keith Guericke, Chief Executive Officer, and Mr. Michael Schall, Senior Executive Vice President and Chief Operating Officer. For opening remarks, I'd like to turn the call over to Mr. Guericke. Please go ahead, sir.

Welcome to our second quarter earnings call.

This morning we're going to 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.

In addition to Mr. Schall this morning Bob Talbott is on the call, as well as Mr. Dance, Mike Dance.

Last night we reported earnings per share of a buck sixty five per share, and FFO of $1.07 share, well ahead of consensus for the quarter. For the quarter, the portfolio grew, revenues at 3.7% greater than the same quarter in the 2004, and 1.1% on a sequential basis. Things are improving.

On the website, you'll find our expectations for market rent performance for the year 2005. These values are unchanged from the last quarter.

Also on the website is a schedule titled New Residential Supply, which includes total residential permit activity for the larger U.S. metros, as well as information on median home prices and affordability, as compared to the Essex market. To get those details, go to the our website under Analysts Resources.

On the call this morning, I would like to give a mid-year update of our current economic and market conditions versus our original forecast of the beginning of the year. Our original and local economic 2005 forecasts were based on national job growth of 1.7%, GDP growth of 3.5%, and a modest increase in interest rates. The data from the first half of the year are in line with achieving these expectations. A significant surprise to the upside has been personal income growth, specifically wage and salary growth, which are growing at 7% on an annual basis.

In my comments, it's important to note that in 2004, job growth was stronger in the first half and slowed significantly in the last six months in the our West Coast markets. Thus, we expected year over year comparisons for June 2005 to be well below our final year end forecast -- forecasted values.

Now, going to the specific submarkets, starting with Seattle, year over year job growth through June is 35,300 jobs, or 2.6%. This growth is ahead of schedule by roughly 15,000 jobs. The unemployment rate has fallen to 4.7% in the second quarter, from 5.2% during the same period last year, and labor force has grown by 1.2% during the same time period. Supply is unchanged from our previously published estimates of 10,000 homes, and 1,400 apartments, or 8/10 of 1% of total supply. Commercial absorption totaled 5 million square feet or 7% annualized in the second quarter, and over the last four quarters absorption equaled 3.5%. Overall demand is outpacing our initial forecast, resulting in occupancy gains exceeding expectations.

In northern California, year over year job growth through June is -- has been 12,000 jobs, or 4/10 of 1%. This growth is ahead of schedule by roughly 10,000 jobs. The unemployment rate fell to 4.9% in the second quarter from 6% during the same period last year. Labor force grew by 6/10 of of 1%. Supply is unchanged from previously published estimates, again10,000 homes and 5,000 apartments, or 6/10 of 1% of total supply. Commercial absorption totaled 5.2 million square feet, or 2.7% on an annualized rate, and over the last four quarters absorption's equaled 1.8%.

Over the last six months, occupancy is up 50 basis points in the northern California, concessions have been significantly reduced, and market rents are up approximately 2%. As in Seattle, demand is outpacing our initial forecast, resulting in improving rent growth and occupancy gains exceeding expectations. This is the first time in four years that we've seen significant positive job growth, labor force growth, and commercial absorption in the Bay Area, all at the same time. Although positive growth is spread across the entire region, the improvement in the job survey for the last six months has been strongest in San Jose.

Now going to southern California, year over year job growth through June is 72,000 jobs, or 1%. This again is ahead of scheduled by roughly 15,000 jobs. The unemployment rate has fallen to 4.8% in the second quarter from 5.8 the same period last year, and labor force had grown a strong 2.1% during the time. Supply is unchanged from our previously published estimates of 26,000 homes and 17,000 apartments, or 8/10 of 1% of total supply. Commercial absorption totaled 8.6 million square feet, or 2% on an annualized rate during the second quarter. Over the last four quarters absorption has equaled 1.7%. Over the last six months, occupancy has been constant in Southern California. Concessions are virtually non-existent, and market rents are up 1 to 2.5% percent, depending on the submarket. These results are in line with our expectations.

Industry job growth is significantly ahead in Los Angeles, and flat or slightly behind in Ventura, W, and San Diego. All the markets are showing improved labor force growth, and sharp declines in unemployment rates. The San Diego commercial markets remain strongest during the second quarter. We experienced significantly improving job markets in the first half of '05. We expect this growth to continue through the second half of the year.

Unlike last year when job growth cooled, each of our markets has a tail wind of strong and improving commercial absorption. Although commercial absorption is not always a precursor of employment growth, we believe in the current environment there is little irrational exuberance, and firms are only adding space when needed for additional employment.

We maintain our year end targets for rents and occupancy, the probability of meeting and/or exceeding our forecast targets has improved, given the economic performance of our markets during the first half of the year.

Now a quick update on acquisitions and dispositions. On the acquisition side, our goal for the year, as you recall, is $325 million. Year to date, we've closed 124 million, we currently have in contract approximately 135 million, of which 53 million could close in the third quarter. Given current visibility, we are slightly behind scheduled. However, I expect by year end we will be close to our target.

Dispositions during the quarter, we sold one property to a condo converter as sub 4 cap rate, with a sales price of approximately $48 million.

The condo market continues to be overheated in our West Coast markets. We disclosed during the quarter that we had listed five properties for sale that have condo maps. Our goal is to obtain yields in the sub 4 range. These are assets that we have owned for a while, and have huge built in gains. As a result, we would need to find 1031 exchange properties to replace anything we sell. Given that requirement, we would not sell more than 50 million per quarter. Currently, three of the five properties have significant buyer interest.

Now, I'd like to turn the call over to Bob Talbott.

Thank you. Hello, everyone. Thank you again for joining our call.

Today I will touch briefly on current conditions in each of our markets, but first I want to update you on our overall view of the market, and how it's affecting our operating strategy.

As you may know, we design our operating strategies to achieve our key goal of maximizing property cash flow. While this may seem obvious, we believe operating strategies will differ depending on market conditions. For the past four years, a soft economic environment has dictated a defensive high occupancy strategy.

For awhile now, we have been positioning ourselves to take advantage of better economic conditions, particularly in the Bay area, and the Pacific northwest. We are finally seeing the kind of marketing tightening the supports a change in operating strategy. The market's improvement has been a gradual occurrence throughout the year, but it became significantly more noticeable in mid-May. While we still don't want occupancy to fall below 95%, we have implemented an operating strategy that is more aggressive and is focused on raising rents.

Now, let me share a couple of examples on how we're doing this. Incentive programs have been revised to reward our associates when they succeed in increasing rental income. We've instituted focus training programs to give the field staff confidence that they can lease without a concession, and that it's okay to hold out for higher rent. This is particularly important considering how conditioned some of our associates have become to operating in a softer market. I, and the other senior executives, are reinforcing a strategy during our field visits. In many instances, also, we are finally able to give our existing residents a rent increase without increasing turnover.

We are a encouraged by the response so far, and our occupancies continue to remain high, giving us confidence that we can continue pushing.

Our stabilized occupancies are 96% or better in every single submarket. This is something we haven't seen for several years. Our availability is also no greater than 5.5%, and in many submarkets, it is under 4%.

Therefore, in the interest of time, I will limit my submarket comments to those issues that are of significant interest. In the Pacific Northwest, Seattle is performing very well. And Portland continues to show signs of recovery. Concession activity continues to decline in both Seattle and Portland, coming in at an average of $128 per turn for the quarter, compared to $190 per turn a year ago, and $160 per turn last quarter. Traffic was flat compared to a year ago.

Home purchase activity continues to be the most common reason cited for moveout. It was 25% for Seattle, and 33% of our moveout activity for Portland. For the portfolio, it is running 18% year-to-date.

In northern California, the Bay Area is finally showing some strength as revenues were up both year over year and sequentially for the first time in quite awhile. The market is stronger in the San Francisco and Oakland MSAs.

San Jose is performing better than it has for some time, although as a result of the modest job growth and new supply, it does not yet have the rent growth momentum that we've seen elsewhere. But we are more encouraged about San Jose than we have been for awhile. Concession activity is down nearly 60% compared to last quarter. Moveout activity remains below our portfolio average, with 16% of our year-to-date moveout attributed to home purchases.

Turning to Southern California the LA, Ventura, and Orange County markets are performing very well, with little to no concession activity. Year-to-date home purchases represent 13% of our moveout activity in the L.A., Ventura markets, and 22% in Orange County.

Finally, a comment on San Diego. San Diego is stable. Although some concession activity is present, it's minimal. It's typically running $200, $300 off on a vacant apartment. Traffic is up sequentially, and it's down 13% from a year ago.

Comment on condo conversion -- condo conversion activity is something we continue to watch closely. Recently we seen some reports that conversion activity is starting to slow.

Many believe conversion activity will result in reduced rental supply. However, it remains unclear how many condo buyers are speculators who never intend to occupy their unit, and will simply return it to the rental stock. Certainly the high prices of these units relative to incomes suggests that our residents are not the buyers, and our moveout activity supports this. Year-to-date only 8% of our moveout can be attributed to home purchases.

Now, let me turn the call over to Mike Dance.

Thanks Bob.

My comments today will focus on our results for the June quarter, and will conclude with some explanation on how to reconcile the taxable resubsidiary activities to funds from operations. Mike Schall will follow with an update on our guidance for the year for the rest of year.

As Keith highlighted, funds from operations for diluted share for the quarter was $1.07, a 10.3% increase from the prior quarter, and $0.5 over the revised guidance we discussed on our first quarter conference call.

Property operations continue to improve faster than we anticipated, and is the biggest contributor to our current results exceeding our last quarter's guidance. Property revenues for the second quarter were up 12% from the same quarter last year, for a total increase of $8,300,000, same property revenues are up $2 million, or 3.7% over year. and the properties not in the same store comparison contributed to the balance of the increase.

The increase in same property revenues is due to higher rents of $1.2 million, and a drop in vacancies added another half million dollars to revenues, and the remaining $300,000 was due to reduced concessions and delinquencies and an increase in other property revenues. Property operating expenses continue to be less than our guidance.

We believe a favorable experience variance is primarily due to seasonality, and we expect will increase in the second half of the year as we schedule more leases to expire in the summer months, and our fourth quarter has historically been our weakest for attracting new residents.

Interest expense for the June quarter was slightly higher than our revised guidance, and increased approximately $3 million from the same quarter last year, due to the rise in the Libor and BMA rates on our variable interest obligations, which added approximately $2 million interest expense.

The increase in total borrowings added another $600,000, and last quarter we announced our plans to reduce our variable rate exposure by taking advantage of the flat yield curve, and adding $80 million in fixed rate mortgages to pay down our unsecured line of credit. During the quarter we added $46 million of new fixed rate debt, and in July we closed on another $40 million mortgage. This brings our variable interest rate exposure to 26% of total debt, and our lighter base debt is now approximately 11% of our total debt.

This financing activity added approximately $120,000 to interest expense, which was included in our guidance. The remaining difference is due to reduced capitalized interest on our development activities.

Other factors that contributed to our results exceeding the funds from operation guidance for the quarter is the net impact of the funds generated by our taxable rate subsidiaries. These activities are not easy to discern from our GAAP income statement. Some of the TRS activities are included in the gain on sale of real estate, some in interest and other income, and some of the costs are included in G&A, and income tax expense.

Let me start with this quarter's $5.3 million of gains. Included in this gain is the net profit from the sale of two real estate transactions, which added 1.4 million to our funds from operations. Included in the interest and other income of 2.4 million for the June 2005 quarter, is our interest and preferred return on the participating loan from the condo conversion at the Essex at Lake Merritt of $1.8 million.

The taxable rate activities resulted in additional G&A expense of $300,000, and is expected to result in additional income tax of $1 million, for a net contribution of approximately $1.8 million, to funds from operations.

However, the gain from our TRS activities were offset by the nonrecurring charge of $1.5 million for litigation accrual. We have taken proactive steps to reduce our exposure from the litigation disclosed earlier in the year, and our current estimate for the total cost to settle this case has been accrued as of June 30, 2005. The terms of the memorandum agreement are to remain confidential until we receive preliminary approval from the court.

Our sale of Eastridge during the quarter generated a gain of $28,500,000. In conjunction with the sale of Eastridge to a condo convertor, we deferred $2,200,000 of the total gain, because they only own tax and resubsidiaries funded a participating loan to the buyer. This participating loan is on similar terms as the loan to the buyer of the Essex at Lake Merritt. Proceeds from Eastridge were reinvested in the 1031 exchange for the acquisition of Mission Hills in Oceanside, California, which we expect to add $500,000 per year to our ongoing fund from operations.

That concludes my remarks, and I will now turn it over to Michael Schall.

Thank you Mike, and thanks everyone for being with us this morning.

I'm going to cover two topics on the call. First, is an update of FFO guidance for the remainder of 2005, and second is an update on the development and redevelopment transactions and activity.

So, first topic -- FFO expectations. By way of background, our press release dated December 17, 2004, contained our original guidance for 2005, which was a range of from 437 to 445 per share in FFO, based on same property revenue growth at 2.5%. In May, we increased and tightened the guidance range to 447 to 453 per share, based on improved same property NOI growth and nonrecurring revenue sources. Same property revenue growth was 2.9% in Q1, and accelerated to 3.7% in Q2.

In addition, as Mike pointed out, the operating expenses were less than expected in Q2, although we expect to -- we expect seasonality to increase them for the second half of the year. The same property revenue result and overall strength in the markets would ordinarily lead us to another increase in our FFO estimates for the balance of the year. Unfortunately, the settlement of the employee-related lawsuit in the second quarter has offset the impact of improving operations. Accordingly, we are leaving the guidance range unchanged for the balance of the year.

At the midpoint of the guidance range we expect FFO per diluted share of $1.12 in the third quarter, and $1.03 in the fourth quarter. Our new Q3 guidance of $1.12 is down from $1.14 per the previous press release. The two cent reduction is due principally to the timing of the Fund I promote, a piece of it, approximately $200,000 occurred in Q2 and was in the guidance for Q3, and slightly higher G&A levels attributable to improved operations and slightly higher incentive comp expectations. In Q4 2005, our previous guidance was for FFO of $1.06. The $0.03 per share reduction is due to our participation in the sale of condos at the Essex at Lake Merritt, which occurred in Q2 and Q3, rather than in Q3 and Q4 which was assumed in the guidance.

Essentially, the $0.03 per share in Q4 that was assumed in the guidance, we essentially moved back to Q2, and Q3 remained approximately the same. The Q&A runrate used in our model in Q3 and Q4 averages approximately 4,425,000 per quarter.

Now, on to the second topic, development and redevelopment. You will begin to see our development and redevelopment activity expand over the next several quarters.

In development, several deals that we have been working on for the last couple of years have come to fruition. One of them a 200 unit transaction in Ventura County submarket of Moorpark was added to the development pipeline during the quarter. We have also, during the quarter, revised upward our cost estimate to build Northwest Gateway, which is located in downtown L.A.., by 8.5 million. Most of the cost increase relates to direct construction costs which have risen rather dramatically of late.

Couple of factors that contribute to this. First, contractors are not aggressively bidding jobs given the pickup in the level of construction activity in the greater LA area.

Second, many contractors are concerned about California's latent affect laws, as they relate to conversions of apartments to condos, and accordingly, have begun bidding apartment deals more like for sale projects which historically gave commanded a significant premium. Given the increase in costs and increased rent expectations, Essex and its JV partners have reevaluated the transaction and consider it economically viable. We have also decided to use a prominent general contractor who will provide a contract with a guaranteed maximum price, which is assumed in the new cost number.

In redevelopment, we had added staff to increase the capacity of our redevelopment team. Given that we have several projects -- given that we have a several projects that will be added to pipeline in the coming quarters, our objective is to be able to conduct approximately $25 million in redevelopment expenditures per year, from which we expect to generate an average return of from 10 to 15%.

During the quarter, we added bridle trails in Kirkland, Washington where we will both renovate existing units and add 16 new units.

That includes my comments -- concludes my comments. We would like to thank you for joining us, and now we would like to give you the opportunity to ask any questions that you might have.

[OPERATOR INSTRUCTIONS] All right. We'll go first to Dave Rodgers at Key McDonald.

Yeah, Keith, I think in your opening comments, or maybe it was Bob, I can't remember, but you made the comment that three of the five products that you put out for sale to condo convertors are marketing well. Any reason why the other two wouldn't? Is it a geographic location? Are you trying to be a little more aggressive? Can you give us some color there?

Sure. One of the two is a larger project and has a smaller unit format, so it's the product type and we were just as agressive on that one as the other. And then the fifth product is a -- is an older product, and I think people are concerned about the -- perhaps the level of improvements they might have to put into it prior to marketing as a condo. So, the fact it had a condo map on didn't make it an automatic condo sale.

Okay. And then, what's your outlook for the second half of the year in same store revenue growth? I didn't hear you say. I know you kind of outperformed in the first half of the year, and you expected that the second half was going up against an easier comp. Do you have any thoughts?

From a guidance perspective, we are expecting to remain in the 3.5 to 4% revenue growth area, so essentially maintain about the same level of outperformance going forward that we had in Q2. I think the comments that Keith made about things improving over an earlier comp the year before were more on the economic side.

On the job side.

On the job side, so clearly year over year on a the job side, we see a fairly dramatic pick up. How exactly that translates into the same property, we think it's going to remain about the same level.

Okay. Then I guess Bob, one question for you is, in tracking your moveouts, as you've begun to push rents, it looks like maybe you haven't started yet as more agressively, or you may start soon, but have you seen any indication yet of greater moveouts based on higher rental levels?

No we haven't. And that would be our hope, that as a resident gets a rent increase, they can go out and look in the marketplace, and if you have that pricing power that we've talked about in the past, they find that their alternatives are just as expensive, if not more expensive, than what we are offering them. And so they will sign up with us. And so our goal is to be able to push those rent increases without necessarily increasing turnover.

In fact, in a couple of the submarket, I think Southern California's turnover was, on an annualized basis was flat and we were down slightly down in the northwest in northern California.

Yeah, actually, let me make one additional comment, and that is we have been pushing rents a bit. So, from my perspective it takes awhile for rent increases to really register through the portfolio.

In the past, we talked a fair amount about loss to lease, which is essentially movements of market versus scheduled rent. And there was a fairly dramatic increase in loss of lease during the quarter.

In other words, it went from about 2.5% of rental income, to about 4.4%, so the market rent certainly has been increasing pretty dramatically, and it just takes time to essentially reflect that in our portfolio, but it's coming.

All right thanks, guys.

[OPERATOR INSTRUCTIONS] We'll go next to Anthony Paolone at JP Morgan.

Thanks. Keith, I didn't catch your comment about acquisitions. You mentioned 100 and some odd million dollars in the pipeline. What was that again?

Oh, sure. Let me give you that. 135 in the pipeline with various stages of contingencies removed. 53 will close in the third quarter. The remaining property has got a long contingency and it may drift into the fourth quarter.

Beyond that, we're fairly active, and I'm expecting that we're going to get close to our 325 million for the year.

Okay. And how much split between the core and the fund?

It depends on how many of these condos we sell and have to replace with 1031s. If we sell none of them, it would all go to the fund. Of the three properties that we have significant interest on, total about 110 million, so theoretically about 110 million could go to the core, and anything above that would go to the fund.

Okay. On your redevelopment pipeline, just in the press release, when I look at the $33 million that you cite, does that including things like adding 62 units to Hillcrest Park, or is that without the incremental.

Actually, that -- the additional of units to Hillcrest Park is not assumed in this number. That's going to be the next phase of redevelopment for that property. But, the addition of 16 units is included in the Bridle Trails transaction. It's not in the Hillcrest number because, until we get entitlements, we are not going to approve that, so we're still in that process.

Okay. And on the loan that you made on the condo asset that you sold, you mentioned half a million a year that you'll pick up in interest income there. Will there be -- and you mention that you participate in condo gains?

Yes let's go back on that one. The half a million that Mike referred to is the cap rate differential from the sale of Eastridge in the high 3's approximately, to the cap rate on the replacement property, which was around 5, so -- 5 and a quarter, something like that. So, that's the half million dollars. So, with respect to the participating loan, there is an interest rate, but practically speaking, like the Essex at Lake Merritt, we're not going to recognize any of that income until the loan has been repaid.

So essentially -- the defer Mike talked about, when we originate the loan we have deferred gain equal to the loan amount that's approximately $2 million. We've got to collect the loan amount, and then when we get further collections they will be able to be reflected in the interest income and/or participation income when we receive the cash, or effectively receive the cash or when the escrows close.

Okay. And just, given conditions when or to what magnitude do you think those gains beyond the loan might be?

We think that's a 2006 event.

2006. Okay. And then, is there any more promote income left to be recognized on Fund I?

Yes, there are. There is some additional promote income. We will be selling -- we've actually press released the sale recently in the last week, of the River Terrace transaction, and there is approximately half a million dollar promote related -- or that's our projection at this point in time -- related to that which is already in the guidance and was in the guidance before.

And then, that leaves one transaction, which is the Kelvin site, which we are marketing. It's a site on which is entitled to build 132 units. And we decided to market that rather than build it. And that was outside of the EDR contract, so it wasn't subject to the EDR contract. That process is ongoing and there could potentially be an additional promote related to that transaction.

Would it be significant?

It's around half a million as well. For planning purposes it would be approximately half a million.

Okay. Great thanks.

And there are no further questions at this time. Mr. Guericke, I will turn the conference back over to you for any closing remarks.

Thank you for all joining us this quarter. We look forward to continuing the dialogue in the future. And thank you very much, bye. [ Operator Instructions ]