Essex Property Trust Inc (ESS) 2008 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second quarter 2008 Essex Property Trust earnings conference call. My name is Marsha and I will be your coordinator for today. At this time all participants are in a listen-only mode. We will conduct a question and answer session toward the end of this conference. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Keith Guericke, President and CEO, you may proceed, sir.

Thank you. Good morning and welcome to our second quarter call. This morning we'll be making some comments on 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 companies filings with the SEC and we encourage you to review them.

Joining me today on the call will be Mike Schall, Mike Dance and John [Eudy]. Again, we're going to try to keep our comments short, so -- even though we're all going to speak. Included in this earnings release on our web site you'll find our market forecast for 2008, these forecasts are unchanged from the previous quarter. Also, included with the earnings release is a scheduled titled new residential supply which includes total residential permit activity for the (inaudible) US metro's as well as well as the information on median home prices and affordability as compared to the markets that is we operate in. A note of interest, single family permits for our combined markets, the Essex markets, are down approximately 40% from the same quarter in 2007. This represents about 0.4 of 1% of existing stock. Multi-family is approximately the same. In order to get those details, you can visit our web site under investors and media.

Last night we reported another strong quarter with core FFO increasing 11.7% per share, for the quarter the portfolio grew revenues 5.1% greater than the same quarter in '07 and 1.3% in a sequential basis. Again, I think the strong performance just demonstrates the fundamentals of our supply constrained markets. In the second quarter of 2008, we saw some signs of stabilization in our California existing home sales markets. Even though prices were down 21% and transactions were down 20% from the previous year, however, we track movement from quarter-to-quarter. And the traditional seasonal increase, Q2 over Q1, was much stronger this year. In Q2, '08 transactions in our markets were up sequentially 50% over Q1 '08. Last year, the same period, the seasonal increase was only 8%. Lower prices are inducing transactions, albeit below historical levels. We think this is important because the increased transaction level indicates a confidence by the consumer that we are nearing the bottom of the price decline.

Going to each of the markets. In Seattle and northern California, the economies are doing well with the exception of the Oakland MSA, where the outlying areas are more heavily affected by the decrease in the housing jobs. The apartment markets in both Seattle and Northern California, have performed at or above expectations through the first half of '08, with occupancy rates well above 95%. And rent growth at 10% for Northern California and 7.8% in Seattle for the second quarter. These two markets continue to be the two best rental markets in the country. Southern California, as of June year-over-year job growth across the region, remains weak. We're seeing signs that the weakest sectors are beginning to stabilize. As we stated last quarter the cuts in the housing sector occurred at a much more rapid pace than anticipated and we believe the worst of the cuts, the big cuts, are behind us.

And now going to each of the markets and I've sort of lumped these by pain, and Ventura and Orange are the markets where we've had the greatest issues. The Ventura and Orange County markets experienced disproportionately high growth in the home financing jobs, with the housing [bubble] that started in late 2001 and '02. The job losses in the home finance sector began in early 2006 and accelerated in the second half of '07. Again we believe the worst losses have already occurred as of June, jobs in the sector are back to the late 2001 levels. We expect these job markets will stabilize going forward and single family supply will to continue decline to even lower levels. We don't expect to see significant job losses from a multiplier effect because the home finance sector does not have significant sub industries that feed it.

Going to Los Angeles, home financing jobs were also cut back in LA and are back to late 2002 levels. However, in LA, the bubble in the sector was much smaller relative to the markets economy. By comparison, over the last 12 months, home financing jobs are down 6.5% of the sector's total however this is only 0.10 of 1% of the total jobs in LA. LA has also seen a large reduction in residential construction jobs however these have primarily been in North LA county, which has little direct impact on downtown, West LA and long beach where our portfolio primary is located. Manufacturing jobs have been the biggest drag on the economy. And we see signs of improving conditions in this sector in the first half of '08 relative to '07.

Finally, San Diego, this economy is out performed the rest of Southern California for the last 18 months. It had considerable job losses relative to construction, home construction. That's behind -- primarily behind us, however San Diego is a much smaller exposure to the home financing jobs and heavy manufacturing. Manufacturing jobs are flat year-over-year and this trend is continuing. They've had strength in the bioscience and other technology sectors and that's clearly helped the San Diego market. The market occupancy has remained above 95% and above levels from the same period last year. Generally we come in on Cap rates. We continue to see softness there although you know, the number of transactions have been significantly smaller than typical. It's difficult to get a real, you know, sort of fix on what Cap rates are based on transactions, however we would estimate that cap rates have probably slipped another 25 basis points moving across the board in each of our markets. So, for AB products, in the bay area, we think that the spread is somewhere between 4.5 for the best and 5.75 for the B. Southern California, the spread is probably 100 basis points, 475 to 575 and Seattle 4.5 to 5.75. With that information, I will turn the call over to John.

Thank you, Keith. Our active development pipeline including (inaudible) two transactions, is comprised of eight developments under construction we're at 1,658 units, $622 million dollar. We're about half way through the construction process, completion and delivery operations will occur fairly equally at the rate of about $200 million a year over the next three years, consistent with our strategic plan. During the quarter we have added too the active development pipeline, [Jewel Broadway], 295 units in Seattle in Tasman Place place, 284 units in Sunnyvale. On the remaining active development projects, I have the following to report: East Lake 2851 in Seattle, is now substantially complete and 94% leased as of yesterday. Right on plan. Belmont station in Los Angeles last quarter we reported beginning -- we expected to begin occupancy in July. I am disappointed to report that occupancy will slip into the first half of August and possibly as early as next week. We have previously reported that due to partnership capital defaults from the prior developer we became the developer after construction started. In retro speck, we did not fully understand the extent -- the plans were not coordinated properly and we underestimated the transition issues when we took over the developer roll. Our people in the field have risen to the occasion and we are almost done. To date, I am extremely pleased with our pre-leasing team and the lease activity to date. The first 79 days, since we opened, we have 98 leases or over 0.3 development leased and ready to occupy. As an abundance of caution, we have moved our stabilization date to June 2009. If we continue to lease at the current rate, we will beat that date significantly.

The balance of the other active development projects including the Grand in Oakland, Fourth Street in Berkley, Studio 4041 in Studio City and Cielo and [Chadsworth] -- are on time and on budget to date consistent with prior quarters reporting. On pre-development activities we have chosen to be defensive on our Hollywood -- Essex Hollywood transaction and we extended the lease with out tenant through July 2009 thereby delaying our anticipated start date. The Cadence transaction in San Jose and the Main Street transaction and Walnut Creek developments are both on track and pending construction start in January of 2010. In our supplemental S-9 we have noted two joint ventures, both transactions include money partners having equal equity investments with us, unlike Belmont Station, we're the developer from the start do not expect to have any kind of issues like we've experienced on Belmont Station since we are driving the transaction from day one. There are no other changes on our land held for development from last quarter. One note on the recent spike in oil, we have seen additional pressure in metals and other oil based materials such as asphalt and plastics. However, the labor side of the equation has been very, very competitive more than I've seen in the last 15 years. The offset to materials costs have netted out to annualized construction cost increases of less than 10% which we have already built into our modeling. At this time I would like to turn the call over to Mike Schall.

Thanks, John. And thanks everyone for joining us today. Before discussing the quarter I want to report that Essex sustained no damage from the earthquake that was centered Chino Hills area of Southern California on Tuesday. Now on to the quarter. Despite the housing gloom and doom stories out there that you hear, we had another strong quarter operationally. Long-term current conditions all seem to point to lower supply of both rental and for sale housing which is good for Essex in the short term operating conditions remain good in southern California and very strong in northern California and Seattle. The summer is our peak leasing season and therefore is critically important to us and we remain well positioned for the remainer of 2008. During the second quarter, Northern California led the way with a 10% same property revenue growth, well above our 2008 guidance of 5.5% to 7%. Our Seattle revenue growth also exceeded the top end of the 2008 guidance range. in this case by 0.8%.

In Southern California, our revenue growth remained near the top of the guidance range which was 1.5% to 3% and we continue to have the same challenges that we've discussed on prior calls, largely related to localized supply or job loss issues. Still it appears that is recent shocks at Country Wide and [Amgen], for example are not getting worse and management is effectively working through those challenges. Operating expenses grew at 3.6% for the quarter near the high end of the guidance range of 2.5% to 4%. Year-over-year expenses were influenced by a couple of property specific issues and the impact of new initiatives including level one and yield star. Recall that our guidance included large property tax re-assessments at many of our Seattle properties which is have contributed to their expense growth. The 2.5% sequential increase in expenses reflects the cost that I just referred to plus the seasonal increase in turnover which ran at a 42% annualized rate in the first quarter and increased to 56% in the second quarter. We expect operating expenses to remain near the high end of our guidance range for the remainder of 2008. During the quarter, we completed our conversion of our property management and general ledger systems to Yardi, in addition we are now -- we now have 24 hour call center support for all of our properties. We note that typically 30% to 40% of calls come in afterhours or while the staff is otherwise unavailable, so, the call center support is very effective. We continue our implementation of Yield Stars price optimizers software and it is running at 70 properties up from 24 reported on last quarters call. Loss to lease, which estimates the difference between market and in place rents without regard to concessions, rebounded at the end of the second quarter to 2.4% of rental income versus 0.9% reported for the first quarter. Most of this change was attributable to firming rents in Southern California as compared to the discounting that was required to hold occupancy in the first quarter. Overall in Southern California we reported positive loss to lease of 1.8 million at June 30, 2008, versus negative loss to lease of 3.5 million at March 31, 2008. Our actions to maintain occupancy in the first quarter allowed us to be more aggressive in the second quarter resulting in higher rent levels and a 50 basis point increase in sequential occupancy. Now, I would like to provide some additional facts on each major part of our portfolio starting in the Northwest. All markets surrounding and including Seattle are strong. We continue to carefully watch the supply picture particularly in Bellevue. Although job growth has been sufficient to absorb new units. As of July 22, our physical occupancy remains strong at 96.9% with net availability at 4.1%. Home purchase activity represented 15. 8% of move outs for quarter compared to 21.5% a year ago.

In Northern California, as before, all sub markets performing well, although the East Bay has greater supply issues and more fallout from the problems in for sale housing. Again, for Northern California as of July 22, physical occupancy was 97.2%. Net availability of 3.7%. Home purchases declined substantially. They were only 8.3% of our turns for the quarter compared to 19.7% a year ago. Southern California -- Southern California, obviously is a huge area and there are considerable variations in results based on property location, the inland empire has by far the greatest difficulties with combination of more supply and too many, more or less, more transient jobs, like for example construction jobs. Fortunately we have a very small presence there. Our view is that San Diego, Los Angeles and Ventura Counties improved marginally during the quarter and, in Orange County, conditions were effectively unchanged. Overall, I believe that our operations group did a very good job of implementing an occupancy-based pricing strategy during the first quarter which positioned us to firm rents in the second quarter. Physical occupancy as of July 22, 2008 LA, Ventura, was 95.5% net availability at 6.3%. In Orange County 95.8% occupancy -- physical occupancy, net availability 5.6% and San Diego physical occupancy 96.1% net availability of 5.8%. For all of Southern California -- Southern California combined move out activity attributable to home purchase was 7% for the quarter versus 14.5% a year ago and that pretty much follows similar patterns no matter how you break that down by county. That concludes my comments. I'd like to turn the call over to Mike Dance. Thank you.

Thanks, Mike. My comments today are intentionally brief to allow more time for the questions and answers that will follow. The strong June quarter results beat the first call consensus estimate for funds from operations by $0.02 a diluted share. The second quarters results are very similar to the results we reported for the first quarter. Given the uncertainties in the economy and the volatility in interest rates we believe the results achieved this quarter are an appropriately conservative run rate for the results that can be expected for the remainder of 2008. The favorable second quarter results benefited from a decrease in the interest expense of $20.2 million in the first quarter of 2008 to $19.8 million for the second quarter. While the total debt increased by $80 million. The decrease of $400,000 in net interest expense, reflects the additional interest expense of $900,000 from the mortgages originated in 2008, less the increase in capitalized interest of $500,000 on the costs incurred for development communities. And the reduction in the weighted average interest rate of 5.6% to 5.4% during the second quarter. This reduction in interest rates reduced our borrowing cost by $800,000, which is attributable to the $400 million of variable rate debt as of June 30, which paid a weighted average interest rate of about 3.5%. We believe that the fed will quickly increase short-term interest rates as soon as there are indications of a recovering economy to reduce inflationary pressures. If we continue to benefit from the current low interest rate environment with continued strong demand for housing in Northern California and Seattle. We are confident that we can beat the midpoint of our guidance. If there is a spike in short term rates without the strong demand for rental housing there's some risk we will fall below the midpoint of our guidance. Except for the change to project a 2008 interest expense we have no other significant changes to our 2008 guidance.

Before I close my remarks I want to highlight some of the accomplishments achieved during the quarter. First, I want to recognize the finance teams' success during the quarter, as the company obtained approximately 70 million in secured 10 year debt financings funded by Freddy and Fannie. They negotiated a 5 year extension on the secured line and increased the line's borrowing capacity by $150 million and arranged a $60 million construction loan from two of the commercial banks that participant in our unsecured line. Given the liquidity concerns caused by the turmoil in the credit markets we feel fortunate to have a financing partners with the resources and commitment to meet our on going capital needs. Next, I want to highlight the economic performance of our value fund two during the quarter. In our earnings supplement on S-11, the operating communities owned by the fund achieved year-over-year net operating income of 15%. Based on our economic research we refocus our capital allocations from Southern California to the Bay rea and Seattle and this has proven to be the correct strategy. The ability of our fund acquisition and development teams to source value added opportunities and supply constrained markets has to date exceeded our high expectations. And lastly I want to personally thank all of the employees in our information systems accounting and property operations that demonstrated outstanding team work and a willingness to work long hours to successfully complete the roll out of our new property management and accounting platform. This concludes my remarks and I will turn the call back to the operator for questions.

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Dustin Pizzo from Banc of America Securities. You may proceed.

Hey. Good afternoon or morning to go you guys.

Hey, morning.

Keith, has there been any change to your underlying same-store revenue growth assumptions?

No. I mean we guided down inventory accounting for last quarter and I think we out performed our worst expectations, but we have left everything else in place.

Okay. So, I guess, how do you think about it then, I mean, because the current range implies a pretty dramatic slow down to about 2% in the second half. Is that just overly -- being overly cautious on your part or are you seeing anything -- and it sounds like you are not since you mentioned Southern California appears to have the worst behind us. Can you just help us think about that a bit?

Yes. You've been very kind, you haven't used the sandbagger word. And it -- those who know us know that we've been generally pretty conservative we'd never want to disappoint. And I think as Mike accurately described it is that we are being conservative this quarter and we probably could have tightened the range a little bit but felt that even though we think that the worst of the job cuts are behind us and we don't see any storms in the horizon, I think that we feel good about where the rate where our guidance and we certainly don't ever want to have to guide down have -- or re-guide up after we have guided down. So, we've just been, we've been conservative and again it's just uncertainty in the future with respect to what in the heck is going to go on.

Alright, fair enough. And then as you think about the potential for interest rate spikes as you mentioned, when are you expecting the fed to first increase rates?

Well, they will be based mainly on recovery. And what we are seeing in GDP growth was stronger in the second quarter but disappointed expectations, so, until the housing drag is over which probably won't be for another couple of quarters, there probably won't be a spike in interest rates.

Those are the words of John Lopez our Economist.

Okay, so you think that's more of an '09 event than '08?

Probably.

And then just lastly, should we expect any one time charges associated with the new line of credit in the fourth quarter?

No, the old line of credit is end of term. It expires in January. So, this is we expect to roll that out in the next couple of quarters here so it won't be significant.

All right. Perfect. Okay.

Thank you.

Your next question comes from the line of Alex Goldfarb from UBS. You may proceed.

Good morning.

Morning.

Hi, Alex.

Just going to the (inaudible) forecast, I'm just comparing the jobs forecast that you have in your first quarter to the second quarter and essentially it looks the same although looking at the data the job situation seems to be getting worse. Can you just give us an update on what your thoughts are for leaving the forecast the same?

Yes, Alex. Southern California the year-over-year numbers look depressing and mainly because the losses were big in the second half of last year. So, we're expecting that those comparisons will get better as we go on and that's why we're holding our forecast there. And San Jose, the industry jobs are down a bit but if you look at the household survey the numbers are quite strong. And so, we think that given the possibility of correcting those numbers that we're well within the guidance growth range, in that area The weakest are would be Oakland right now, the outlying areas of Oakland.

Okay. And then moving to go the new line, can you give us a comparison what the new pricing is relative to the existing pricing?

We're not going to disclose that until we have it finalized and we file our 8-K.

Okay. The Hollywood office lease extension on that development site there, is that your decision to renew or extend the lease? Is that, what's the driver of that? Is that capital preservation -- is there -- are there other projects that would have come on line at that point? Is it entitlement issue? What's the driver?

We have a tenant that has wanted to extend every year. They've been in the building for ten years and the lease that we did with them, the extension is an accretive transaction, it gives us a bit of breathing room to wait out the market in Los Angeles area and we think the pricing on the buy out will get better over the next 12 to 18 months. So, we've made the select decision to push it out.

Okay. Then my final question is a two part development question. One if you can just let us know the yield impact of the cost increase on Belmont Station and the second part is you guys continue to look at sort of busted condo development sites, are you seeing any increased pressure or incentive for the existing developers to want to make a deal now versus earlier this year?

On the impact of the, the construction increases for Belmont, it is about a 35% to 40% -- a 40 point basis decrease in our expecting yields on it. We are going to end up on that -- and remember that's a bond deal, Alex. So, there is a lot of accretion associated with bond financing. We are going to end up at about the 560 to 590 range on the stabilized yield. As far as the broken condo question, Keith, you want to handle that?

Yes. We've been -- you know we've had a, our acquisition guys out looking for those kind of things and there are a number of transactions that we've looked at, you know, frankly we've been looking at not the raw land as much as sort of deals that are truly either half constructed or completely done and unable to sell. And frankly the developers generally don't have any equity so you are really having to go back and negotiate with either the [mez] or the construction lenders. And you know, we have not been able to cut any deals yet. We've been very close on a couple of transactions but I am seeing the pressure on the developers increase and you know, as -- frankly every deal seems to get a little bit closer. So, I have confidence here that we're going to see some of those transactions come to fruition.

Thank you.

Your next question comes from the line of Jonathan [Halverman] you may proceed.

Hey, guys, Jay Halverman here, just a question starting off in sort of second half. I know you are being a bit more cautious. I'm just curious you mentioned sort of in southern California, focusing a bit more on occupancy to stabilize rates -- do you see that trend picking up a bit more back half of the year in terms of not being able to push rent growth as much?

You know, I think that has been sort of the management philosophy or strategy in Southern California all year, to hold occupancy and if you -- you know, traffic patterns remain, you know, remain sort of typical as in prior years and we'll benefit from that because we'll not be starting off in a hole. So, I view, you know, I think Southern California still is, you know, has some head winds and as a result of that, I think we will continue to be sort of a defensive management approach. So, it will be hold occupancy, I think we can continue that for the rest of the year and likely into probably into early 2009.

But, even holding occupancy you still have fairly big embedded gains to lease in certain markets particularly Northern California and Seattle?

Gains to lease?

Loss lease, sorry.

We do. Yes, we do. Are you asking what does that mean for renewal pricing? Is that -- ?

Well, just getting to your assumptions for the back half of the year. You're being more cautious but it sounds as though you still have some upside embedded there?

Exactly -- .

On the occupancy [side]?

I think the rebound in loss to lease really, you know, paints a pretty strong picture because you know, southern California loss to lease at the end of Q1 where we were pretty much discounting to maintain occupancy, you know, we had a loss -- we had a gain to lease -- a negative loss to lease of $3.5 million. That flips around completely by the end of Q2 where we had a real loss to lease of $1.8 million. So, clearly pricing firmed during the second quarter. Again, part of this is because, you know, we had relatively high occupancies. We made that we had relatively high occupancies coming out of the first quarter which positioned us for the second quarter. So, and you all heard the -- you know, I went through the physical occupancy numbers. So, you know after the end of the quarter, we're now 0.6 of the way through our summer peak leasing season and occupancies have continued to be firm through the end of July. So, all that seems to indicate that we are well positioned for the rest of the year and we will be able to push a little bit harder on rents and don't see a lot of -- don't see real soft conditions where we're going to have to be very aggressive as we were at the end of the first quarter.

Right and just going back to the other comment on the fed increasing interest rates, what are your expectations for Cap rates over the next, say, six to nine months? Are you waiting on the sidelines for more opportunistic activities and does that in anyway influence your timing of a new fund?

The answer is yes. We have not closed -- you know our acquisition goal for the year was is $100 million which is very minimal. We haven't closed anything as of yet. We've got one very small transaction here in Northern California that will close, actual I think it's closing today, had a pretty significant cap rate better than we've seen in the past. And we do think as pressure is put on the sellers that Cap rates will improve. You know, unfortunately this is a matching game as we all know and to the extent that our, you know, interest rates go up or our stock price were to back up, it's, you know, you have to match the (inaudible) yield and the debt cost against the yields in the marketplace. So, you no some times Cap rates going up significantly -- or even -- unless it goes up significantly it's hard to make -- it's hard to make these transactions work. So, we are being very selective in trying to conserve our capital and use it wisely.

In terms of uses of capital, just from weighing the benefits of development now versus acquisitions, I mean, given that we're seeing Cap rates, in some cases, move up closer to development yields, how does that then bias your decision?

Well -- and frankly, one of the things that we recognize here is that you can't get in and out of the business of development. We can be conservative, you know as John said in Studio City, we leased that site for another year because we think costs are going to come down and that might help yield a little bit. So, we can be, we can lighten up on the development but we can't get out completely. But I would tell you that if cap rates move another 25 basis points you know, acquisitions is going to be a very compelling investment alternative and we will push on the pedal for that. And you know, we will consider a fund three.

Great. Thank you.

Your next question comes from the line of Karin Ford with Keybanc Capital Markets. You may proceed.

Hi, good morning.

Morning.

Hey Karin.

One of your competitors talked about seeing some credit quality issues in southern California a couple of markets there. Have you guys seen similar type issues there?

We have -- I listened to one of the calls that was referring to that and no we really don't see it. Those would typically be more of the outlying areas and our credit or delinquencies are running, you know, as low as they have for the last several years so we have seen no change in that. Where you would expect those changes would be once again in the Inland empire where you are pushing up against affordability issues and a lot of job losses and those types of, those types of issues which tend to precede, you know, significant delinquency issues but not an important factor in our portfolio.

Okay. Next question relates to dispositions. I think you guys had talked on the last call that you had some [teed] up in Southern California and I think you've targeted 100 to 200 million for year. Can you just talk about -- give us an update on that?

Sure. We've got three properties on the market. One in Seattle and two in Southern California as we speak. There's some activity on all of them. We do not have contracts with contingencies removed and our policy has been not to report the stuff out until it's -- you know, it's done. So, there is activity. And we would expect that at least a couple of those will get done before year end which will probably be close to our target for the year.

That's helpful. Final question, it sounds like you guys economically are expecting an inflection point in the California economy and the home market late '08 early '09. Does that inflection point make you reconsider your current asset allocation (inaudible) you know, what you guys did between Southern Cal and Northern Cal a few years ago?

You know I think we -- .

We always are looking at that and you know part of your process is to, you know, approximately semiannually, and John Lopez is here so he runs this process. He ranks our 30 something sub markets by three year rent growth potential. And so we're very focused on that, continue to run that. I don't think that we are ready to make a change at this point. However, you know, some of the dynamics are beginning to change and we continue to evaluate that on an on going basis. So, I think for now we're happy with the prospects in Northern California and Seattle.

Great. Thanks very much.

And your next caller comes from line of Michael Bilerman from Essex Property Trust. You may proceed.

Hi. This is David [Todie] here with Michael Bilerman.

Did we hire Michael?

I don't know. I think we're still in New York, but -- (laughter).

We'd really like Michael to come work for us, that would be great.

Just a couple of questions -- you guys have answered a few details today. As ground up development becomes more challenging in the context of increasing supply and sort of -- and uncertainty, do you see more of a focus on redevelopment, repositioning?

We, you know, we have a separate group within the organization that does that, and we think it's an important part of what we do. You know, just taking a step back sort of the macro picture is we believe in locations first and if you are going to be very, very selective as to locations which we are and you all know we are, then you have to have more flexibility with respect to what to do with product that is well located. So, we believe that, you know, redevelopment (inaudible) and acquisitions are all, all things that we have to do well given our -- the restrictive nature of where we buy -- where we buy or where we invest. And so I think that same dynamic applies, we look at all of the different options, we try to allocate capital very actively within the company and we try to find where the best yields of growth, everything is benchmarked effectively against what does it do for FFO per share today, what is the impact on [NEV] per share. What is the impact on the growth rate of the portfolio. So, basically all transactions are sort of benchmarked against that backdrop. And we will do any of those three execution options clearly redevelopment is is, in many cases the best. So, sorry if that's maybe a little too general but that's the way we approach it.

No, that's helpful. And then just another sort of big picture question when thinking about the second half of the year and you're sort of hedging your expected performance somewhat, are you growing increasingly concerned about unemployment or are you more concerned about supply issues?

I think it's the macro economy that we're more concerned about. So, the supply, the nice thing about supply is you can pretty much plot them on a map. And we have done that. So, we know where the supply spreads are. And they, you know, they don't you don't get surprised on that front or if you do it's shame on you. The real uncertainty here is in the general economy and what's going to happen -- what's going to happen there. And so that is much more difficult to project and as you know John Lopez is here. He can talk about that a bit more but he is very focused on the jobs data. We have a weekly Monday morning meeting that he reports out any new activity in that area and we are very sensitive to that data.

Great. And then just one last question, if you could potentially quantify any changes in the underwriting to the developments that you're looking at in your shadow pipeline today versus developments that are currently underway.

Well, you know, as you know, we target the mid 6 Cap rate on our deals with, you know, the current environment, it is challenging to get there in the short run, except for on unique deals. So, I'd say while we are keeping our powder dry we are look at every transaction. The level of volume on our -- on our shadow pipeline is declining a bit over the last six to 12 months. Especially in light of if Cap rates have moved up a little bit. You know that alternative is more attractive.

Great. Thank you very much.

And your next question comes from the line of Anthony Paolone from JP Morgan. You may proceed.

Thank you. On the deal flow, you talked about not having done anything year-to-date and the data (inaudible) spreads still being pretty wide. Are you seeing a lot of the deals that you bid on year-to-date or have looked at, actually clearing or is it that these projects or properties are still lingering in the market? Trying to get a sense as to whether it's the markets bid (inaudible) spread thats remained pretty wide or is it just that it's not yet at a place where you want to participate?

Well, if you just look at the two primary markets we're trying to do, where we're trying to expand our portfolio, and thats the Bay area and Seattle. In the Bay area there's only been for the first half of the year I think three or four transactions, you know, one was in San Francisco at a very low Cap rate and the other two were in -- one in San Jose and I think one in the East bay. At you know, modest Cap rates and most of the stuff that we've looked at generally has not cleared in either market. In Seattle the sort of the same thing applies, there's only been a few transactions, you know, again one on Mercer island at a very low Cap rate is a brand new property. And a couple on the east side at, you know, sort of low five to mid five cap rates. So, you know, it's as I said earlier we're trying to be judicious with our capital and make sure that what we've got allocated to development and whatever we use on the acquisition side is accretive to what we're trying to do and make us a little bit better company. So, I guess generally I would say that the, just the volume of transactions is down. Nobody is really aggressively buying out there. And we haven't been able to get to transactions that make sense for us. We've had to you know, we've been into several that we've gotten pretty far down the road and just couldn't make it work at the end of the day. So, we've keep our discipline and walked away from them.

Okay. And then, looking at Northern California and Seattle it's been several quarters now that you've been growing revenues at a pretty rapid clip. How much do you think you have left in that market?

You know, we benchmark that against you know, the relationship between rents and meeting income levels and you will recall that these markets are the markets that you know, Northern California, Seattle, I mean -- are the market that is got beat up the most coming out of the last cycle, and so rent to median income relationships were pretty -- were pushed down quite a bit when we started this cycle. So, I think that -- and John Lopez again, he knows these numbers better than I do, but I think in San Francisco we're sort of at the long term historical relationship between rent and median income, which means that going forward there will be a bias toward growing at about median the income growth rate but in Silicon valley, East bay, Seattle, certainly, we are still at a 5% to 10% lower relationship. So, that means that you should be able to push rents -- continue to push rents. So, we think there still is upside potential there. The other sort of barometer is that typically during -- when economic conditions deteriorate you have more of a propensity of people doubling up. And we really haven't seen that to any great extent at this point in time. So, we, that sort of is obviously the reason why we continue to look at Seattle and Northern California from an acquisition standpoint. So, all of these things sort of tie together at some level. So, we think that there's still room to grow here.

Let me just throw another sort of piece of information in there. The other thing we look at is single family affordability. And even though we've seen home prices drop, you know, anywhere from 8% to 20% depending on those sub market in Northern California and Seattle, even if at the top end, at 20% in Northern California that takes the, sort of the median home price down to $600,000, which given the median household income in this marketplace keeps the affordability at about 60% which is very similar to Seattle. So, again, single family affordability still is an issue, you know, in these markets.

And just one last thing to add is obviously future growth is obviously depending on future job growth. So, we are in good conditions and if we get good job growth we can maintain above average growth in those markets.

Okay. And then also on the expense side, you've had margin expansion in those markets because the revenue side has been so robust but I guess expenses on a stand alone basis have grown at an above average clip in those areas too. If those markets were to slow, do you think expenses will come down commensurately?

Well, you have to -- I think you have to break that apart. Really, the percentage of expenses above what you would consider normal. If the normal expense growth is 2.5% to 3%, some significant amount of that can be explained with these new initiatives, the property tax situation in Seattle, and the other stuff that I commented on in the call. So, I think that those things are beyond sort of the normalized expense growth and really are the reason why our expenses are above sort of the long-term you know expected increase in expenses. So, I think it's more timing of different things. Again Seattle property tax we've got some big re-assessments up there based on valuation -- significant valuation increases. That's not going to happen every year, that's a phenomena that's sort of a one-time only event. And is affecting us. Again similarly, level one call center support [Yield] Star, some of the other initiatives that we're working on, have a, sort of a one-time increase in expense. So, I think it sort of will go back to a more normalized level from this point on. Mike, do you have anything to add to that?

Yes, we also changed our philosophy on how we allocate property management fees back to the properties. So, this year we -- some properties that weren't paying any property management fees, we're now starting to charge them a fee and that kind of again increases the allocation away from G&A the property (inaudible) so it impacted the NOI. No impact on FFO it was just reallocations. We were much lower than our peers in what we were allocating so we're closer to the middle of the group now.

Okay. Thank you.

Once again accounting rules world. I'm just kidding.

And your next question comes from the line of Steve Sakwa from Merrill Lynch. You may proceed.

Thank you. A couple of questions. Can you just talk about the development yields that you expect I guess, on that 600 million, how that's maybe changed and what kind of returns are you targeting on the redevelopments and what kind of dollars do you think that you'll spend sort of annually on the redevelopment program?

On developments, the range is 6.25 to 6.5 on the stabilize number.

In redevelopment.

Yes, redevelopment we will spend $30 to $40 million and the average will be about 8% return on that $30 to $40 million.

Okay. Mike, is there any, do you have any update or have a quantification on the convert with regard to APB 14 or is that not applicable to your convert deal?

The that's the -- APB 14, you'll have to refresh my memory. It has been a while. But if your looking at the new rule thats coming out effective January 1.

Yes, talking about the non-cash interest expense.

Yes, basically it will take what we are paying at 3.62 and will probably bring it up closer to 6% on $225 million. So, add at least 100 basis points so that will be a couple million dollars.

Okay. Will you put that in your Q, or do you know exactly what it will be or you're still kind of finding things out?

We probably should put that in the Q. I don't know that we have done that yet. So, I will check it, it's probably closer to $4 million a year. So, probably, it's, about 200 basis points on $200 million. So, that is -- and -- but it is we restate all prior periods so it doesn't have a year-over-year impact.

Right, no, I understand. I just, I didn't know if and when you were going to disclose that, if that had been out there or whether you were still working through it.

Several analysts have are done a pretty good job of estimating it. I think it's already out there. But its a good idea for us to corroborate that and put it in the Q. So, I don't think we have yet but it's not too late. We haven't filed it yet. So thank you.

Okay. Thanks a lot.

And your next question comes from the line of Michael Salinsky. (OPERATOR INSTRUCTIONS). You may proceed, sir.

Good morning. Looking a little bit more granular at Northern California performance do you have a break out of that for class A versus class B within your portfolio?

What do you, what are you looking at specifically? What do you want broken out?

I am just looking at if you saw people moving from -- to -- if the -- a performance relative to what you had previously kind of indicated for the quarter was more focused in the class B segment or how the A and B segments were performing on a relative basis.

Actually we don't have -- I mean, and this is sort of antidotal, I mean, I have the property by property operations this front of me. Don't see a lot of change between class A and class B. It is much more effected by location. So, Southern California being a huge area 20, 25 million people. It is local sub market specific to a much greater extent than it is class A versus class B. So, I don't think there was a significant difference in how one class of property acted relative to another within a local marketplace.

Okay, so it's safe to say you're not seeing anybody trading down from A's to B's yet in the cycle?

It's hard to tell but no. We're not -- I mean again, some of this is -- some of the class A to class B, activity there are some lease ups in a variety of different areas. And you know I think the dynamics of those lease ups for example affect all, they don't affect one versus the other, and it's hard to generalize in terms of [gee] are people moving up or down. It's sort of dependent upon the local supply in the marketplace and rent levels. So, -- and they all relate to one another. So, it's -- it's pretty difficult to generalize on that statement. But the overall trends we don't see a big difference between A and B, (inaudible) say that.

Okay, Mike in your comments you were talking about the performance of fund two, when do you expect to begin harvesting value from that fund just given what we're -- the strength we've seen in Seattle and (inaudible) in California over the past couple of years?

I think that selectively it will start harvesting those that are in more outlier locations but those that are close to the jobs, we believe there's a lot of runway left and we'll hold on to them for another several years.

Okay. Third just looking at the opportunities within your portfolio, looking at also some of the pressure we've seen in some other markets around the country, a couple of years back you parted with a consortium there to look at a portfolio in the DC area. Is there any chance fund three, if and when it does materialize, would be outside of your target geography at this point?

Probably not. We've built our skill set around investing in the West Coast and I would guess that those partners who want to come in and invest with us, would look to that skill set and expect us to stay true to that. If we were to do something like go after another market at DC or Boston or New York or whatever, we'd probably team up with one specific partner who had an interest in it as opposed to trying to do it through fund three.

Okay, that's helpful and then finally just looking at you had the TRS income there in the first quarter, is there any additional income we should be looking for in the second half of the year, any opportunities on the horizon at this point?

There are but I'm not enough certainty at this point in time to disclose any of them.

Thank you.

And your next question comes from the line of Rich Anderson from BMO Capital Markets. Yaw may proceed.

Thanks. Most of my questions have been answered just one on -- or one or two on the busted condo strategy. How big of an opportunity would you say that is? And how many assets are out there in dollar value would you say.

Wow, it's tough. I mean if you go through, you know, sort of the San Diego market started it and we went down there and looked. And I think most of that has passed now. We had a couple of deals that were in contract and ultimately couldn't, couldn't get there and the developers, I think, in both cases found additional equity to bring in and saved themselves so those deals went off the market. There's a couple of deals in LA we're looking at. You know, I would guess that.

Is it $100 million or is it a billion? You know.

I would guess it's closer to a billion than a hundred million. I can think of one or two deals right off the top of my head that are $100 million. So, it's probably in the billion dollar range.

And when you talk to those folks and sometimes as you mentioned you are speaking to the lenders, are they, is it different conversation since that you're not really talking about Cap rates necessarily (inaudible) the bust the condominium. I mean is it -- are they a little bit out of touch with that, sort of, conversation or are they pretty, you know, pretty skilled at the process?

It depends. I mean we had one transaction we spent a fair amount of time on recently, that the developer knew he was toast and he was just looking to save a little bit of his own equity and the -- the [mez] was gone and really what we were doing is we were dealing with the construction lender and we were looking at it from an apartment deal trying to make it work as -- I mean, because the condo market isn't working for them it's not going work for us. So, we were looking at it on a Cap rate basis and trying to buy new product at mid to, you know, high 5's, and we had dialogue but you know frankly at the end of the day I think the construction lender found people with a better set of rose colored glasses than we had on. So, the transaction -- and again the transactions, there are people out there who have raised funds who are looking for that kind of stuff so those transactions are happening and I think they will clear probably at Cap rates that we're not willing to pay.

Okay. And just a quick one, maybe for Mike Schall. Is there any seasonality to speak of in Southern California relative to -- relatively speak to Northern California or Seattle?

Yeah. Actually there is. I mean it is, I think it's less. Seattle has the most seasonality because things pretty much shut down from Thanksgiving to mid January. But the Holidays are a phenomena for everyone and so we do try to scale back our lease expirations beginning in mid November through mid January. So, and you know, effectively take those lease expirations and lump them into the summer months. So, it's less dramatic but yes it is still seasonal.

Okay thank you.

And your last person comes from the line of Paula Poskon from Robert Baird. You may proceed.

Thank you. How r worried are you, if at all, about the impact of a potential (inaudible) strike in southern California?

You know, it's, I don't know that we are, you know, we went through the writers strike and you know I've heard some comments on other call that [gee] it was a horrible thing. And you know I talked to our operations people and Mike Schall is here, who runs ops. I think we had five people that said [gee] I'm having a little tough time. So, and I don't think our properties are necessarily located in generally different locations than our competitors. So, we haven't seen it. We're not particularly concerned about it, but apparently that's a concern in the marketplace.

I've had some questions about it. Thank you. And then lastly what are you seeing in insurance trends?

Insurance?

Yes, your insurance court costs.

They've declined over -- in last year and we don't expect. I mean there was a huge run up in insurance costs for the last five years, up to about the last year, and then you know, costs have moderated and I think our expectation -- I think the expectation of the insurance industry is that property casualty is going to be a softening market. And I think we've seen that in our most recent renewal and I think that will probably continue for a while.

Thanks very much.

We have no further questions and I would now like the turn the call back to Mr. Keith Guericke, President and CEO. You may proceed.

Thanks a lot for joining us and again if there's any questions we didn't answer, please call any one of us and we are here. And we'll talk to you next quarter. Thank a lot. Bye.

Thank you for your participation in today's conference. This concludes the presentation. And you may now disconnect.