Essex Property Trust Inc (ESS) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the second quarter 2009 Essex Property Trust earnings conference call. I'll be be your coordinator for today. At this time all participants are in a listen only mode. We will conduct a question and answer session towards 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 presentation over to your host for today's call, Mr. Keith Guericke, President and CEO. Please proceed.

Good morning. Thank you for joining the call. This morning we're going to be making some comments in the call which are not historical facts such as expectations regarding markets, financial results and real estate projects. These statements are forward-looking statements which involve risk 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.

Joining me on today's call will be Mike Schall, Mike Dance, and John Eudy. Included in the earnings release on our website you'll find our market forecast for 2009 plus several schedules providing information on supply of all new housing by market and single family affordability. To get those details visit our website under investors and media.

Yesterday, we reported funds from operations of $1.43 per share, which is approximately 1% higher than on a year-over-year basis. Given the tumultuous operating environment we faced during the quarter, we believe we adopted the correct strategy in managing to occupancy in all of our market which is resulted in a 96.8% occupancy at the end of the second quarter thus far the highest of all of our multi-family peers.

I want to talk about two things this morning. The health of the single family housing in our market and our view of where cap rates are and will go for multi-family transactions in our markets. First let's talk about single family housing in our markets. Central and Southern California became the poster child for the recession. Certainly, parts of our Coastal Southern California markets contain jobs related to home financing. Single family construction was up as home prices increased but nowhere near the degree of the Inland Empire, Central California, and other construction bubble markets like Phoenix, Las Vegas, and South Florida.

Recent evidence indicates that the Southern California Coastal housing markets in our portfolio are stabilizing quicker than other markets. The main indicators of a stabilizing housing market are increasing transactions, higher prices, and a reduction of unsold inventory on the market. In the second quarter transactions were up significantly. June transactions in our Southern California markets were up 25% year-over-year and up 73% from the bottom in September 2008. Median prices in June for both single family and condo stood at $340,000 up 14% from December 2008 bottom of $298,000. These increases are being driven by very hot conditions at the low end and an increase in activity in the middle segment of the market. The month supply of unsold inventory has dropped sharply and now stands at levels that are typically associated with healthy markets. For California overall, unsold inventories represented 4.1 months supply versus 6.6 months at the start of the year and 16.6 months in 2008. The levels of unsold inventory in San Diego and Orange County are both at just over four months, while LA County stands at just under six months which puts it among the lowest of major US Metros in June according to a recent Wall Street Journal report.

In contrast, in the Inland Empire transactions are up significantly; however, median sales prices in June were $166,000 down 16% from the December 2008 value of $198,000. We're encouraged by the signs we've seen in Q2. A stable single family market is key to a stable total residential market. According to independent surveys, apartment occupancy levels stabilized in Q2 after significant fall in the first quarter. We also believe our underlying core of high-tech and business service industries will lead the recovery of jobs in the US. We expect to be positioned with good occupancy levels, low single family affordability, affordable rents and relation to both income and the cost of owning the median price hope as the job recovery begins.

Now I'd like to talk about cap rates, where they're at today and where we think they're going. There have been very few transactions in the last year, year-to-date in Northern California there have been three multi-family properties sold, Seattle has also seen three transactions, and Southern California there have been seven properties sold. Cap rates on current economic rents have remained lower than expected. In Seattle they range from 5.75to 6.5, in Northern California, 6% to 6.5% and in Southern California, cap rates range from 6 to 6.75. Many people expect large amounts of distress and as a result cap rates are expected to go to 7.5 or higher. I think that's wishful thinking for a number of reasons. First, operations and occupancies aren't that bad. Second, I believe lenders are going to work with borrowers who have maturing loans, probably the most important is GSEs are furnishing debt in the 5.5 o 6% range and you can probably get a 70% LTV loan. That would produce cash on cash returns of approximately 10% if you were able to get a 6.5 cap, and finally, sellers aren't going to transact at high cap rates on the expectation that things will get significantly better by 2011 and 2012. My belief is cap rates are going to stay in the 6 to 6.5% range near term and over time will start ratcheting back down.

The implications of this are that NAVs at most multi-family companies are probably understated and the buying opportunities and significant external growth that is being talked about does not materialize. Now I'd like to turn the call over to John Eudy.

Thank you, Keith. Since last quarter, we completed Seattle and Studio City in Los Angeles which are now in lease up. The Grand in Open is nearing stabilization at 94% leased having averaged over 37 units leased per month since the opening in February. Our operations team did a phenomenal job in a very difficult economic environment. We have two deals under construction, Fourth Street in Berkeley and Jewel on Broadway in Seattle, which will be delivered in Q2 and Q3 2010 respectively. The remaining funding requirement on our development projects under construction is $108 million of which approximately $58 million is from our construction loan on Jewel and the already funded equity on our Fund II development, Ciello. The remaining $50 million is from cash which is in our business plan.

Construction costs have stabilized between 25 to 30% below their late 2007 peaks back to late 90s, early 2000 levels. We do believe costs have stabilized and will not go much further down. Land prices have come off their peaks, although it is difficult to assess how much since no notable deals in core in fill areas have traded or closed escrow yet. We're following a few opportunities mostly from banks and financial institutions and if we can get pricing levels at opportunistic levels dating back to the mid 90s range of land pricing we'll be at the table. The last land deal prices we negotiated in the current development portfolio pipeline were between 2003 and 2005 prior to the land spikes of '06 and '07. We did avoid overpaying on a normalized value albeit on today's rents we cannot justify starts of any magnitude at this time.

Lastly, we were recognized recently by the development industry at the Pacific Coast Builders Conference in 2009 in June with two Gold Nugget brand awards and one merit award. We were one runner up away position from a sweep in the conventional rental multi-family categories. Our developments were judged against our peers for multi-family in all three categories, best low rise, best high rise and best design on Eastlake the Grand and Jewel on Broadway respectively. Obviously we're proud of our team and their superior attention to detail without spending anymore on construction than necessary building a competitive rental development.

When you compare the velocity of the lease up that exceeded our peer group on both Eastlake and the Grand for example, besides our on site leasing team efforts in some part it ties back to the superior communities we've created. At this time I'd like to turn the call over to Mike Schall.

Thank you, John, and thank you everyone for joining the call. The quarters results followed the path that we expected and discussed in last quarters call. As you know, the West Coast apartment markets continued to present operational challenges during the quarter, mostly due to the following factors. First, the realization at lease termination of reductions in market rent that occurred primarily from December 2008 to March 2009. Second, delivery of a substantial apartment and condo development pipeline, particularly in Seattle and several Southern California sub markets. Third, condos and condo projects being rented as apartments, and fourth, working with a consumer that is reluctant to make long term financial commitments. These factors directly relate to the weak economic environment and massive job losses that have affected virtually every part of the country. We have revised our forecasted 2009 job losses for the US to $4.1 million or 3.1% from $3.6 million or 2.6% that was discussed on the last quarterly call. As a result, we have also revised our forecast of 2009 job losses for all Essex markets to 328,000 or 2.9% from 245,600 or 2.1%. As before this information is included in our supplemental financial package that is available on our website.

The greatest contributor to the downward revision in jobs in the Essex markets is the larger than expected job loss in construction and retail trade. Despite the greater job losses we have not changed our expectations for 2009 market rent decline as published in connection with our first quarter results although we have reduced the expected market occupancy rates in Seattle and LA by 50 basis points.

Our markets have experienced rent declines since December 2008 that were larger than we would have normally anticipated given the magnitude of job loss and new supply. Although job losses continue at a distressing pace, we believe that fear on the part of the consumer and lack of confidence about recovery, about a recovery contributed significantly to these rent declines. During the second quarter, expectations about the timing and magnitude of the recovery improved as did consumer and business confidence which is helping to stabilize rents and occupancies across our markets. We've also factored into our outlook the impact of the California budget situation. Job losses are already occurring as part of the $15 billion spending cuts this fiscal year. These job losses will cause California's recovery to lag that of the US Fortunately, most of the Essex Metros have very little exposure to government jobs as a percentage of the job stock and local GDP. We expect the majority of the state government job losses to be centered in Sacramento; however, job cuts in elementary and second after it education will be uniform across the state. In addition, specific markets will be affected by job reductions at the University of California and Cal State University system such as downtown San Francisco, West LA, and the North Coast of San Diego.

During the quarter, we continued to maintain strong occupancy although we backed off that approach as the second quarter progressed as we work to recover some of the large reduction in market rents that occurred in the previous months. That effort began with a focused effort to renew leases for existing residents. Our annualized turnover rate for the portfolio increased slightly to 62% in Q2 '09 from 60% in Q2 '08; however it was challenging to maintain essentially flat turnover rates given the increase in residents such as those that lost jobs that are not una position to renew. For the quarter, the turnover due to job loss represented 6.4% of our turned units in Q2 2009 which was four times the 1.6% experienced in Q2 2008.

In addition, nearly 10% of all move outs for the quarter bought a home versus 10.3% in Q2 '08. This reverses the direction of the last couple of quarters where we saw 25% plus reductions in the move outs to purchase homes as lenders tightened lending standards. We view this spike in move out to buy home purchases as temporary and tied to the sales of foreclosure and other distressed situations. Longer term, the rate of production of all housing has now fallen dramatically and it will take years to restart that development pipeline. This is the most significant factor affecting our future as we believe that the current conditions will reverse in late 2010. That is, rather than having large development deliveries, amid falling employment, we will have strong employment growth and minimal for sale and for rent housing supply. This supports our belief we will experience a strong recovery in rents at very high occupancy rates. Delinquencies have increased modestly during the quarter and were 0.54% in Q2 '09 versus 0.45% in Q1 '09. That's a scheduled rent versus 0.35% in Q2 2008 for our same property portfolio.

Now I'd like to briefly review each major part of the portfolio starting in the Pacific Northwest. We are maintaining our expectation for 40,000 job losses or 2.7% compared to 3.1% for the Nation and a 12.5% market rent decline that's December '09 versus December '08 and have lowered our market occupancy forecast by 50 basis points to 93%. The labor market started to stabilize during the second quarter losing 9300 jobs compared to an average of 26,000 during the previous two quarters. As of July, Boeing has cut roughly 2700 jobs or 3.5% year-over-year which is significantly better than the 12% year-over-year declines reported nationally in the manufacturing sector. Employment at Boeing has been flat over the last three months, the retail trade and leisure hospitality sectors have also stabilized. The unemployment rate in Seattle is lower than the US 8.2% versus 9.1% while the labor force has grown at a much higher rate indicating a stronger labor market in Seattle than the Nation.

Given the regions unique exposure to technology, trade, particularly Asian trade and healthcare, we expect the Seattle labor market to begin recovery earlier than the national average. The latest survey of apartment market data vendors that we use showed Q2 occupancy remained flat at 93% after a larger than expected 125 basis point drop in Q1 '09; however apartment and condo development pipelines continue housing supply through mid 2010 in downtown Seattle and Belleview which will delay the impact of better than expected recovery in jobs. We expect improving rents and occupancy to begin in late 2010, early 2011.

As of July 2009, our Seattle physical occupancy or Seattle occupancy included approximately 2.6% Boeing employees, less than 1% WaMu now JPMorgan employees and 5% Microsoft employees. As of July 20, 2009, physical occupancy in Seattle was 97% and availability was 4.9%. In Northern California, we've adjusted our Northern California job loss forecast to job loss of 92,000 or 3.1% equivalent to the national average from 66,000 or 2.2%. We are maintaining our guidance for rent declines at approximately 8% and market occupancy of 94%. These revisions are driven by much larger losses of construction and retail jobs particularly in San Francisco which was also negatively impacted by larger than expected losses in leisure hospitality jobs.

The region lost an estimated 28,800 jobs in Q2, roughly half the rate of loss in Q1 of 50,000 jobs. Given the steepness of cuts particularly in construction where the level of jobs is back to 1997 levels, we expect job cuts to continue to moderate in Q3. Our vendor survey showed occupancy remaining flat at 95% in Q2 after falling 100 basis points in Q1. We expect occupancy and rents to remain at current levels for the rest of 2009. Minimal residential supply, low affordability, and improving jobs point to improving markets in mid 2010. As of July 20, physical occupancy was 96.9% in our Northern California portfolio and net availability was 4.5%.

Then on to Southern California, Southern Cal contained the majority of the downward job revisions. We've increased our job loss forecast from last quarter to a loss of 196,000 jobs at 2.8% from 140,000 jobs or 2%. Again, this compares to a projected 3.1% job loss for the US. Two-thirds of this revision comes in Los Angeles which experienced 17,000 lost jobs in the motion picture industry, across the region the revisions were driven by higher than expected cuts in construction, retail and tourism, job losses did slow in Q2 across the region similar to the US with a notable exception of Los Angeles. We are maintaining our guidance for rent declines averaging 9.5% in Southern California and lowered overall market occupancy 30 basis points to 93.6% due to a 50 basis point decline in Los Angeles which is half the region.

The survey from major vendors of apartment market conditions showed occupancy remaining flat at 93.75% in Q2 after falling 100 basis points in Q1. The supply pipeline has been completed in Ventura, where there is virtually no current residential construction. The multi-family pipeline is near completion in San Diego, particularly the high rise downtown condo buildings. The Orange County apartment delivery centered in Irvine are also nearing completion with the exception of one large project. In Los Angeles, the supply pipeline has more deliveries, in downtown, West LA, and Woodland Hills through 2009. The pipeline, however, will drop dramatically in 2010. We expect stable occupancy as job losses slow and the supply pipeline is completed.

Improving occupancy and rental growth is expected to return in mid to late 2010 for areas with limited new supply. In areas with larger development pipelines of recovery and rent should occur in late 2010, early 2011. As of July 20, 2009, physical occupancy in LA Ventura was 96% with net availability of 5.2% in Orange County occupancy was 95.5%, net availability of 6.8% and in San Diego, occupancy was 97% with net availability of 6.1%. Now I'd like to turn the call over to Mike Dance.

Thanks, Mike. Today I will start my comments by drawing attention to the use of proceeds from our common stock issuances during the quarter which led to an increase in the mid point for 2009 funds from operations guidance of $0.05 a share. During the quarter we issued 1.145 million shares of common stock at an average price just over $67 a share. The $75 million in proceeds were used to invest in $82 million of unsecured bonds of multi-family REITs. It is unusual for an equity REIT to make investments in fixed income securities; however we believe that when the yield on multi-family investment grade unsecured debt exceeded the cap rates of multi-family assets that there was an arbitrage opportunity to take advantage of the dislocation in the credit markets.

Our first choice was to retire our own convertible bonds which we did at the end of 2008 and the first quarter of 2009. We made several unsuccessful attempts to retire the remaining $100 million in the Essex convertible bonds, only to be told by the 1 remaining bondholder that they had no interest in selling their holdings in our bonds.

When we could not retire the Essex bonds we changed our focus to buying unsecured bonds of our peers. By issuing equity to buy these marketable securities we have strengthened our balance sheet while immediately adding accretion to FFO per share while cushioning further declines in FFO expected from the expected decline in scheduled rents. The investment in redebt is expected to add almost $0.05 of FFO per share in the second half of 2009, that was not included in our guidance at the end of the first quarter.

We believe this investment provides flexibility to effectively deal with future capital plans depending on the following scenarios. If real estate credit spreads continue to compress and the yield on the bonds drop lower than the cap rate on direct investments and multi-family assets then we can recognize a significant gain and deploy the capital to earn higher returns. If credit spreads increase, or the access to debt from the GSE tightens, we can sell the bonds in the second half of 2009 to pay off known debt obligations. When we could not retire the Essex convertible bonds we essentially have a sinking fund comprised of the bonds of our peers that will be sold if we don't have access to other cheaper sources of capital. Or lastly, we can hold the bonds to their put or maturity dates and recognize an average yield of 10%.

The ongoing rally in the debt markets have driven current yields on the unsecured bonds of investment grade multi-family REITs to below 8% which has resulted in an uestimated unrealized gain on our bonds as of July 31, of approximately $8 million. This gain will be recognized as FFO either as interest income as we amortize the discount to par value over the holding period of the bonds or as one-time FFO gains if we sell the bonds prior to their maturity date. The strong operating results in the June quarter were achieved by maintaining high occupancy coupled with strong cost controls on expenses.

These revenue results were in line with our expectations and the mid point of our guidance, the year-to-date operating expenses are running much lower than our guidance, however we have seasonally experienced operating expenses in the second half of the year. The year-over-year same property revenue comparisons will be much more difficult in the second half as we compare to the second half of 2008. The mid point of our guidance for funds from operations in 2009 assumes that year-over-year same property revenues will be down almost 4% and the same property net operating income will decline by approximately 6%.

In July we continued our high occupancies and low expenses and if we are successful in maintaining high occupancy through the remainder of the year and if we have found the floor on market rents, then our FFO results could reach the high end of our guidance. During the second quarter, non-same-store revenues from the 100 Grand did not recognize the 300,000 in rent concessions as our revenue policy for leases with concessions is on the cash basis. We expect another 150,000 in free rents in the third quarter from this asset and in the fourth quarter we should have stabilized rents. Interest expense for the second half of 2009 will increase as we have stopped interest capitalization on the 100 Grand now that it has reached stabilized occupancy and during the third quarter we will stop capitalizing interest on the Cadence campus pre-development as we have reached the end of our entitlement process.

I will close my remarks by committing on the status of our current bank facility which matures in March 2010. We have received indicative terms from our current lead bank and proposals from a number of well capitalized banks that can get a lead or co-lead a new bank facility for $200 million. The proposed fees for the committment plus the spreads on amounts borrowed and proposed covenants that are not borrower friendly has caused us to weigh the benefits of maintaining a $200 million unsecured facility versus expanding our current secured facility to $400 million at better terms than what a bank group can offer. We have had a long mutually beneficial relationship with our bank group and it is our desire to try and negotiate a new facility; however, if during the third quarter we are not able to negotiate a cost effective bank facility, we have a Plan B which will be to expand our secured facility. Our bank facility only has $25 million drawn which can be paid off immediately with our current cash balances. If we do not renew the bank line we will have $350 million additional capacity in a new secured facility and over $150 million in cash and marketable securities providing us access to $500 million in capital. This concludes my remarks and I'll turn the call back to the Operator for questions.

Thank you. (Operator Instructions) Our first question will come from the line of Jay Habermann from Goldman Sachs.

Hi, good morning everyone. Just your comments about cap rates, where they stand today and your expectations that cap rates should remain fairly low, obviously a function of where interest rates are today. But obviously you guys made the decision to buy the unsecured bonds of your peers, but I'm just curious, if you think that inflation or interest rates will pick up in the future, why not go out and buy assets today if you think that you can actually buy assets at 7, 7.5% cap rates and ultimately they will be worth as you said mid 6s?

Well, no, I don't think you can buy them at 7.5 today. That was my point. All of the transactions we've seen and again there aren't many, three in the Bay Area, three in Seattle and seven in Southern California the cap rates ranged from 5.75 to about 6.5 and there's a couple in Southern California that hit 6.75 so you can't buy at 7.5, and again, that's at marking rents to current market and in California taking the prop 13 taxes to the appropriate level and the NOI and looking at the cap rate and there just are not 7.5 caps out there so the leap is -- again our cost of capital does not align with 6.5 caps, and we don't see significant growth for another 12to 18 months, so I think they are going to stay at sort of these 6to 6.5% range for a while so as we get closer to rent the whole thing, this whole deal is cap rates going in and growth rates, and that's -- you have to balance those two things and if you can balance them successfully you can get growth and you can get FFO growth and if you screw it up, you shoot yourself in the foot so we're trying to keep our gun pointed in the air instead of at our feet.

Sure and then you mentioned looking at land, I guess at mid 90s pricing but at the same time, if you do back to the mid 90s, cap rates on most of the apartments were probably more in the 8% range? So I guess is there risk you think ultimately cap rates could back up to those levels? Funding costs clearly will rise going forward if you assume the cost of debt will over the next two years be higher than 5, 6%.

I mean, I think you're right. Interest rates are the wildcard and if cap rates, I mean if interest rates on our sector go to 7 or 7.5, the cap rates have to go up, but in today's world, I mean, and I don't see it changing near term, you just can't have that much positive leverage. It's just not going to work. You're going to have other people stepping in. The real estate guys will be left on the sidelines, as I said in my comments, if you can buy a 6.5 cap with 70% leverage and 5.5% interest rate you do the math. That's about a 10% cash on cash return and I think there are a lot of investors out there that would step into that situation. Are you starting to hear -- are you starting to see institutional interest pick up? That's my last question. Well, as I said, the transactions that have been done have been primarily private investors. One of our peers bought a deal in Seattle. There's been very little institutional buying. It's been mostly the private market.

Okay, thanks guys.

Our next question will come from the line of David Bragg from ISI.

Hi, thank you. Just a couple operational questions. First, Mike Dance, just from your comments on same-store guidance, I just want to make sure that I'm getting correct what's being implied for the second half of the year. So with your same-store numbers of revenue down 4% and NOI down 6 for the year, am I correct that implies revenue down 8 and NOI down 12 for the second half?

Roughly, yes. Again, we have a very tough comparable period. We have great second half results in 2008 and we see some headwinds for the second half of this year.

Okay. Got it, and then just on the job forecast, Mike Schall you talked about that and how you've adjusted your job loss expectations but did not adjust market rents. Does that imply a potential nother leg down in market rents for 2010 due to the lag effect?

I think there's another factor here which is not one that's easily measured which is the consumer psyche. We have again, as I said in my comments, if you just look at how much supply came online in these markets and how many jobs were lost, you would not have implied from that that market rents would have gone down projected about 9% in 2009 and a little bit more in Q4 of 2008 so we've had a very dramatic reduction in market rents relative to the absolute magnitude of job loss and new supply coming online so we think that part has gotten better. In other words the consumer is no longer in sort of shell shock mode and I think everyone will relate to how it felt back in March when no one wanted to commit to anything, buying a car or buying anything, it was savings rates spiked nationally, and a variety of things happened. Well, I think that that environment is different now and whereas we had I think a lot of people doubling up and a number of things that were happening that were reducing renter demand. I think some of that is uncoupling itself, even though we still haven't seen the turn in the job market. I mean obviously, that has to happen at some point in time for us to really get some traction here, and so as to your point with respect to another leg down, I know others have talked about that.

I kind of think that we will have a difficult operating environment but I think maybe rents decline a little bit but I don't see a big drop from this point going down and I think as the headlines get much better, I think in early 2010 I don't think that is going to precipitate a drop. I think people are going to start feeling better again and be more willing to make that rental decision.

If you did see that minor drop as you alluded to, which of the three markets would you most likely see that southern California, northern, or Seattle?

If -- I think across the board, if you look at market rents from December to now they're off about 8.5%, worse in Seattle, less in Southern California. It's hard to tell. I mean, we didn't expect San Diego to do as well as it has done this year so we're a little bit wrong there. I think there's weakness everywhere except perhaps San Diego in terms of our overall operations. It is difficult. I'm talking about if there's another one or 2% decline in rents and I think that's sort of the magnitude going forward and I see it in almost every market given the supply issues in Seattle even though the job market appears to be bottoming and recovering faster, we think Seattle ultimately is in pretty good condition with respect to jobs, having said that it's got too much supply which is going to continue to drag, but I think that it's hard to tell exactly where it's going to happen. I'd say it's going to be equivalent throughout our marketplaces with possibly the exception of San Diego.

That helps. Thank you.

Our next question will come from the line of David Toti from Citigroup.

Hi, guys. Michael Bilerman is here with me as well. Did you, did the REIT bonds that you acquired in the quarter, did the issuer know of your acquisition?

No. We go through bank traders, brokers.

Do you have any appetite for other types of securities outside of your own, outside of the bonds?

That's not our business. If we find opportunities that we can underwrite and understand, I mean, we stocked multi-family investments, things we know so we aren't speculators. We're pretty conservative investors.

I was just wondering if you're starting up an internal portfolio?

No, we're not starting a new business.

And then I didn't hear if you mentioned that equity issuance prospects for the second half, are you expected to continue that program or do you see that opportunity as (inaudible)?

I think our strategy has not changed. If we find opportunities to create FFO per share accretion, on a NAV basis, and improve our portfolio, we take advantage of those opportunities, we don't find issuing equity, put it in 1% money-market funds or pay off 1% debt to be a very attractive investment for us.

And this is Keith. I also want to comment and I know you all understand the program, but this program works very well for us. We can call our Company the morning when we see stock prices that we think are appropriate and we can give them an order for that day if they executed at the prices that we like, they do it and at the end of the day the order is off the table so we can be very specific in the pricing that we get, so I think that it's an advantageous program and I think we can control, as Mike said control our downside on this program.

Okay, and just one last question along those lines. I'm struggling with how you weigh not buying back your stock relative to buying unsecured bonds versus, issuance and how all that is mixing together in your view in the context of the belief that your stock is under valued relative to market cap rates?

Well, this is Keith again. What -- we look at a couple of factors. One is what we can do on an FFO standpoint, that's probably the least important. The most important is what is the NAV of our stock, excuse me, of our underlying portfolio, and if we're within a band range of the NAV, we have various options and we weigh those options and try to make the best choices we can, so it's certainly not a science, but a lot of different things are considered before we pull the trigger.

And rather than the direct strategy it's more timing specific, opportunity specific?

Yes, it's all relative. I mean, we view the world in terms of making investments of almost every kind as being a relative game and back to the question that Jay had a while ago, it's pretty darn difficult for us to buy 6.5 or 6.25 caps when the implied cap rate of our portfolio is 7 plus. Unless we have some very substantial growth rate on something that we might buy at a lower cap rate than our portfolio you can't make that work so I would say a lot of these investment transactions including the REIT unsecured bonds were just simply a matter of looking at the relationships of how do we create, how do we create for various types of value given the market scenarios and there was a pretty unique opportunity I think within the REIT unsecured bonds which frankly isn't there today, so I think we are trying to be opportunistic and thoughtful about how to create value and that made more sense than investing in real estate we thought at that time and the other piece of the thing is building the balance sheet and preparing ourselves for, as Keith said we don't see a lot of distress but preparing ourselves so that we are ready to invest externally when we see conditions being appropriate and the ability to sell REIT unsecured bonds and use that as the equity capital to invest in in property is something that is important to us. So I think it gives us great financial flexibility, it made money relative to the Company relative to our overall cost of capital, and so it just made a lot of sense but we don't see that condition repeating itself, so sort of a one off type of transaction which I'm sure everyone will give us a multiple of 1 on.

Okay, it's all very helpful, thank you.

Our next question will come from the line of Rich Anderson from BMO Capital Markets.

Thanks, hello, everybody. I like the negotiating tactic by the way, Mike Dance, on the facility in making that public how you plan to have a Plan B, but anyway, one wrench that could get thrown in there is in the news today in the Journal was the regulated FHFA guy stepping down and some talk of the general conversation about how Fannie and Freddie could change shape and function over the course of time, so I guess I would like to get your comment on that change in sort of management for those two firms effective today and how you feel about the future of Fannie and Freddie in the whole scheme of things.

I'll take the first cut at it. Obviously Freddie and Fannie have been fairly creative in ways that they can meet their mandate of reducing their balance sheet. Freddie did a $1 billion collateralization of CMBS-like product that they call CME that was very well received by the marketplace and they actually sold off a B piece so that the first risk of loss was with private investors, not with Freddie, so they've been creative and been well received in the marketplace which is very positive. They also get a lot of pressure to continue subsidizing the residential form of their business and astutely they go back and say the only way we can do subsidies is if we make money elsewhere and making money elsewhere to them is in the multi-family side of their business. I think they shared with us a few weeks back that Freddie has only like 4 basis points of losses in their entire portfolio and none on the West Coast. So but they also admit that their destiny is somewhat uncertain but they continue to work hard to justify their ongoing role in providing an important source of capital for workforce housing in our economy so those are the positive signs and then I kind of lost, oh, yes, and then we do recognize and again I said our first choice is to have a bank group. We love our bank group and we prefer not having all our eggs in one basket and have diversity in our credit but to give us a facility that is not cost effective doesn't accomplish anything either so it's a fine line.

Okay, and then my follow-up question is Keith, your comments about you not seeing that acquisition opportunities of scale really materializing based on your comments on cap rates and then also, your sort of downsizing and unwillingness to do anything from a new starts perspective for development, so I guess the question is what do you do? You just operate the portfolio and think less about external growth? Should we be thinking about this as this is an internal growth engine primarily for the time being?

Well, I mean, everything changes, and yes, today for this and I think that it's different. I think that the development we're probably 12 months away from making anything work. As John said we've seen costs come down 25 to 30% and we're actively out there looking for good land values, so I think that that will come back. It's not a gone or forever. Acquisitions, we're seeing 6 to 6.5 caps and at our current cost of capital, it doesn't work, but as you know we've had funds in the past, we like the fund business, and in the fund format, we can lever up to about 70% and as I said in my earlier comments, if you're finding 6.5 caps, 5.5% leverage and it's a cost of your money and 70% leverage you can see pretty significant cash on cash, so we are going to look at the fund business very very hard and we hope that that will give us opportunities to be active in the acquisition business near term.

Got it. Thanks very much.

Our next question will come from the line of Alexandra Goldfarb from Sandler O'Neill.

Yes, hi, good morning out there.

Good morning, Alex.

Mike, just going to the guidance just want to make sure I caught all of the loose ends there. If you can run through the debt gain, is that reflected in the same -- in the marketable securities line on the balance sheet like that includes both your cost basis and the gain? And then two for the balance of the year, is there some sort of securities gain that we should be modeling in and just wondering again if there's anything sort of non-NOI based, any other goodies that could be in the back half of the year?

We always look for goodies, but we don't always share them with you, but to answer your question on the guidance, our mid point does not assume any recognition of gains on selling the bonds we've purchased. It just assumes continuing amortization of the discount to par that we pay for them, so that's generally accepted accounting principles to do the effective interest rate method to bring them to par value when they mature, so that is in the guidance.

The amortization, that's already, we can use the second quarter as a run rate or do we need to adjust something in the third quarter?

You can't use the second quarter as the run rate because we didn't buy the bonds all on April 1. We bought them sporadically throughout the quarter as opportunities presented themselves, so you need to take the $100 million, invest it at that 10.3% yield that we disclosed and add to that our structured finance interest, come up with a run rate. I could walk you through that off line if you'd like.

Yes, off line is probably more appropriate. Second question then is sort of a two part. One, just want to get your sense of what you think the Prop 13 adjustment to a cap rate would be sort of on your portfolio and then two where do construction costs have to be the all in to make a deal pencil today?

Hi, Alex, it's Mike Schall. We think that the prop 13 adjustment is around 6 million to 7 million, still so we shouldn't expect therefore any significant reductions in property tax will probably go up close to 2% next year. Our plans are to appeal, I think that anything acquired after, this is general but anything acquired after 2005 about and then with just finishing off that scenario with respect to property taxes, Seattle doesn't have a prop 13 and therefore there is probably some roll down in valuation that could affect the 2010 numbers; however, the millage rate in Seattle is not set and so it could be offset by an increase in the millage rate so we're not sure exactly where that's going to go from a budget or a guidance standpoint next year but those just couple comments on property taxes.

On the construction cost, we don't see them going down much further than where they are just because labor pool has been shrunk down to the best of the best that are out there and the fact that the materials aren't going to go down much further unless something happens in the overall economy that goes the other direction. As far as when it makes sense it's all driven to rents and jobs and that's the expectation that we have before we start pulling the trigger on some of these deals.

(Operator Instructions) Our next question will come from the line of Jim Wilson from JMP Securities.

Thanks, good morning guys.

Good morning.

Was wondering the rent declines you've seen now so far through Q2, how much would you say that might have eaten into loss to lease?

Loss to lease actually is fairly flat from March until now at about 7%, so we didn't see a lot of it eaten up as a result of the second quarter, and so but it appears to be flattening and I would expect that to go down throughout the balance of 2009 and into 2010.

Okay. And then within your pay per (inaudible) -- effectively give or take 8% down revenue estimate for the back half of the year, is that I assume kind of tilted 10% or so to Seattle and LA and then obviously below that 5, 6, 7% for the rest of California? Is that in the ballpark?

I think that sort of follows. As I had mentioned earlier that if the average market rent decline is 8.5%, Seattle was worse than that and Southern California a little bit better than the average and Northern California essentially was the average so you would expect those same relationships to follow as we -- in terms of revenue recognition over the next six months.

Okay, great. Thanks a lot.

Our next question will come from the line of Michelle Coe from Banc of America.

Hi. I was just wondering in your opening remarks you talked about the stabilizing of the housing market and in my mind, it's not that clear if it's a positive or negative for apartments because on one hand, when home prices stabilize, rental rates could stabilize as well; however, you could also see more move outs due to home ownership, so I was wondering if you could tell me how you think about this and if you view the stabilizing in the housing market or improvement in the housing market as an overall positive or negative?

This is John. We look at the stable market as a positive and the transactions being up isn't necessarily because people are moving from apartments into homes. It's because homeowners are transacting between each other which is a sign that they have confidence and so we look at it more as a sign of the consumers who have confidence and we think that translates to our renters and really when we saw the worst of the move outs to homes was when there was cheap finance in our markets. We operate here because it's very difficult still under current conditions to afford a home versus renting and it's only going to get tougher going forward.

And just put differently, Michelle, as long as you're not increasing the supply of for sale housing, if you increase the supply of for sale housing we know that people are going to occupy those homes and that will take away from, subtract from the renter pool and if you just look down on the guidance, the market forecast, part of our guidance, Southern California is producing 0.1% of its existing single family supply Northern California0.2% and Seattle 0.4%. Those numbers are as small as I've ever seen them in my career here, so as long as you're not expanding that pool of single family housing, I think that this will be sort of self-correcting as John said.

Okay, great. And then just one other question, I was wondering if you could help me understand a little bit better how you were able to maintain such great occupancy with such small, relatively small decline in effective rents. Is it mainly due to renewals and what's the new lease to renewal spread and do you expect that spread to narrow going forward where the renewals move closer to the new leases, and what quarter do you typically have the highest turnover and also are there residents that maybe haven't renewed leases yet but are going month to month trying to decide whether or not to renew?

Okay, Michelle, you've covered a lot of ground there.

Sorry.

You may have to help me. I think that's blurring the one question one follow-up rule, but we'll go with it.

Sorry.

No, that's okay. From my perspective, it takes about the same number of renewals and rentals to maintain 97% occupancy as it does 93% occupancy. The key is not to let it fall and if you don't let it fall, again, continuing it really doesn't take more people. It just takes continuing with the program going forward and not letting occupancy slip. I would say that our success here, and I give great credit to the Essex team here, is not having especially large assets that fall behind. We have maintained high occupancy really throughout the portfolio, sort of without failure and that is not easy to do and that is really what accounts for our success, so the other point is if you just look at the numbers, you have 26,000 units in 130 communities, if you just break it down on a per community basis, it only takes a couple of people to move the occupancy percent 1% so we're talking about two leases per community to generate 1%. If you stay focused on it and really stay on top of it and really manage it strongly, I think that you can have very good success as I think you've seen maintaining occupancy, and it just begins, it's the whole program.

It begins with the turnover rate and what you do at expiration, we're doing a variety of things. There's no one size fits all program here. We try to taylor it to making the renewal experience very simple and very easy and very fast and giving incentives to where we need to to get people to sign quickly and it has worked pretty well but then beyond that just making sure that we're very vigilant in managing week to week our occupancy and making sure we're keeping up with what's going on in the marketplace. So again, I think that is the crux of the matter and I'm sure I missed some pieces of your question of the can you tell me what I missed? You back, Michelle?

Yes. Hello?

Did I miss something?

Hello? Could you tell me what the spread is between new leases and renewals?

Yes, the spread is around -- the difference between the expiring lease rate and the current market-rate, it's about 40% of that, we're giving up about 40% of that spread on a renewal. So it changes from market to market but just typically, we're giving up about 40% of that spread so we're keeping about 60%.

Okay. And which is your highest turnover quarter?

Oh, yes. The second and third quarter are our highest turnover quarters so we're right in the middle of our peak leasing fees so this and Q3 will be about the same, 60 to 65% turnover rates.

Okay, great. Thank you.

(Operator Instructions) Our next question will come from the line of Paula Poskon from Robert W. Baird.

Thank you. How does the actual leasing velocity and pricing power of the lease up properties compare to your performance?

Well, velocity wise, we did very well, I think John mentioned those numbers we were at 30 plus a month on the Essex at Lake Merit. In terms of rental rate, we were about 5% behind our budget for this year and in terms of concessions, we budgeted one month and we have used six weeks to two months as part of that program, but again, the name of the game in lease ups in this environment is do it quickly and I think the results are in the absorption number so the fact that we're very aggressive in leasing those units, I think reflects aggressive pricing and a very neat product, that I'm very proud to be part of.

Our next question will come from the line of Michael Salinsky from RBC Capital Markets.

Good afternoon. Two more forward-looking questions actually. Kind of one is a follow-up to Rich's comment. Can you talk about -- one of the hallmarks of Essex has always been asset allocation. You guys are able to time markets a little bit better. Where do you see the best opportunities during the next cycle among your current portfolio and also, how far out are we talking for fund three? Is that something we could have in place in six months? If cap rates do not climb up to meet your cost of capital expectations?

Well, I think external capital whether it's called Fund 3 or Fund 2.5 or whatever you'll call it is probably something we should see in the second half of the year. I think we're going to aggressively work on another fund which would probably get put in place some time early next year, so there's probably a transition fund and another larger Fund similar to Funds I and II. Where do we see the opportunities?

I mean, it's difficult because we've seen pretty significant rent drops across our portfolio and similar cap rates across the portfolio. I think one of the things that we constantly look at is trying to anticipate growth and where might there be the best growth and I think that if you look at affordability and what the median household income spend for rent is, clearly Seattle has got probably the best numbers there; however, again, we're looking at a fair amount of supply coming on so if I had to guess, it's probably going to be Seattle, Northern California where the best opportunities are, and we're, unfortunately as I said there's only been three transactions in both markets in each market, so there's the three transactions that happened here in Northern California, there were 15 to 25 bidders on each deal, so there's a tremendous amount of interest in the few assets that are out there, so it is going to be a real dog fight to get our share.

Our next question will come from the line of Chris Summers from Green Light.

My question has already been answered, thank you.

Our next question will come from the line of Rob Stevenson from Fox-Pitt Kelton. Please proceed.

Hi, guys. Just a quick one here. On the development pipeline page in the supplemental there's a footnote saying that you guys increased your ownership interest in the Seattle project from 50% to 99 I guess. What drove that and what was a consideration if any paid for that?

We had, as you know, rents have gone down in Seattle and we had a fairly aggressive squeeze down with our partner option to initiate on if there was a capital call and given that it's a financed asset and it will be financed on its take out, there was going to be a big adjustment, we had the opportunity to take advantage of it, so we took it. It's compensation was $10.3 million. And now we own basically all of the deal.

Our next question will come from the line of Andrew McCulloch from Green Street Advisors.

Hi, good afternoon. A couple quick things. Back to the cap rates, Keith, I think you mentioned earlier what CapEx assumptions are embedded in the numbers you threw out?

It was -- those NOI numbers without CapEx. I mean I think if you're going to look at the cash on cash returns, if you throw in another $500 a unit on top of that, it will take your cash on cash down a little bit but those cap rates were based on NOIs.

Okay, and then to follow-up back to Alex's question on prop 13 and the $6 million to $7 million delta you threw out, how do you think about those savings when you're thinking about your own NAV?

We operate continuously a NAV model and part of the NAV model is to adjust market rents to market, property taxes to market so we take that into consideration just like buyers and sellers would in the ordinary transaction market, we mark management fees to market et cetera, so we make all of the adjustments and coming to our NAV that you would need to make in order to make it consistent with transactions that we underwrite in the open market.

(Operator Instructions) Our next question will come from the line of Jeff Donnelly from Wells Fargo.

Good afternoon guys. Keith, a question. Have you seen a period in the past perhaps maybe in a particular market you can point to where the consumer psyche has priced in that rents I guess have moved down and in effect ahead of the actual job losses that we've incurred in the market?

I think if you go back to the early 90s, I don't remember that it was specifically done in advance like what we saw. I mean, I think this time, I think the poster child for this whole experience has been Seattle where again if you look at over two years and last year, they produced 40,000 jobs up there and this year lost 40,000 jobs over a two year period jobs are flat and the new supply in the market is about 1%, even though there's a fair amount being delivered it's still only 1%. If I were to give you those facts and I ask you what you thought rents were going to drop you'd say well it's probably flat or maybe up down a little bit, or down a little bit so this has been a very unique situation and I don't think that in my lifetime, my work experience I've ever seen it to this extent and again, I just relate this back to NAREIT in San Diego last year and everybody was walking around, we were supposed to sort of understand this and we were all light and I'm sure the consumer had the same feeling or same thoughts so everybody just really dialed back and there was fear in the marketplace, so I think that unfortunately, it's not very scientific but I think that explains a lot of it.

And that concludes today's question and answer session. I'd like to turn the call back over to Mr. Keith Guericke for closing comments.

Thank you all for joining us. We appreciate your support and we'll talk to you again next quarter and if anybody needs any follow-up, please call any of us. We're available for follow-up. Thank you.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.