Essex Property Trust Inc (ESS) 2012 Q1 法說會逐字稿

Greetings, and welcome to the Essex Property Trust Inc. first quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions)

Statements made on this conference call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made based on current expectations, assumptions, and beliefs, as well as information available to the Company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found in the Company's filings with the SEC. It is now my pleasure to introduce your host, Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, Mr. Schall, you may now begin.

Thank you. Welcome everyone to our first quarter earnings call. Erik Alexander and Mike Dance will follow me with brief comments on operations and finance, respectively. John Eudy, John Burkart, and John Lopez are here for Q&A. I'll cover the following topics on the call -- Q1 results and market commentary; second, investment markets; and third, disposition activity.

First topic. Q1 results and market commentary. Last evening, we reported FFO and core FFO of $1.63 per share for the first quarter of '12 which is ahead of our internal expectation and above consensus. We continue to see strong growth in Northern California and Seattle and a continuation of a steady recovery in Southern California demonstrated by exceptional same store NOI and revenue growth of 11.2% and 7.1%, respectively. This result reinforces our expectation for a strong 2012 driven by very limited supplies of housing and job growth that exceeds national averages in Northern California and Seattle and is near the national average in Southern California. We don't see a significant departure from this basic theme until at least 2014. Erik will discuss portfolio trends in greater detail.

Our projections for rental and for-sale housing supply for 2012 are including on page S15 of the supplement. As expected, we see continued growth in multi-family deliveries in many of our target markets. We closely track the supply of both rental and for-sale housing and project deliveries through 2014. From now through 2014, the largest percentage addition to the existing multi-family stock occurs in San Jose, where we expect multi-family deliveries for 2012 to be 0.5% of stock or 1,100 units, growing to 1.2% of stock, 2,600 units in '13, and 1.4% of stock, approximately 3,000 units in 2014. Seattle has the second highest multi-family deliveries estimated for 2012 to be 0.5% of stock or 1,800 units, growing to 1% of stock, 3,800 units in 2013, and 1.1% of stock, 4,400 units in 2014. All other West Coast metro areas are expected to average less than 1% annual rental supply growth through 2014. LA and Orange Counties are expected to have the least multi-family supply averaging 0.3% and 0.6%, respectively, through 2014.

The other housing supply risk relates to for-sale housing production. We continue to believe that affordable, for-sale housing is a significant threat to apartment rent growth. Our for-sale supply expectations remain muted in our coastal markets, largely due to high median home prices and restrictive lending practices, which should be beneficial to Essex. Seattle's single family deliveries are estimated to approach 0.9%, or 6,300 units in 2014. However, both Northern and Southern California have very little for-sale supply averaging less than 0.2% of stock in 2012, growing to 0.4% in 2014. As a result, even with the growing apartment supply, we expect very tight housing conditions in each of our targeted markets through 2014.

Subsequent to quarter end, we completed the buyout of our partner's interest in Skyline Apartments located near Irvine in Orange County. I have commented previously that institutional co-investments provide an important alternative source of capital as compared to financing on Essex' balance sheet. In this case, we estimate that we issued 320,000 fewer common shares by acquiring Skyline initially with a partner, and then the subsequent partner buyout, as compared to the pro forma acquisition of Skyline on our balance sheet back in March of 2010. Obviously, the stock price performance was a major factor in that result.

In development, we started five development projects in 2011 and started the second phase of our Epic community in San Jose during the quarter. All of which are outlined on page S9 of the supplement. The average cap rate on these construction projects based on current market rents is approximately 6%. Aside from these transactions, our shadow pipeline, which is not included on S9, consists of three potential developments in Northern California that could start in 2012 and have an expected cost of approximately $360 million. Thus, by the end of the year, we expect our construction pipeline to aggregate up to $870 million, of which Essex will own from 50% to 55%. We also have three smaller land parcels that are held in our land inventory that could be started within the next year and an operating retail property on 12.6 acres in Santa Clara that we acquired in connection with a bankruptcy amid the great recession that we are entitling for apartments. As suggested on the last call, the ramping of our redevelopment efforts continues as we once again are seeing residents willing to pay more for improved apartment homes. I am pleased with both the strategic direction of the redevelopment team, as well as their growing impact on our overall results.

Second topic, the investment markets. Cap rates continue to be aggressive in the coastal markets. Cap rates range from 4% to 4.5% for A property in A locations and from 4.5% to near 5% for B property in A locations. As with 2011, transaction activity abated at year-end and is now rebuilding. We closed two small transactions in the quarter and continue to believe that total acquisitions will equal or exceed our $400 million guidance for 2012. In fast-moving markets, we have an information advantage given our economic research and historical data in our existing portfolio. We continue to find value in acquisitions through redevelopment, anticipating marketing trends, and complex deals. Development deals on the West Coast underwritten based on today's rents generate development cap rates ranging from 5.25% to 5.5% or 6.25% to 7% upon stabilization.

Third topic, dispositions. We announced two dispositions in the greater San Diego area during the quarter, both of which were acquired in connection with the merger between Essex and John M. Sachs, Inc. in 2002. Both generated unlevered IRRs of approximately 10%. As stated previously, we look for opportunities to cull parts of the portfolio that have lower growth characteristics. Fortunately, we don't have significant numbers of property that are in this category, giving us flexibility to optimize the timing of dispositions. We will also begin marketing selected properties from our Fund II portfolio, which is scheduled to terminate in September 2013, subject to an extension option. I'd like to thank you for joining us. Now, I'd like to turn the call over to Erik Alexander. Thank you, again.

Thank you, Mike. It's always nice to be here especially when there's good news to share about another strong quarter for Essex. Coming off a high occupancy condition at the end of the fourth quarter, Essex was poised to make gains in scheduled rent during the first quarter of this year, and that's exactly what we did. We had solid results everywhere, but it should be no surprise that Northern California and the Pacific Northwest led the way. Los Angeles has strengthened and begun to contribute more to our results. We look for this trend to continue and are also optimistic that Orange County and Ventura County will be following suit in the coming quarters.

The first quarter was characterized by good demand in all of our markets with the exception of San Diego, and current demand is consistent with our expectations for this time of the year. We experienced healthy renewal activity throughout most of the portfolio during the quarter and have finally seen some increase in our rate of turnover. We view this turnover activity as healthy because it provides us with more opportunity to grow rents. Additionally, we only saw a nominal increase in move-outs due to home purchases and affordability. Portfolio-wide, we increased rates on new leases by 5% during the quarter and over 6% during April. We expect turnover to rise during the second and third quarters thereby decreasing overall occupancy, but we anticipate the rate of turnover to be just over 50% for 2012. A modest decline in occupancy coupled with these higher rent levels will help us achieve solid revenue growth throughout the summer and give us a better chance of achieving the higher end of our guidance for the year.

As Mike pointed out, new, multi-family housing supply remains very low and largely concentrated in a few areas of our portfolio. However, we have seen a few developers accelerate projects that we have been tracking and view this as yet another sign of strengthening in our markets. These favorable supply conditions will allow Essex to grow rents at or beyond expectations in the coming quarters. Again, our 2012 and '13 delivery projections are detailed on S15.

During the quarter, we completed nearly 3,300 new lease transactions and signed almost 2,700 renewals. Renewal and new lease rates continued to grow during the quarter and were 5% higher than expiring rates for the period. Renewals recorded during April were 5.3% better than the expiring rental rates with the expectations for May at 5.6% higher than expiring rates. So, looking ahead, renewal offers for June and July average 4% to 6% in Southern California, 6% to 8% in Seattle, and 7% to 9% in the Bay Area. At the end of April, our loss to lease for the portfolio was approximately 4%. Reveal is our only active lease up at this time, and that leasing activity remains ahead of plan. Currently, Reveal is 93% occupied and 96% leased.

Turning to operating expenses, those were down during the quarter compared to last year, as well as compared to our budgets. Repairs, maintenance, administration, and utilities were all lower than the first quarter last year. We do anticipate some higher turnover costs during the second quarter, but do not see pressure on any other controllable expenses at this point, nor do we expect any significant variances with utilities to hinder our ability to manage costs. Now, I'll turn my comments to each region, starting with Seattle.

Market rents were up 6.5% compared to the first quarter of 2011. So, depending on the submarket, we are now 4% below to even with our prior rent peaks. As of April 30, occupancy was 96.1%, with a net availability of 5.1%. The job picture continues to be strong in Seattle. We saw more jobs than expected added during the quarter and have raised our forecast for 2012 to 2%. Our property managers continue to report strong demand from employees of Microsoft and Amazon. Office absorption remains positive as another 650,000 square feet were leased during the quarter. We also saw a surge in the industrial demand in the south end of the region.

In Northern California, market rents were up 11% year-over-year, and so based on submarket location, we are now above previous peaks by as much as 5.5%. As of April 30, occupancy for the region was 97.2% with a 4.6% availability. Job growth continues to be solid in Northern California and is driving our rent growth. We saw the biggest gains for the quarter in the San Francisco and Oakland MSAs and have increased our forecast to 1.9% job growth for 2012. This is highlighted on S15 of the supplement along with all of our submarket job forecasts. Absorption of office and R&D space continues at a rapid pace and supports our belief that the region will continue to experience a healthy economy and continued job growth for the foreseeable future. During the quarter, another 1.5 million square feet of office was leased in the region, with the East Bay accounting for just over half of that absorption. SanDisk, the global leader in flash memory, took down nearly 600,000 square feet of R&D space in Milpitas during the quarter, and vacancy for such space has dropped to 14%.

Turning to Southern California, it is the jobs picture in SoCal that is probably the closest-watched economic factor. We were disappointed by the 2011 revision, particularly in San Diego, where we have lowered our growth expectation to 1% for 2012. This also translates to a lower than expected rent growth for the year which now stands at 2.5% in San Diego. Los Angeles and Orange County, however, have fared better. The March posting of year-over-year job gains was 1.2%, so these employment gains match our annual expectations for 2012. The military, obviously, has some impact on the San Diego housing market. The troop rotations remain consistent with our expectations for 2012. I shared on our last call that the USS Ronald Reagan had moved to Bremerton, Washington in January, but at least six other ships have returned to San Diego since then, including the USS Independence which ported yesterday. Changes in military base housing policy have some impact on lower ranking personnel's ability to live off-base. We will continue to monitor this item, but during the first quarter we actually saw an increase in our military leasing activity and now maintain overall exposure in San Diego of about 15% which is within our historical range.

Market rents were up 3.2% versus the same period last year. Based on submarket location, rent levels remain equal to, or 3% to 5% below prior peak. As of April 30, occupancy stood at 96% in Southern California with 6.3% net availability. Office space absorption for the region was modestly positive during the quarter with transactions in parts of the San Fernando Valley, downtown Los Angeles, and creative office space on the west side leading the way. Commercial development has picked up in the region. Marriott is breaking ground on two hotels adjacent to L.A. Live, while the Glendale Galleria is expanding the regional shopping center as part of a major renovation. RiverPark in Oxnard has resumed construction after suspending this retail development back in 2009. The developers at [Pliavis] are proceeding with the construction of Phase II of their project.

All in all, we are very happy with the results of the first quarter and are optimistic about the summer leasing season. I think we are in an excellent position to take advantage of strong fundamentals, and we believe that we will enjoy solid growth well into 2014. So with that, I'd like to turn the call over to Mike Dance.

Thanks, Erik. Today I will provide brief commentary on our first quarter results and an update to our '12 FFO guidance. Before I begin on the quarter's results, I want to highlight a new line item we added to the income statement which breaks out the costs of providing the management fee income from our general and administrative expenses. This is an allocation of the direct and incremental cost of the employees and departments that are involved in providing, on behalf of our partners, the property operations, the asset management, the capital markets activity, and the development oversight for the properties that are not consolidated on our balance sheet. With a near-doubling of our management fee income, we felt it was important to break out these costs separately to show the operating margin from this activity. Overall, the gross operating margin on the management fee income was 33% and our corporate G&A as a percent of property revenues was 4.3% in the quarter. Subsequent to quarter-end, we increased the investment capacity of our Wesco co-investment partnership with the partners committing an additional $100 million of equity to the venture. This gives Wesco $200 million of additional buying power and is expected to increase management see income in the second half of the year.

We continue to make progress on unencumbered in our portfolio. We are on track to have 50% of our net operating income unencumbered by the end of the year as we are considering the prepayment of up to $200 million of secured debt on or near June 30. The cost of prepayment penalties and the write off of unamortized loan fees from the early payment of secured debt is expected to result in a loss of up to $2.5 million which will offset $2.3 million income from the incentive partnership interest earned on the Skyline transaction. We are also in the process of negotiating an amendment to our current bank facility, and we expect to increase the line capacity to $500 million, with an accordion to $600 million. This amendment should also extend the term to December 2015 with two one-year renewal options at our option.

As mentioned earlier, we are pleased with the favorable variances from our internal estimates for both property revenues and expenses resulting in the increase of the midpoint of our diluted FFO per share by $0.03 for the year. Yesterday, we also provided second quarter FFO guidance of $1.60 to $1.66 per diluted share. For the second and third quarters, we expect financial occupancies to drop to 96% as resident turnover returns back to historical levels of approximately 55%. The estimated 90 basis points loss in occupancy will be offset by higher scheduled rents, and our estimate of the second quarter sequential revenue growth for the same property portfolio is an increase of 75 basis points. During the quarter, the lower level of maintenance and repairs expense is mostly timing-related, and we expect same property expenses to be higher in the second and third quarters, associated with the increase in resident turnover.

For the second quarter, we expect a sequential increase of 5.5% in the same property operating expenses, or a 2.3% increase for the second quarter '12 over the second quarter in '11. The projected increase in same property rent growth is more than offset by the expected increase in operating expenses, and the midpoint of our second quarter guidance assumes a sequential decrease in the same property net operating income of 1.3%, or a $1 million decrease. And the second quarter's year-over-year increase in same property net operating income is expected to be 8%.

As discussed on previous conference calls, our first half of the year's property operating expenses are still benefiting from the reduction in property taxes from the temporary declines in the Prop 13 assessed values. If, as of July 1, the new assessed values are reinstated to the maximum allowed under Proposition 13, our property tax expenses will increase by approximately $400,000 per quarter beginning in the third quarter of this year. Accordingly, we still expect same property expense growth of 2% to 3% for the year. Also, we are expecting in the fourth quarter of 2012 that Expo, formerly known as our Queen Anne development, will open 5 months ahead of our previously disclosed schedule. The earlier-than-expected lease-up of this development for its opening in November of '12, will decrease our income from co-investments as we expense the operating cost and the rent concessions during the property's lease-up. This ends my comments, and I'll now turn the call back to the operator for questions.

(Operator Instructions) Thank you. Our first question comes from David Toti from Cantor Fitzgerald.

Good morning. I quickly want to touch on a detail in rent growth. There was double-digit rent growth in San Mateo and Santa Clara with what looks like very little occupancy damage. How sustainable do you think those rates are? And, where else might we see this type of pricing power in other parts of the portfolio?

This is Erik. I think you could expect to see pricing power really in all areas of the Bay Area. We have seen the strongest occupancy, as you pointed out, on the Peninsula in San Francisco, but it has also been strong on the East Bay and in San Jose. So, when you look at the gains that we're making in both renewals and new lease rates, they're really happening across the board there.

Do you think these numbers are aberrational for the rest of the portfolio? Or, are we in the first wave of double-digit rent growth?

I don't know about aberrational. I'm not going to be surprised to see them occur in parts of the Pacific Northwest, and again, as we have tight occupancies in all of the submarkets -- again, it puts pressure on pricing and gives us that pricing power wherever those conditions occur.

Great. And then, my last question is just relative to the loss to lease being about 4% for the portfolio so nearing prior peak, can you tell you us where you are relative to the average portfolio rent as a percentage of resident income? And, how that compares to the loss to lease?

This is Mike, David. John Lopez is here. The rent to income relationship, we use on a market basis. We think it is a lot less appropriate, or meaningful, if you do it on a property by property basis, or our portfolio which is, I think, what you're asking. We would rather look at the overall market when it comes to rent to median income relationships, and we track that very, very closely. We are less concerned on a property by property basis primarily because the decision, the local decision, is whether you move into apartment A, B or C, not what your particular income is relative to the rent that you're paying. So, even though people may be able to pay more rent, given their income level, it doesn't necessarily mean they will because everyone is concerned about what are the trade-offs? Where can I get the value represented in the best apartment, relative to the -- relative to its price. So, that's why the pricing dynamics within a local market are so important, and rent to median income is really the measurement of the broader market -- the affordability of the broader market which I think is much more meaningful. I have John Lopez here. Can you talk about the rent to median income in some of these metro areas?

Yes, David, probably the market where we're closest to our long-run norm is in San Francisco. Having said that, that is after 15% rent growth last year. In the East Bay and in Silicon Valley, in particular -- Northern California, we're still significantly below those numbers. I would say, also, that same goes for Seattle, as well, and Los Angeles. Probably San Diego is where we're pretty close to the long-run averages, and I think why even with job growth, we're seeing less rent growth in that marketplace. So, if you look from a strata, it is San Diego and San Francisco are pretty close to their averages. Orange County somewhere in between, and Los Angeles, Silicon Valley and Seattle and Oakland, significantly below.

And, David, actually, let me add one other concept which was -- we had talked about our expectation for 28% portfolio rent growth over five years, and one of the comments that came back was that our assumption in there, which was 3.5% median income growth, was too aggressive. The reality is, I think we're seeing more like 4% to 5%, or even higher in the tech markets which, is -- which is not unusual. Obviously, I've been here for a really long time and have seen a lot of these cycles. So, when the tech markets do well, they tend to do very well. And, obviously, the opposite is also true. But, the point is, we're seeing in the skilled labor -- we're seeing a real dichotomy out there in terms of the tech worker with the skills that are demanded by the tech companies, we're seeing great income growth rates which are supporting higher rent levels. Then, we're also seeing the other side, which is markets that don't have that tech component that are more price-sensitive and have less median income growth rates.

David, I just want to follow up. That average -- long-run average rent to income level, it is not a ceiling. If you go back and look at the past, when we had expansion cycles, particularly in our tech sectors, that rent to income level typically runs well above the average. Although, as I mentioned in San Francisco we're approaching that rent to income long-run average, it doesn't give me any concern that we can't push the rents given our expectations because typically during expansions, it runs much higher than the long-run average.

Great. Thank you for all of the details.

Our next question comes from Swaroop Yalla from Morgan Stanley.

Yes, hello. Question on Skyline. Do you still see a conduit for this investment in the coming years? Or, is the plan for this to be part of the corporate portfolio now?

Swaroop, it's Mike Schall. Our expectation and our belief is that the highest and best use for that asset is a condo. It is a 20-something-story high-rise that has Viking appliances. It has super-high finishes. A number of us would like to bid on the snake skin couch that is down in the wine locker area. And, our thought about what the CapEx associated with Viking appliances might be gives us chills. So, we know that its highest and best used as a condo. We look for a condo exit. But, in a market that rents have not moved very much, we thought it was still a decent apartment addition in the interim.

Great. And then, just sort of a big picture question, Mike. Recently, we've heard the Bay Area and Southern California local governments have indicated a preference for more multi-family housing -- both condos and apartments in the coming years. How do you see that long-term for your business and for your portfolio? Are you concerned with your markets getting oversupplied by this competing product?

You know, Swaroop, we have been here for a long time, and I don't think that that sentiment by the local officials has changed much in the last 20 years. I'm looking at John Eudy, who I'm sure has an opinion on this one, as well. Yes, we know that, but at the same time these are also markets that are very difficult to entitle property. The entitlement process is long. It's cumbersome. It's full of potential pitfalls. We have gravitated toward a -- let's find the deals that we can start construction soon. So, we're not taking a huge amount of entitlement risk unless we get paid a lot more for it in terms of cap rate.

If we can get a -- there was actually one transaction that we did which was the -- I alluded to it in my comments. It's the Santa Clara site that we bought out of bankruptcy that we are going through an entitlement process, but that was underwritten at a -- what? A 6.75% cap rate in the midst of the great recession, and the cap rate is much, much higher now, potentially. So, we try to make good value decisions, but to your point or to your question, we don't see anything that's going to fundamentally change the outlook for multi-family housing in the short term. It is just the process is too cumbersome and too difficult.

Actually, I'll make another comment because I chair a non-profit housing board, and California has essentially taken virtually all the funding away from the redevelopment agencies in many of the major cities in California, which has only gone to undermine the production of affordable housing in these marketplaces. That is an area that remains a dilemma and remains an issue for the non-profit home builders, which are doing exactly what you're suggesting, because their primary funding mechanism has essentially been greatly reduced.

Great. Thank you for the color.

Thanks.

Our next question comes from Rob Stevenson from Macquarie Research.

Good afternoon. Can you talk a little bit about where, given the strong rental rate growth that Northern California and Seattle were during the quarter, where new move-in rents were versus renewals in those two markets?

Yes, this is Erik. If you heard, they were very close to each other -- the growth rates for both new and renewals were in that 5% range. And so, now like if you look at just April for the portfolio, new lease rates and renewal rates are within $5 or $6 of each other, on average.

What is the gap that you feel comfortable with in terms of having somebody move out versus what do you want it to be to make sure that you keep somebody? If new move-in rents are X, what is an acceptable renewal rate in order to keep it in place and not drive that turnover cost?

Yes, I think, you've obviously touched on something that is important to all operators, which is you kind of want the good turnover. And, the good turnover is the folks that are furthest away from market, and we've taken the position, and I think Mike has shared with everybody on several occasions that we're not overly aggressive in trying to send renewals out above current offered rates. Or, they're forecasting months in advance. We find that to be a difficult proposition. Some people will accept that. Many people are offended by it. So, again, when we're within -- the renewals end up being on the high end probably at offered rates, and within a couple of percents of the offered rate.

What is your hard cost on unit terms today?

It varies greatly. You're talking about what goes -- as far as painting and cleaning and miscellaneous maintenance supplies? That kind of thing?

We'll throw vacancy in there, too, right? Hard costs are 400, and vacancy might be another 400.

Okay. And then, one last question on San Diego. If you assume that the troop rotations continue the way that they have been for the last decade, or so, what's the attractiveness of that market at a similar IRR, or a cap -- going-in cap rate, and growth expectations versus Northern California or L.A., Orange County?

Well, this is Mike. I'll answer that. This is part of our process which I think is fundamental to the Company and its success which is ranking these submarkets -- our 27-some-odd submarkets up and down the West Coast from Seattle to San Diego by future expected rent growth. And, the person that does that is John Lopez, who is here. And, it changes pretty dramatically over time, and two years ago, we were buying everything that we could find in Northern California and Seattle, and right now we have a more balanced program in terms of we're buying in selected places in Southern California, and Northern California. I think our number one market continues to be the east side of Seattle in terms of submarket. But, again, it changes over time. We go through a semi-annual process in re-evaluating submarkets and re-ranking them and use that as acquisition and disposition decisions.

In terms of San Diego, specifically, its long-term value is, I think, still meaningfully attractive in terms of it used to be a military and entertain -- or tourism town, and it's become much more than that. There is real dynamic job base there, including biotech and a variety of other things, and it is improving. But, the other piece of San Diego that has historically been an issue is just housing production. Housing is a little more affordable except in the coastal areas. There has been a tendency to overbuild San Diego, and so affordability concerns have been there.

The other thing that has happened more recently is you will recall a couple years ago, San Diego had less reduction in rent than most of the other markets. Our average portfolio reduction in rent was 14.5%. San Diego performed the best in the downturn, but if you flip that around and you say, okay, well now you've suffered that loss of rent, who has the greatest upside? San Diego does not appear at the top of the list. Long-term, I think San Diego is a decent market. We view this business as one of timing and making good decisions and getting the value creation pieces put together in the right order. I think that there thus will be a time when we will reenter San Diego, it is just not now.

Rob, this is John. I just want to stress one of my points was that going into this recovery cycle, San Diego was at the bottom of our expectations list. Primarily and solely because of the fact that the relative rent in the marketplace versus the incomes in the marketplace were relatively high compared to other markets. And so, we didn't initially forecast lower job growth, but we knew it would be at the bottom of our rankings. Hence, our activity down there on the buy and sell was concentrated in other areas.

I was just trying to figure out whether or not the sales this quarter portended to additional sales there as you cycle out at least for the time being?

We cycled out of Portland several years ago. We've cycled out of a variety of other markets. That is not our intent here. Our intent here is to pair a piece of the portfolio that is lower growth rate. It's interesting because I cited 10% unlevered IRRs which is pretty good. But, as Mike Dance has pointed out to me when you start at somewhere around an 8% going-in yield, it is not that difficult to get to a 10%, a concept I agree with. The reality is, it is more the growth rate that we were concerned about in those particular assets. And, again, we're going to be careful and thoughtful about the timing on exiting from the things that we consider non-core.

Just one last thing to add, Rob, in our core markets if you look over time, some markets are highly ranked. Some move and up and down that ranking list. San Diego had been a good market, probably middle of our portfolio for long-run growth. From a long-run perspective, this is not a market we would exit because of long-run, low growth expectations.

Thanks.

Thank you.

Our next question comes from Jana Galan from Bank of America Merrill Lynch.

Hi, thank you. I guess following up on that kind of non-core -- I realize this is a small part of the portfolio, but can you speak to the lower occupancies in Riverside County? Could these or maybe the Santa Barbara assets potentially be disposition candidates? Or, do you expect longer term revenue growth to improve there?

I don't think -- this is Erik -- I don't think we expect longer term revenue growth from the Riverside assets. The Santa Barbara assets, as you know, are heavily dependent on the student population. So, we're in the middle of that first demand window right now. And, what we're seeing is, I'd say average demand with good results. We've seen it in years past pick up a great deal later in the year. So, again, given the challenges we had there last year, we're watching it carefully and making sure we're addressing what the students want. But ultimately, there is just not a lot in Santa Barbara, and so there very well could be -- not a lot of choices -- but, I mean, not a lot of supply. There very well could be upside in those assets.

Thanks. And just to confirm the 2012 guidance assumption, is that still $100 million in dispositions?

Yes. As Mike mentioned earlier, when you include our pro rata share of the fund it will likely be higher than that.

Great. Thank you very much.

Thank you.

Thank you. Our next question comes from Eric Wolfe from Citi.

Hey, thanks. I'm not sure if you track this, but I'm wondering if you track the percentage of tenants moving into your Northern California portfolio that are in the tech field? The reason I'm asking is because if you look at the tech news sites, you find that there is just billions upon billions going to these tech start-ups. Many of which are pre-revenue but are still using the funds to hire pretty aggressively. I'm curious whether you're seeing this influx of capital into the tech space in your tenant space as well?

Eric, this is Erik. We don't have a specific measurement on those folks coming in as it relates to industry. Again, when there are big movements, whether it's in tech or anything else as I commented on Seattle. With all of the activity that Amazon has, we see an uptick certainly in that. We have seen an uptick in the Microsoft residents, particularly in the east side, Bellevue and Redmond. And, in the Bay Area, it is certainly a component of the people that are moving in.

Okay. And then, second question is, there was a couple announcements today in terms of funds and REITs being formed to buy and rent single family homes -- the biggest of which, I guess, would be Beazer Homes. I'm curious, what you think is going to be the biggest challenge for these REITs? And, what sort of yield you would need to have in order to compensate for these types of challenges?

Eric, it's Mike. I recognize you and I have talked about this subject a few times. I think the biggest challenge will be the discipline of buying the right property in the right location at the right time, and the concept of buying a vast portfolio, where you don't have a choice as a buyer over exactly what you're buying, you're somehow going to manage this large, geographically decentralized portfolio. We think that is the peak of inefficiency, and we actually did buy a portfolio of single-family homes in the Sacramento Valley as part of RTC in the early '90s so we have some experience there. It is a challenge. It is a challenge because of the centralized nature of what you're doing, and I think that the ones that make the most sense as far as we're concerned, would be ones that you can somehow control that process which is a very local business. I think it's probably more suited toward private, wealthy investors that are -- you have the right combination of skill sets from the real estate side to the management and operations side to put together a comprehensive team that can deal with these things. But, you can control what you own and the price that you pay and have some synergy with respect to location and product that you own and control. So, I think it's just a different business. It's one that we're interested in but have not taken steps to pursue given the difficulties I just mentioned.

This is Michael Bilerman. I'd like just a question as well. Mike, I appreciate the disclosure as you broke out the management fee expenses now on the income statement so that we can better align what that profitability of at least doing the fund business. Is there a sense -- I know you're going to be selling some assets in the fund, and you're obviously taking Skyline on. How scalable -- I guess, if you were to add additional joint ventures, could that margin get, right? You talked about being about 33% margin. It was 25% last year. If you were to substantially increase joint ventures, could that margin grow substantially?

Mike, it is Mike Schall. I don't know which Mike you were directing that at, but I'll take the question. The fund business -- it is less about the margin on the fees, more about the promoted interest and the overall cost of capital. So, our hope is that we will be marginally profitable, let's say, because we're not trying to skimp on the cost side of managing the -- our co-investment assets. In fact, to the contrary, we believe -- this is why we don't do fee management is because the dynamics of fee management is you're incented to keep the cost very low in order to keep your margin higher. We're not at all incentivized to do that when it comes to our co-investments because we're such a big part of them. Therefore, our focus is not on the margin on the fees, the focus is on how do we maximize the overall returns and the promoted interest, and we are -- we spend -- we need to spend on the fee side.

In terms of how scalable could it be? I think it can continue -- we can continue to grow that margin to some extent. I'm not sure that we will. For us, we look at this as another source of capital, and we're constantly comparing -- just like we compare our 27 submarkets up and down the coast, we're doing the same thing on the capital side. Trying to find the right mix of capital to buy the properties that we think are going to perform the best. Having essentially no difference between what we would buy in our own portfolio versus what we would buy in these co-investment assets. So, there is some margin growth, but [canna] we're just not focused on that. More focused on how do we get the promote as high as it can be, and how do we get the cost of capital as low as it can be?

How much assets are you selling out of the fund at the back half of the year?

Again, we don't have -- we don't pressure to sell. We think it's a good environment to sell some assets. It could be approximately half of the fund to portfolio.

Okay. And then, are you in process right now of trying to raise additional capital for opportunities?

Yes, Mike Dance commented that we have increased marginally the Wesco venture by $100 million in capital. So, we have done that. So, the answer is, yes. The reason why we're doing a relatively small amount there is to just keep our options open with respect to what we do in the future. And, that's part of the advantage of having Wesco is that we can decide to commit a little bit more capital to an entity which then, of course, allows us to be open with respect to how we finance stuff six months from now.

In case something else came across in your markets, or even outside of your current core markets, you could then find another joint venture partner and raise capital on that specific opportunity if it were to come about.

Or, just buy everything on balance sheet.

And, issue equity.

Exactly.

All right.

Thank you.

Thank you. Our next question comes from Alexander Goldfarb from Sandler O'Neill.

Good morning. Mike Dance has been a little bit quiet. So, I'll start with him. I heard Erik Alexander's comments on the rents. Sounded like you are pretty bullish. But, you beat strongly on the first quarter, and yet you didn't raise the top end of the guidance. Sort of curious, is it the real estate taxes, or is it turn costs? What's keeping you from raising the top end of the guidance, as well?

We haven't done an in-depth analysis to justify it at this point. I think we're coming into our heavier leasing season, and we'll reconsider that at the end of our second quarter.

Okay. So, it's nothing specific.

No.

Okay.

It's me being lazy. I have some other things to do and didn't make that my priority for this call. Sorry.

Alex, let me add something to that. It is our objective to not give up the 90 basis points of occupancy, obviously, in Q2, that Mike has assumed in the guidance number. Our hope is that we can maintain -- we can do both. We can get good rent growth without sacrificing a tremendous amount of occupancy. We all know that this is a dynamic world, and things change relatively quickly. It just -- we would rather wait and see -- wait and have one more quarter under our belt before we commit to that, and just as a general statement, we just gave guidance in February. So, I just think that it makes sense for us to take a look at it after the second quarter. I think that is just the appropriate way of doing things.

Okay. And, switching to development, you mentioned the Queen Anne development is going to come on line early. Last quarter, you had a few projects that came on early. Is this a matter of just having a conservative development timetable where you're able to bring things on-line sooner? Or, is it weather conditions? Or, maybe just better contractors who are working quicker? What is the driver that's allowed you to bring projects on sooner than anticipated?

Hi, Alex, this is John Eudy. Most of that surrounds the fact that we committed that in the fall of 2010, started it last spring before any meaningful construction started in Seattle. So, the best of the best contractors, subs, were available, able to push the limits and we were able to take advantage of it. A typical time frame for that would be around 22 months for that complicated of a building. Obviously, we're doing it in about 18 months. I don't expect that will be the norm going forward. Historically, 20 to 24 months for that type of building is the range to expect. So, going into next year, I don't think we're going to have that advantage. We have been able to take advantage of the labor pool, is the reason.

Okay. And, just the final question is, as you stay in touch with institutional investors and you've seen cap rates compress a lot on the coast, are you seeing people who originally were interested in coastal apartment venturing to other sorts of inland apartments or other asset classes? Or, once the institutional investors and the consultants make the decision to go for coastal apartments, they stand in the queue until their number is called?

Yes. Alex, this is John Burkart. What we've seen is they are very interested in the West Coast apartments, and we're talking regularly with them. We're not seeing people that have expressed an interest in investing with us looking to go elsewhere other than to the extent it is part of their normal business plan. But, the focus is on the West Coast apartments, and further, that there really is a difference at this point in cap rates between the more desirable areas that we're in, and the less desirable areas out there in the marketplace, whether it be Sacramento, or what not. The investors are pretty focused getting in the right spot, so they're willing to pay the price to get into the better locations.

Okay. Thank you.

Thanks, Alex.

Thank you. Our next question comes from Rich Anderson from BMO Capital Markets.

Hey, good morning out there.

Hey, Rich.

I think it is morning, yes. What is the difference between the rent median income and the rent to property level income ratio?

Well, I think this is a question that essentially we addressed before. As Mike said, I don't want to contradict that, but to answer your question specifically, when we do look at a broader range for our individual regions, Northern California, Pacific Northwest and Southern California, there are a couple of percent higher for some of the applicants that we see coming in. So, incomes have been increasing among applicants over the last year, and obviously, so have rents. As John said, if rent to median incomes are in the 18% to 22% range, ours are in the similar range, maybe plus 2%.

Actually, Erik showed me some demographic reports last night which were measured upon move-in. I think beyond the move-in, we don't really know. But, at move-in, I think the average income of our residents was slightly above the median.

Okay.

Median income. So, it was not materially different from the median, if that's where you're going.

Yes, that's where I was going. The next question is, what do you think the over-under is on this Prop 13 issue in July?

I'm not sure what you're referring to because I reported last quarter, and I think this is not any different.

No, I know, I know. I know it is not new, but just curious from like a probability standpoint, what do you think the likelihood is you'll be paying higher property taxes next --.

Oh, I'm sorry. You're going back to Mike's comment.

Yes, yes.

I think it is unlikely that we pay increases before $400,000. We have a cadre of experts that help us negotiate and appeal the assessed values. So, I would -- they will definitely go up. The $400,000 per quarter is the worse case. I'm hoping we do better than that. But, who knows? It is subject to appeals and negotiations, ultimately.

Chalk another one up to Dance conservativeness.

Dancing around. (laughter) The other day, BRE said they had a weather benefit in the third quarter. Did you have anything like that?

We did notice that our snow removal cost had declined significantly. I'm just kidding. (laughter) I don't think that weather was a material factor. Erik, do you?

No.

Okay. Continuing on with my (inaudible). The rent peak number -- I know people talk about this or that above or below peak, is there any relevance to the peak rent? You have different people. The situation is completely different than it was back when you had that other peak rent. Isn't that just another number that doesn't really have any relevance to where things will go or not go in the future?

I totally agree with you. I think the relevance of that is pretty much in the history books now. I think it was highly relevant when you were in 2009-2010 time frame to know that Seattle rents had gone down 20%. I think that was very important at that moment because it was a key part of the way we look at our ranking process where we looked at, hey, these rents are really low relative to what the income levels are and what people can pay. So, it becomes relevant at that point. Now, that a lot of that has been erased, I think it's much less relevant, and we get back into the more traditional measures of rent -- rent to median income, the affordability tradeoffs between the medium-price home and rental rates. And, those types of things, I think, are much more relevant than prior peak.

Rich, this is John Lopez. Let me add one thing, when we were looking at those numbers, as Mike said, they were very relevant because we weren't sure what direction incomes were going and things like that. And, what we have seen as we've popped out is, we're a little bit behind to a little bit ahead in most of our markets. Our median household incomes are above that level, the previous peak level. In and of itself, it is not important, but when you put it in context of how our incomes have grown since that prior peak and you put those combinations -- that is why it gives us confidence that the rent to income levels are still in our favor here.

Big picture for Mike Schall. Do you think now is a good time for multi-family M&A, or do you think we're not at that point, yet?

Actually, we are -- as a historical statement, I've spent a fair amount of time looking at the different combinations of companies, and I think it is starting to become a more interesting time.

Interesting.

Not that there's anything that's happening that's specific, but, I think at the bottom of the cycle, every Company is very reluctant to do anything because they perceive that they are at the bottom of the cycle, obviously. As you get closer to a top of the cycle -- or mid-cycle -- I think the opportunities present themselves. That's a very generic statement, and again, there is nothing specific happening here.

I'm not suggesting there is, of course. And then, the last question is, you are trading at almost $160 a share. Have you ever thought about a stock split? Or, you're going after Google?

That is probably my philosophical bias as taught by Mr. Guericke who preceded me. We look at the listing fees and the ongoing fees associated with that, and we wonder why we should do it with overwhelmingly institutional investor base which the trading costs are typically on a per share basis, and we're 90%-something institutional. So, why do it? The reality is we could do it, and if there was a compelling desire among our shareholders, we would do it. But, I haven't seen that.

Okay. Great. Thanks for the color.

Thank you.

Thank you. Our next question comes from Karin Ford from KeyBanc Capital Markets.

Good morning. Just one question. If you end up having meaningful sales out of Fund Two this year, is there a possibility that you could get some promote income this year? Or, is that a 2013 possibility?

The way you account for that is based on how you distribute out of the partnership, and we have to return to all our partners the 10% hurdle first. So, the likelihood of reaching that from the '12 sales is not likely. So, most -- all of it would be done near the end of the sales process -- the disposition process.

Got it. Thank you very much.

Thank you. Our next question comes from Tayo Okusanya from Jefferies & Company.

Yes, good morning. Quick question. If you could draw an invisible line through your portfolio and put your A assets on one side and all the other assets on the other side, could you talk a little bit about overall operating trends you're seeing in these two buckets? Is one meaningfully outperforming the other? Or, is everything just going gangbusters at this point?

Tayo, it's Mike Schall, and Erik may have some follow-up comments. We believe that it is much more a locational issue than it is a product issue, and because of that, or as an example of that, I would tell you that the lease-up of our brand new Via project got rent that way surpassed our expectations. From that, if you have a new property in Silicon Valley, we were able to get a very significant premium. If you go down into Orange County and look at other properties we bought -- a number of condo buildings that are rented as apartments which are the nicest assets at the highest level A that you can buy within those market places -- we're having trouble moving rents or generating any significant premium over the B quality assets in the marketplace.

So, it's very different by location, and I think that is why we focused so much time and effort on getting the locations right and these submarket ranking processes right because that, to us, is much more important. Trying to understand where supply and income levels are, and where the people's, I guess, it comes back to consumer psychology. How comfortable do they feel about their job, their income level versus the cost of renting, and how willing are they to step up and pay significantly more in rent? And, what do they get for it? So, I think that that relationship is what's most important here. Clearly in the North, we're seeing people willing to pay a lot more and having the ability to pay a lot more, less so than south land. Erik, do you think that is right?

That is absolutely right. And then, with respect to product, even in the strong markets of the Bay Area, some of the top performers end up being property that we have invested a little bit of money in, in prior years, like the Commons in Campbell. Solid product in a good market. I don't think everybody would classify it as an A. In April, it has taken up 12% rent growth on expiring rates, and similar on renewals. And, again, that is not just a result of renovation because that's been done for some time now. I just think it speaks to the value proposition for that group of customers that want to be close to jobs and have good housing. And, to the extent that people start to feel like they're paying more than they want, we're seeing the increases as people move to the East Bay. We're seeing good growth in Fremont and San Ramon and are excited about the prospects for those properties as well.

One other question. In regards to Fund Two, are there assets within Fund two that would be of interest to you to just own outright?

On Fund Two, this is John Burkart. On the Fund Two assets because of the nature of the ownership structure, we won't be making offers on those assets. Those will be sold. There are many assets that we love in the fund. They're great assets, but we won't be making offers on those assets.

Appreciate that. Thank you. Congrats on a great quarter.

Thank you. Our last question comes from Mike Salinsky from RBC Capital Markets.

Last, but not least. Good morning. Two follow-up, bigger-picture questions. Mike, you talked about development stabilized yields being 6.5% to 7%, and you talked about acquisition cap rates being in the low 4% today. At what point does it make much more sense to start developing as opposed to acquiring? Just in light of the $400 million of acquisitions?

Mike, if we were buying those 4% cap acquisitions then I think I would agree with the premise that you would favor development, but the reality is we found value opportunities within the acquisition area. There were a couple of assets, for example, that we bought in the Fremont area, I'll tell you why we bought them. We can do an exterior and some unit turns there, and we can substantially improve the physical asset. We also believe that Fremont is a beneficiary of the Bay Area -- I'm sorry -- Silicon Valley. Essentially, having a lot more jobs and demand relative to its supply. So, we think that the beneficiary will be Fremont and other high-quality cities that are surrounding Silicon Valley. So, if we can put together a couple of those components, and I think that the cap rate -- the cap rate going in there was around high 4% or low 5% range. I don't remember exactly what it was. But, if we get that combination of transaction characteristics, I think it supports a strong acquisition program, as well. And, so we're doing that.

But, the reality is we can do both. And so, we have been active on both areas, and we built our development pipeline pretty significantly over time. I think that we feel very good about where that sits, and we can simultaneously do acquisitions, as well. I'm blessed because I have John Eudy who has been here for 20-something years running development, and Craig Zimmerman, same amount of time running acquisitions. We've got a machine on both those areas, and so we can pursue both.

That's helpful. Can you remind us what your risk premium you need is on a development versus acquisition?

Yes, we say around 20%, but I have to caveat that because that's 20% if we can start quickly. So, without -- as we know, California entitlement processes can get -- could be a little bit cumbersome. And, ultimately time is money, especially if you missed the window with respect to construction costs and some of these other things. So, we're saying 20% if we can start the construction process almost right away. I also noted that in the case of that Santa Clara deal that we bought out of bankruptcy and have chosen to go through an entitlement process -- and incidentally, we own 100% of that transaction. That was bought at a 6.75%-type cap rate. But again, you have got the entitlement process which we expected at the time to take about three years. So, you need more risk premium to make that happen. What John and I try to do is sit down and understand the risk profile of each of these development deals, and make good decisions with respect to how much risk are we willing to take? And, how do we get compensated for that risk? How much premium do we need for that risk?

The second question for Mr. Lopez there. I realize you are looking at submarkets, but as you look at the growth prospects in Northern California, and you referenced the 28% growth, I think, you quoted on your last call for the full cycle. When do you get more bullish on Southern California versus Northern California? Or, is it really going to be -- is it market-by-market for the entire cycle?

Well, it is market-by-market for the entire cycle, but we definitely feel that probably some time in the early, mid-next year is where we would expect a potential acceleration in the targeted Southern California markets to accelerate up to current run rates in Northern California and Seattle. So, obviously, going out over time, barring a 1999, 5% job growth in Silicon Valley, naturally at some point the rent growth in the Northern California-Seattle markets will slow below their current levels. That is probably a couple years out. We probably think our target Southern California markets will approach next year and probably a year after that be some of the leading markets.

Appreciate the color. Thanks.

Thanks, Mike.

Thank you. I'll now turn the call back over to Michael Schall for any closing comments.

Well, I guess, in closing, we appreciate your participation on the call, and we look forward to seeing many of you at NAREIT in June. We're obviously pleased with the progress made during the quarter and believe that our outlook remains bright. Thank you all for joining us on the call today.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.