Essex Property Trust Inc (ESS) 2012 Q2 法說會逐字稿

Greetings and welcome to the Essex Property Trust second 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)

As a reminder this conference is being recorded. Statements may in 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 result to his 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 of Essex Property Trust Thank you, Mr. Schall, you may now begin.

Thank you operator. Welcome everyone to our second quarter 2012 earnings call. Erik Alexander and Mike Dance will follow me with brief comments on operations and finance, respectively. John Eudy and John Lopez are here for Q&A. I will cover the following three topics on the call. Number 1, Q2 results and market commentary. Second, the investment market. Third, an update on California itself and policies and political situation.

First topic, Q2 results and market commentary. Last evening we reported core FFO of $1.66 per share for the second quarter of 2012 which was at the high end of the Company's guidance range discussed on last quarter's call. We continue to see strong growth in Northern California and Seattle and an uneven recovery with pockets of strength in Southern California. Apartment conditions remain strong demonstrated by same-store revenue and annualized growth of 6.3% and 9.2% respectively.

These results lead us to reiterate our expectations for a strong second half of 2012 and continuing into 2013 driven by limited supplies of housing and job growth that exceeds the national averages in Northern California and Seattle and is modestly below the national average in Southern California. We don't see a significant departure from this basic theme until at least 2014. Eric will discuss portfolio trends in greater detail.

A research team tracks many of the major employers in our coastal market for insights into hiring expectations and other trends that can affect departments. While job growth has remained quite strong, there are several companies including Hewlett Packard, Yahoo and Cisco that have reported job reductions along with restructuring programs. Still other tech companies have missed analysts' expectations and have reported slower earnings growth.

We view these announcements as typical and necessary for technology companies. Tech companies of all sizes are forced to innovate or fail as timely product R&D, product updates and similar advancements are necessary to survive. When innovation fails, companies are quickly forced into a restructuring mode and layoffs are a common result. Our expectation is that a relatively small number of tech companies will be in a restructuring mode nearly all the time.

Despite the concerns noted above, current trends support continued job growth in technology. In Silicone Valley for example, year-over-year job growth accelerated from 2.9% in 2011 to 3.8% in June 2012 with no slow down in Q2 and the labor force grew about over 2.5%. Commercial activity continues to be positive and steady and many large scale commercial real estate projects have been started. We provide our annual job growth estimates that are part of our market forecast on S-16 page of the supplement. This quarter we increased our estimated job growth for 2012 in Northern California from 1.9% to 2.4% and in Seattle from 2% to 2.4%.

Our primary economic concerns relate to the ongoing uncertainty within the broader business environment including the effects of public sector indebtedness, potential impacts of the fiscal cliff, and global financial issues. These issues threaten to derail the fragile US recovery. We believe that these issues are best addressed by strong balance sheet and a conservative capital structure.

In development, we announced new apartment projects containing 971 apartment homes with an estimated total cost of $422 million. This brings our development pipeline outline on page S-9 of the supplement to almost $1 billion. I'm very pleased with the performance of our development team lead by John Eudy as locations, designs, and expected financial benefits from our apartment development activities are exceptional. As suggested on previous calls, most of our development transactions will be in a co-investment format in which we own from 50% to 55%. We believe that the co-investment format improves our risk reward scenario and also reduces our forward funding commitment.

We have commenced construction on most of our development pipeline reducing the risks of entitlement and construction costs, increases in delays, and compressing the time between our funding obligation and the delivery of the community. We also moved up the opening of our expo project to this October, approximately six months ahead of our original schedule, and have reduced the estimated cost of construction by approximately $3 million. We now estimate that the stabilized cap rate on expo will be in excess of 7%.

Second topic, the investment market. Cap rates continued to be aggressive in the coastal market, and have not changed materially since last quarter. Cap rates range from 4% to 4.5% for A quality property in A locations, and from 4.5% to near 5% for B property in A locations. As of 2011 transaction activity abated at year end and increases throughout the spring and summer months. Through July we closed $248 million in acquisitions including the partner buy-out at Skyline as outlined on page S-15 of the supplement.

We also have a very active pipeline of potential acquisitions that are under consideration which makes us believe that acquisitions may exceed $500 million for 2012 verses our $400 million guidance. In fast moving markets, we have an information advantage given our economic research and historical data from our portfolio. We continue to find value and acquisition through redevelopment, anticipating market trends and value added situations. Development deals on the west coast underwritten based on today's rents generate development cap rates ranging from 5% to 5.5% or estimated to be 6.25% to 7% upon stabilization.

Third topic is state of California. We remain concerned about the well publicized fiscal issues in California both at the state and local levels. At the state level, Governor brown announced in May, that the projected deficit has increased from approximately $9 billion to $16 billion. Governor Brown also warned that severe cuts to schools and public services would occur if voters do not pass a tax increase proposal that he endorses. Under the plan, California would temporarily raise state sales tax by 0.25% and increase income tax on people that earn more than $250,000. Governor Brownies estimated that the tax initiative could raise up to $9 billion. Notably, the plan does not change prop 13.

Given the situation, we continue to assume that government jobs will continue to be reduced as reflected in our market forecast. We were also concerned about growing political interest in pursuing rent control ordinances in various California cities. With rents increasing at double-digit rates in many parts of Northern California during 2011 and 2012 obviously many residents are being priced out of the local markets. This coincides with more complaints from residents and growing opposition and greater exposure to negative publicity from electronic media. I have commented before that we have provided residents with one at least one renewal option that limits the rent increase to no more than 15%.

Beginning in September, we will reduce this renewal limitation to 10%. We believe that this will have a nominal impact on our financial results as lower renewal rent will be partially offset by lower turn over cost, increased occupancy, and increased rental rates for new leases. It will also be beneficial to our residents which will hopefully -- who will hopefully differentiate ethics from many other landlords that impose no such limits. I believe strongly that the industry needs to impose thoughtful self restraint with respect to renewal policy. That concludes my comments. Thank you for joining us. I'd like to now turn the call to Erik Alexander.

Thank you, Mike. As always, it's a pleasure to be here. I'm happy to report on another solid quarter of operations for Essex. Following the strong first quarter, we executed the plan that we discussed on our last call by trading some occupancy for rent growth in order to achieve the desired revenue gain. We actually only shed 70 basis points of occupancy during the quarter compared to the estimated 90 basis points of which about 50% of that decline is attributable to increased renovation activities. As with the first quarter, demand in all our markets remain strong including improvement in San Diego. As expected, we experienced seasonally higher turn over during second quarter but annualized rate of turn over through the first half of the year is only 50%. We still expect this ratio to be in the low 50% range for the full year.

Although move outs due to home purchases and rent increases were higher this quarter compared to the first quarter, both reasons for move out are well within historical ranges. Less than 12% of residents moving out during the second quarter stated that they were doing so to purchase a house or condominium. This compares to 11% of responses received last quarter and 10% of move outs during the second quarter of 2011. You may recall that this figure was north of 12% as recently as the second quarter of 2010 and as high as 18% in 2007.

During the quarter, about 18% of residents moving out cited some kind of affordability issue as the primary motivation for giving us notice to vacate including their most recent rent increase. This compares to 15% of all residents moving out last quarter and 15% in the second quarter of last year. The primary reason people give for leaving one of our communities remains moving out of the area and/or job change with 25% of existing residents claiming one of these two factors.

The bottom line is that so many qualified customers are coming in the front door, we are yet to be concerned about the pattern of move out activity impacting our ability to grow revenues in our markets. Furthermore new multi family housing supply remains very low and largely concentrated in a few areas of the portfolio. These favorable supply conditions will allow Essex to grow rent at or beyond expectations in the coming quarters. Therefore as long as job growth continues to meet or exceed expectations, we continue to believe that the fundamentals in our west coast markets will help us deliver solid revenue growth into 2014.

I think the rental rate growth that we continue to experience throughout the portfolio helps support that claim. During the quarter, we completed more than 3,400 new lease transactions and signed nearly 4,300 renewals. Portfolio wide renewal rates for the period were up 5.4% and were steady throughout the quarter. However, new lease rates continue to grow each month during the quarter and were 7.6% higher than expiring rates for the period and 8.5% better in July. Renewals recorded during July were 5.2% better than the expiring rental rates with the expectations for August about the same.

We are not concerned about a deceleration of rental rates. The fact is that we continue to see healthy rent growth throughout the portfolio. It is merely being achieved in a different manner. I would note that the average expiring rate for those July renewals was $60 higher than average expiring rate on renewed leases during the second quarter. Looking ahead, renewal offers for September and October average over 6% portfolio wide with a range of 3% to 5% in Southern California and 6% to 8% in Seattle and the Bay area. At the end of July, our loss to lease for the portfolio was 5.1%.

Turning our attention to new lease up activities we stabilized reveal asset during quarter and are successfully renewing existing residents. Last month we also began our pre-leasing activities at expo in the Queen Ann section of Downtown Seattle. As Mike commented, this development is tracking six months ahead of schedule and we now expect to move our first residents in October. During the first couple of weeks of our soft opening we have managed 16 net rentals despite not having access to the building. We expect to be conducting limited tours later this month so that we can take advantage of the persistent strong demands in Seattle. I will provide more detail than the project on our next call.

Operating expenses continue to be under control with the second quarter same-store results up less than 1% compared to last year and flat for the first half of 2012. Repairs, maintenance, administration and utilities all remain lower compared to the first half of 2011. Even with higher budgeted turn over costs related to volume, seasonal increases in repairs and maintenance, and possible property tax adjustments related to California Proposition 18 -- sorry, Proposition 8, we now expect total operating expenses not to increase by more than 2% for the entire year.

Now I'll share some highlights for each of the regions beginning with Seattle. Year to date, Essex market rents up 9.4% compared to 2011. The region as a whole is above the prior peak and Seattle Downtown and the East Side remain the strongest sub market. As of July 30, occupancy was 96.2% with a 30 day net availability of 6%. The jobs picture in the region continues to be strong with unemployment falling to 7.2%. We have again raised our jobs forecast for the Seattle MSA and now expect 34,000 new jobs to be added in 2012 or a 2.4% growth. Tech and business services continue to lead the way for the region. The future outlook remains bright as office leasing continues to be very strong as well. Another 850,000 square feet were absorbed during the quarter. Additionally, there is 1.2 million square feet of office space under construction most of which is pre-leased.

One of the more important factors that we see changing amidst strong economic growth during past six quarters is that we now expect rent-to-income level to increase above the long range average of 17%. Although still below that level today, development in Seattle is much more in [tune] with nature. The barriers to supply are higher than in the past. Home prices are rising. The region continues to evolve into a high wage and tech oriented economy. Therefore, the rent-to-income level will be able to push up to the 20% range like other established metros in the US.

In Northern California, Essex market rents are up 8.1% year-over-year and 8.6% year-to-date. As of July 30, occupancy for the region was 97% with a 30-day net availability of just 4.4%. Job growth in the Silicone Valley has been well publicized and, similar to Seattle, this economy has outpaced our initial expectations. Lead by technology expansion, we have revised our regional forecast up to 2.4% for the year.

Despite the impressive job creation over the past few years, unemployment is falling but still above the national average and currently stands at 8.6 for the region. We view this as an indication that there is still room to grow in the Bay area. Supply expectations for the year remain unchanged but as the first projects in San Jose are being delivered we are very pleased with the brisk leasing velocity being recorded by others in the market. And as expected, these new offerings have not adversely affected our stabilized properties in the area.

Looking to Southern California, the jobs picture remains a keen interest point as we all look for signs of growth, strength and sustainability in the region. Year-to-date growth for the entire region is significantly better than last year with June's year-over-year growth improving 1.7%. Specifically, Los Angeles is helping the cause with growth in the private sector posting 1.5% gain year-over-year. So despite losses in government jobs we now see employment in Los Angeles growing by more than 1% in 2012. We recognize that we still need 350,000 jobs in Southern California to return to 2008 employment levels but we are definitely headed in the right direction and I think have good reason to be optimistic about this market in the coming quarters.

Office space absorption for Southern California was positive for the fourth quarter in a row. And 1.7 million square feet was absorbed during the period. This represents the strongest commercial leasing quarter since the recession. There have not been any significant developments with the military since our last call, and we still expect troop rotations to be net positive for San Diego in 2012. Our exposure to military residents in San Diego stands at 14%. As of the end of July, occupancy for Southern California was 96% and the 30-day net availability was 5.3%. Market rates are up nearly 4% in Southern California since the beginning of the year and have now reached levels equal to their prior peaks.

All that translates to a slow and steady revenue growth with noted strength in Downtown Los Angeles, Wilshire Corridor and the West Side. San Diego and Ventura are largely performing to expectations but one area that has posted spotty results for us, is Orange County. Increased renovation activity have muted the results some, along with a few properties transitioning from concession aided pricing last year to net effective pricing this year. However, given the above average job growth for the county and low supply, we expect all properties in Orange County to realize improved rent growth in the coming quarters.

With more than half the year on the books we continue to be pleased with our overall results and think we that we have positioned the portfolio well to maintain healthy revenue and NOI growth for the balance of 2012 and achieve our revised guidance. With that I will turn the call over to Mike Dance. Thank you.

Thanks Eric. Today I will provide brief commentary on our recent balance sheet activities and an update on our 2012 guidance. During the quarter, we prepaid $138 million of secured mortgage debt on eight properties with proceeds from our private placement note offering announced earlier this year. We recorded $1.5 million of prepayment penalties during second quarter and expect to record up to $1 million of additional prepayment penalties in the third quarter from the repayment of additional secured debt with the proceeds from the last tranche of our unsecured notes offering. We also expanded the capacity on our five year bank term loan by $150 million to $350 million and reduced the spread to 130 basis points over LIBOR.

We entered into $100 million of swap contracts to lock in an effective fixed interest rate for five years of 2.2%. With the prepayment of secured debt obligations we have approximately 50% of the portfolio's net operating income generated from assets that are now unencumbered. This quarter's capital market activities reduce our cost of capital and our variable interest rate exposure, extend our debt maturity and strengthen balance sheet so we are now in position to access the public debt markets.

Now turning to guidance, our second quarter funds from operations. Results exceeded the guidance we provided on the first quarter call by $0.02 per diluted share with better than expected net operating income results from our balance sheet portfolio, and the co-investment activities leading to the increase in the midpoint of our guidance of $0.05 per diluted share. Our same property and operating income for the first six months is up 10.2% over the six month results ending in 2011.

The new guidance for 2012 forecast mid operating income increasing at a range of 8.5% to 9.5% for the entire year. The new guidance range includes an estimate for increases in property taxes of up to $400,000 per quarter starting in the third quarter. Our second half forecast also assumes we continue to increase our renovation program to include over 700 apartment units before year's end, increasing the rehab related vacancies by approximately $750,000 over the same period in 2011. The benefits from our renovation program will be reflected in better 2013 results.

I will close my remarks with some numbers that underscore our sequential growth. The sequential same property average rent actually increased 1.7% in the second quarter with average rents increasing from $1,439 per month in the March quarter to $1,464 per month in the June quarter. This compares to the 1% sequential growth in average rental rates achieved in the first quarter. Based on the July 2012 preliminary results of over $1,560 per month on over 2,600 new and renewal lease transactions, we are not seeing any slowing in sequential average rental rates. This ends my comments and I'll now turn the call back to the operator for questions.

Ladies and gentlemen we will now be conducting a question and answer session.

(Operator Instructions)

Our first question is from Eric Wolfe of Citi. Please go ahead.

Thanks. You mentioned this in your remarks, but you moved up the stabilization date on a couple of development projects. Just wondering whether that reflects a more optimistic view on markets in general being able to absorb supply faster, or if it is something particular to those particular assets.

Hey Eric, it's Mike Schall. I think we just moved up this time the expo deal. I think it's more related to the construction labor pool. We are not moving up the stabilization. We are moving up the date that the building is available for occupancy. As you all know, the quality of the labor pool increases when there is not a lot going on in the development world. So, I think it's just overall we're able to build things faster and better and get better contractors and better subs, which ultimately leads to a faster construction period. John Eudy is here. He probably can answer that better than I did.

That's pretty much it, Mike. The only other difference is we had a light winter last year in Seattle, so we picked probably up 2.5 to 3 months, just because it didn't rain until February/March to any degree.

I think the basic comment will also holds true to other development deals because the quality of the construction and labor force is very good, I think, right now.

On everything we have under contract.

Okay. That's helpful. I was just looking at the stabilized operations dates and comparing with last quarter supplemental. But I am probably just reading a little wrong or something. You talked about the initial and stabilized yields you are seeing on development, as well. I think you said 5% to 5.5% on initial and 6.5% to 7% maybe on stabilized. Just curious what sort of value creation that implies relative to where you could acquire assets today, and if you think about that spread there how that compares to the typical value creation you have been able to achieve over time.

It's a good question. The reality is we can do both, though, right? We can build and we can buy. We can find opportunities to be on a risk adjusted basis, contribute meaningfully to the portfolio. So, we are pursuing both aggressively. I would say in the development side, I think I reported last quarter that our cap rate based on today's rents as of March 31st, mark to market, the cap rates, they were around 6%. I think every one of those development deals would sell for a 4 type cap rate if not lower than that. So there is very significant amounts of value creation. I updated this quarter on expo and said it was probably going to be around a 7 or higher stabilized cap rate again. I think that would sell for a 4 all day long.

We view the value proposition differently between development and acquisitions. Development, obviously, involves more risk. You know, from a variety of perspectives we expect to get a premium for that risk. So, we underwrite it a little bit differently, with the expectation, again, on the acquisition side of trying to accomplish something, improve our growth rate of the portfolio.

We can move a lot more money faster in acquisitions, obviously. If we see a change in market growth rates, we can buy into that with acquisitions, which is very difficult to do with development because you have transactions delivering several years after you start them. So, I think they're fundamentally different. I think you can add value in both of them, and so we continue to have a dual prong type of approach to investment, and we're still very active in both areas.

Got you. That's helpful. And then this last question. On co-investment structure, you mentioned the need, or, I guess, the want to mitigate your risk in forward funding commitments. Is there any risk to giving your JV partner too much control over asset management and operating decisions, or do they not have that much control based on the way you are structuring it?

Yes, we're in control of all the major decisions on those transactions. In the case of the CPP joint ventures, they have say over major decisions, obviously. They're an important part of the overall equation. But they trust us. We're 55% of those -- we have 55% ownership in those transactions. We are providers of the services.

We believe in communicating very well with our partners, we spend of time and effort to make sure that that goes right. I think that that partnership has worked very well up to this point. We're excited about that relationship. So, we try to maintain control, but we don't have complete control obviously. But I think in the broader scope, it makes sense from a risk rewards standpoint. Again, if the world wasn't, maybe, as uncertain as it is and the issues weren't what they are, we might approach it differently. But I think in this world this is a prudent strategy, and again, increasing your risk reward or improving your risk reward relationship, we think, is our objective here, and what we have been able to accomplish.

Understood. Thanks for the detail.

Thank you, Eric.

Thank you. Next question is from David Toti of Cantor Fitzgerald. Go ahead.

Good afternoon guys. Quickly I want to follow up with some of Eric's questions from a more strategic perspective on the development pipeline. Clearly you feel there is advantage in timing in delivering a lot of these assets in the sub markets. What are some of the signals you would look for to make it sort of dial back on that volume, is my first question? The second question is, based on your outlook, what does the development pipeline look like around year end?

Again, this is Mike. We have pretty much concluded that we are going to be early to mid-cycle developers. And we are going to -- our format will change a little bit depending upon how much compensation we receive for risks that we take. We believe in this world, we are better off trying to compress the time periods between when we commit and when we deliver a transaction. So we have tried to focus on the shovel-ready type of projects that are out there. And so as you have noticed over the last several quarters, when we buy something and announce it, we are under construction on it the next day, pretty much. Again, we are trying to squeeze that period because of the uncertainty inherent in the world.

But having said that, all these projects are going exceptionally well. Clearly we feel like maybe we did leave something on the table. You don't know that upfront. I think overall the strategy makes complete sense. We are very focused on this unfunded liability that is -- or unfunded exposure from everything but including in particular the development project. So, we have agreed that we are going to be early to mid cycle developers and we're going to tailor off at the top of the cycle. We have spent a lot of time and looking at cycles and where we are in the cycle. Of course none of us really know exactly where we are. But we certainly are going to take a shot at trying to get it right.

I think that as time goes on, if we get another great year in Northern California, you will probably see us decelerate on the development side there. There is a possibility that we will try to find some more transactions in Southern California. We fundamentally believe that, as good as Northern California and, actually, Seattle have been, Southern California really hasn't caught on where we -- rents didn't fall as far, but we haven't seen the recovery come back the other way.

As all of us know, in a world that is 8% unemployed, if you get any change in that scenario, there could be a lot more demand for housing that would be generated by better employment scenario almost overnight in markets that are just chronically under supplied. So, I guess to answer your question, if we get another great year in Northern California, we'll probably scale back a little bit but we can scale up a little bit, or maybe pretty substantially in Southern California.

Okay. That's helpful. And just as a follow up, are you seeing any signs of inflationary trends either on the material side or the land side in your shadow pipeline?

This is John Eudy. On the land side, there are a number of transactions that are out there that are really priced up that we won't be able to pursue or choose not to pursue. On materials, yes there has been a little bit of movement in it. In the summer it backed off here in the last probably 30 days. On labor it still seems to be we are in the buy outs in the last couple announcements to be plenty capacity even in Northern California. I do think by the middle part of next year that will change, with the pipeline that is scheduled to start in '13. But right now, as Mike said, we think in the beginning to middle part of the cycle, we are trying to catch the wave early, and not be caught with run away cost.

Okay. Thank you, guys.

Thank you.

Thank you. Next question is from Paul Morgan of Morgan Stanley. Please go ahead.

Hi. Good morning. Just on the offering 10% cap on rents, could you talk a little bit more about that decision to go from 15% to 10% and maybe what's the adoption rate experience when you have offered the 15% caps? I mean, are these essentially economically neutral to you in the sense that the premium rent that you get roughly off sets the lack of upside at a various point in the cycle?

You know, it can be a little bit different. I mean, this is something that we've done before. As we all know, especially the tech markets can be very frothy when it comes to rent growth. You look at the late 90s and other periods of time and also just the political nature of, obviously, California and I am sure other places around the country, if you look at the nominal numbers, it does event look like it has much of an impact.

If you break it down into actual property by property impacts, it clearly does have an impact. But again, there is also quite a bit of resistance. Certainly the CO website, Eric is I am sure 100 times in his direct involvement of people that just say simply no one can afford 15% increases three years in a row. Some of those magnitudes are certainly out there.

So we think that overall, the cost of the Company, if you ignore some of the side benefits or if you make some assumptions about side benefits, is probably $1 million to $2 million a year in revenue. And at that, we think it's a prudent thing to do. I mean, obviously we're not going to get a lot of Christmas cards limiting rent increases to 10%, because people will still view that as being excessive. But it's something, and it is something that we will likely publicize, because there are companies out there that are charging much, much more and trying to go after every nickel.

Again, obviously, one company cannot completely change the political situation. If there is gouging by two companies and ten companies are showing some restraint, the politicians can still act upon a rent control-type of measure. But there is little we can do about that. From my perspective, it's the right thing do. It's the prudent thing do. There will be some other side benefits to it, and I think it's an important thing.

Note also that the California Apartment Association has a task force that is trying to mediate large rent control disputes between people and landlords. They're getting more and more activity in that. Again, where that fails, where all the processes to try to mediate and come to a normal resolution fail, I think, is where you potentially have some political exposure.

But am I correct that it's an option? It's not an automatic and comes with a different starting rent?

This is Eric. As Mike said, there is always an option at 10%. And that option is anywhere from 10 to 13 months depending on our lease expiration profile. Then there is an alternative that is offered at a different term, and of course residents are always invited to let us know what is most important to them. And we'll price that option for them, as well.

As Mike said, we're not getting very many thank you cards. However, what the sites tell us is that even though initially it doesn't seem like that big of a deal, when people realize what the market rates are for their same floor plan, and when they have done their shopping in the market, they realize there really is an economic benefit to them. And I think they generally feel better about it. So, you know, we have done, or have accomplished, I think, what we are setting out to do, which is to diffuse the issue, take a little wind out of the sail.

Thanks. I think [Stuart had his own] question

Actually following up on the development pipeline question. I notice in F15 panel that you expect 1200 units coming online this year. My question is what do you expect for 2013 and 2014? And how does that relate to your plans for the cadence project also given your decision for phase 2 and 3? Does this impact your decision to maybe start that project earlier than expected or later?

This is John Lopez. We expect build up in north San Jose to probably peak later in the summer next year somewhere around 2500 to 3000 units in that range. Which would put it -- there is about 225,000 to 230,000 total units in the market place. So we are talking about potentially up to about 1.4% or 1.3%. It will probably cap at that for a couple years. If you look at the -- if we look what that construction right now that can be delivered by 2014.

Actually the other numbers you give out John, it is 1.4%, we have talked about in the past but the -- but amid very limited single family housing production, right? So I think that if you look at total housing production relative to stock, it's still in the under 1% range, right?

Yes, because single family supply in Silicone Valley in particular is like 0.2%. And you have to remember that in Silicone Valley unlike San Francisco, 60% of the homes are single family. So, when you do your 1.4% plus 0.2%,it comes out to be 0.5% or 0.6% for the total residential area, which we think is very manageable. If you drop me into a year and say you're getting 0.5%, 0.6% job growth, I would be a happy economist in that market.

So, [Swarhab], the issue, obviously, is the job growth continues to be very strong in San Jose. As I recall, the number is now 3% projected for 2012 job growth in San Jose. If the job growth continues, we don't think Operator supply will be an issue. It will be quickly absorbed.

And just one last point, Swarhab, I think the only thing that's different from this, if you look at previous cycles on total multi family apartments and condos, the only thing that's different here, this isn't going to be a peak year necessarily. It's just that a lot of it is coming to North San Jose. That's also sort of indirectly where the jobs, and the office construction, and the light rail line is. You just can't underestimate the impact of it being on light rail line.

Thank you for the color. If we just add all the feelers and cadence and the [VIA] project how many units are we talking about that Essex will eventually build in San Jose?

The third phase of cadence is 192. I don't have it right in front of me.

[These VIA has already been stopped, Paul] You are talking about unstablized properties?

Yes.

769.

Thank you.

Thank you. The next question is from Janet Guillen of Bank of America Merrill Lynch. Please go ahead.

Thank you. Good morning.

Good morning.

I guess following up on the prepared remarks regarding Hewlettt Packard and Cisco and Yahoo, can you remind us how much of your portfolio is corporate leases in Northern California and Seattle? Have you noticed change in demand from that segment?

This is Eric. We have a very low exposure to the corporate business in our portfolio throughout. There are some properties that do more of that type of business, as you might expect in Seattle, in San Jose and then Redmond. Overall, to answer your question specifically, the corporate exposure is 1.1% for the portfolio. I think the most any one of the buildings have is 15%. Even that is a little deceiving because it's staggered. And we ask corporates to take some longer term leases than they're used to taking, again to protect our back side.

Thanks Eric, so it's completely under control. Appreciate it.

Thank you. The next question is from Dave Bragg of Zelman and Associates. Please go ahead.

Thanks. Good morning to you. A couple follow up questions on this renewal policy. Mike, you mentioned the potential revenue loss, but you also mentioned potentially lower turn over. What's the offset on the expense line? How do you expect this to decrease turn over. And just to put this into context for us, what percentage of your renewal notices that you have been sending out were above 10% anyways?

You know, Dave, all these numbers within the context of what our total annual revenue is pretty meaningless. I think it's all fairly nominal. We have done some estimates of what the impact is, $1 million, $2 million using some assumptions with respect to what turn over might be. You have less turn over, you'll have less turn over costs. You'll have less vacancy, and you will put more -- you'll have more ability to push rent on the other side, because you have less availability, as well.

Obviously those are not numbers you can plug into a model. You have to make assumptions on them. But with the total impact somewhere between $1 million and $2 million we think it's nominal. To get more specific about it, I am not sure would be really all that helpful. Eric, you have anything to add to that?

No, other than timing of the 10% increases. We just started doing the first off, or 60 days out a couple weeks ago that impact the October 1st and beyond -- sorry, September 15th, I think it is, and beyond leases. So we don't have many of the results back from that yet.

As Mike said, the offset that's hard to estimate is the lower availability and what that does to pricing on the new lease side. For whatever reason that we are able to reduce availability, net availability, we always see it increase in pricing on the new lease side. That will certainly help us mitigate some of that. As I commented we are looking to get -- continue to grow revenue and are most comfortable doing it on the lease side.

Eric, on that point, there seems to be a divergence between your renewal and new move in gains in this third quarter this year versus last year. It seems like you are doing better on new move ins, just based on your July metric, and a good bit lower on renewals. Could you speak to that trend?

Well, I think these two periods this summer and last summer are different. As noted in the highlights our net availability overall is lower this year than it was last year. And so, again, I think that's helping us accelerate the pricing on the new side. So, as long as those conditions hold up, and as I reported on 30-day net availability, those are very much in control. I think we have said before that we are trying to manage around 6% and only Seattle is at that level. Southern Cal and Northern California are lower.

Right. What do you think is driving the lower renewals?

What do I think is driving the lower renewals?

Versus last year?

Well at this specific period of time, I would say that it's part of our aggressiveness last year compared to the balanced approach going into the fourth quarter this year.

All right. Thank you.

Thank you.

(Operator Instructions)

The next question is from Alexander Goldfarb with Sandler O'Neill. Please go ahead.

Good morning. I just want to go back to David Toti's question on Northern California versus Southern California. You guys in the past have been very good about switching markets when you thought one market was peaking jumping to another market that was picking up steam. It seems like this cycle, the Northern California market seems to have longer legs than Southern California market, is taking longer. But I thought you said there may be only one more year in Northern California before you switch to Southern California, given the pace of new development activity starts that you are doing. Just sort of wanting more color on your thoughts between investing in the two markets.

Hey Alex, it's Mike. What we do operationally is rank our 30-some odd sub markets by expected growth rate over the next three to five years. Mr. Lopez does that. Pretty clearly the last several years that his focus is more on Northern California and Seattle. But that doesn't mean that we didn't like some parts of Southern California, as well. You can only buy so much and build so much in Northeastern California and Seattle. The markets are only so big. It didn't mean that we wanted to, essentially, not look at Southern California.

But as time has gone on, you have had now a pretty significant amount of rental rates growth in Northern California, 20% plus. A similar number in Seattle. So as we look at the market rankings, there is greater parity. We think Northern California -- it varies a little bit by location. But Northern California as a general statement is about a parity, with respect to projected growth rate, as Southern California.

So, you will see a more balanced approach, I think, from acquisition standpoint between North and South. As to development, development is a little different, because what happens at the top of the cycle is the contractors are busy. They want bigger profit margins when they're busy. Costs tend to spike a bit at the top. So as the comments I was making earlier were really more from a development standpoint, trying to keep our development earlier in the cycle to avoid the potential for cost spiking that can happen toward the type of the cycle. So, moving more of our development interest into Southern California would therefore be something I think will happen and will be advantageous to us.

Alex, this is John Lopez. I know we made the comment last quarter that it might be sometime in the midpoint next year where the crossover between rental growth rates might occur. I think if we look at what's going on in Northern California and Seattle economies it's probably not going to be the case where before '14 that the rates in Southern California will greatly exceed northern California. Although Southern California will pick up and pass Northern California it's probably not going to be the case where the gaps are as big as they are a year ago between North and South, if you get that.

Okay. That makes sense. And then, going to your development program, the billion dollars you outline that's in the supplemental, that's a gross number, right? That's not your prorata, correct?

Yes, that's correct. Of the deals that are under construction, we're up about half. Between 50% and 55% ownership of those.

So, like Avalon Bay has outlined a sort of target limit relative to their asset size and such. Do you guys have a limit that you're looking to keep the development program under?

We don't have an express limit. We have typically been in the 10% to 20% of our activities, develop our -- or capital, let's say, in development. That would imply on $8 billion, $800 million, it would be 10% to $1.6 billion would be absolute max that we would consider.

Okay. Then just the final question is going back to the rent control. Given that part of what causes the rents to spike is making it very difficult for developers to build. As you hear various politicians speak about rent control, do they give any sort of acceptance to the need that they need to make development easier to also alleviate the burden of rent? Or it's the typical sort of let's limit rents and not talk about the other side of the equation?

You're being way too rational, Alex. No, we do not hear those two concepts being spoken about together. In fact, I'd say that because the local governments are under so much financial pressure that there will be more pressure with respect to CBCs and other costs, not less pressure going forward. It will be more difficult to build, probably not easier.

As you speak to local politicians it doesn't seem anyone who is amenable to hearing the development side of the picture?

That's maybe a little bit too tough too. I think some of the politicians are very aware of the issue. But unfortunately, the political will as a general rule I don't think is there. So, I think our expectation, and as we have seen in the past, California can be very under supplied with respect to housing from time to time. I believe that we're going into one of those periods of time. I am not 100% sure. But I know it's difficult, and it takes a lot of time and effort. There are a lot of obstacles to producing housing here. I don't think that changes.

Thank you.

Thanks, Alex.

Operator. Thank you. The next question is from Jeffrey Donnelly of Wells Fargo. Please go ahead.

Good afternoon, guys. Just building on Alex's question about market rotation, how significantly do you think you guys could shift your NOI contribution around California to reweight your exposure? Arguably that was easier a few years ago when Essex was a slightly smaller company.

That's a very good question. We don't think we're going to change, make any huge changes to the concentrations. I think that Southern California got up to about 60% to low 60% range of our portfolio a couple years ago. Now it's down. We have been pushing more in the North and it's become closer to 50%. I think those types of magnitude are what you are going to see.

We are not talking about wholesale changes in the Company. We try to find properties and locations that are solid locations for the long haul. This is a long term business, not a short term business. So, I think you will see us make plus or minus 5% to 10% moves in terms of our allocation over time. I suspect it won't become larger than that.

Just a few housekeeping questions. Concerning Skyline, I apologize if I missed this, can you talk about how the NOI at that project has performed verses your original pro forma? I guess I'm just trying to figure out how much of the appreciation on that asset stem from performance versus the cap rate compression over the last two years.

Over the last couple years, most of it was cap rate compression. To give you a little bit history we bought it for $128 million but we needed to complete a lease up. It was 100% completed but it was vacant. That lease up cost -- probably took costs from $128 million to maybe low $130 million range. I think that the rents increased by somewhere in the neighborhood of 2% to 3% over that period of time, not great, obscured maybe a little bit by what was the impact of the concession at the initial lease up. But the closest we can determine, it was somewhere in the 2% to 3%. Then the rest of that value was really cap rate compression. We bought it at about 5.25 type cap rate. The partner buy out was in the low 4 cap rate range.

That's helpful. Is it fair to say though that that project is still on pace with your original under writing?

Yes, operationally we were ahead of our under writing. I know in the first year we filled it up faster than we thought. More recently, actually, it performed better, as well. I think it's achieving our estimates. We had hoped for a little bit more rent growth in Orange County. And that has lagged. So, I think from the rent growth expectation we did not hit the rents we had hoped for. But you know, obviously, we re-underwrote it. We still think that that rent growth potential is still there. We believe that we will be able to see that in the next couple of years.

How do you think about the timing of -- do you think about timing of selling these inevitably as condos? I think your new basis is probably about $425,000 a unit. What point does it pencil out to explore a sale of these, because with interest rates probably 200 basis points lower than when you bought it? Does it make it easier for consumers to get this math to work? I don't know where the condo market is in that particular part of Orange County today.

We track the condo market. We believe that this is a better condo than it is an apartment building. Therefore it is simply a matter of time in terms of realizing that value. But having said that, the condo market is not strong. And for a lot of different reasons.

Clearly there was an over building of for sale that happened as you are giving people mortgages they can't afford on the homes they're buying. In the process a lot of people destroyed their credit. So, now you look at it a couple years later, you've got normalizing home ownership rate. You have people that don't have credit they need to get a mortgage, don't have the down payments they need to get a mortgage, and therefore you haven't seen a big resurgence, in terms of values on this type of product. Therefore, I don't think we're even close to where we think condo prices would need to be in order to lead to a sale of Skyline. I think it's still several years off.

Just a last question, do you guys have an estimate you can share with us around what promote could ultimately be in Fund 2?

We obviously do have estimates of that. I think it's preliminary to talk about it. I can say it's pretty comfortably in excess of $10 million, but I don't want to go farther than that.

That's great. Thank you.

Thank you. The next question is from Mike Salinsky of RBC Capital Markets. Please go ahead.

Good afternoon, guys. First question, I would just like to get an update on dispositions It seems like it has been pretty slow here at the first half of the year. Also as you look at development and acquisitions typically you match fund, is there any interest given current valuations to do little bit more of prefunding of the new investment there?

Yes Mike, it's Mike. We sold a couple assets in San Diego. At least at this point in time our focus is trying to market and sell the half of the Fund 2 portfolio that's on the market now. I think our disposition focus is pretty much right there. As we approach the end of the year there may be a couple other properties that we put on the market. And there will be a culling process over time within the Company from that point on.

But as of right now, we have our hands full with respect to the sale of those assets. We don't want to dilute that. At the same time, obviously, we had a very active quarter both in development and acquisition. So, we want to keep our time and effort focused on the things that are most important and not take on too much. So, it's a balanced program as it always was. Then you had a second part of the question. Do you guys remember what that was? Mike, what was the second part?

Second part was just talking about funding. Several of your peers have moved to more kind of a prefunding model. Where they started development they are issuing the equity, to fund it completely up front, as opposed to match funding.

Right, yes. That number is an important number to us. The forward commitment to fund our development pipeline is somewhere around $375 million. We are trying to reserve liquidity within our line and other places on the balance sheet to fund that if we need to. So we may look to prefunding some of it. The nice thing about the co-investment program is those forward funding obligations are not as large as they otherwise would be, obviously. That's why we do it. We don't have to. If we can opportunistically pre-fund we will.

In light of that comment is there any plans to cap the current development exposure? Relatively speaking?

Other than what I said earlier, probably we have operated at 10% to 20% of capital. On a net basis, we're not even at 10%. I think we have some room to go there. But we will transition out of Northern California development at some point in time, likely in the next year. I'm expecting, again, good market rate growth that would have to happen to make that occur. Then we may transition a little bit to Southern California. We are going to start delivering some of these development deals as well, EXPO, obviously, later this year. After that, we'll start having some deliveries. We'll look to try to recycle some of the development program going forward, as well.

Eric, just a final bookkeeping question. The renewals that you guys talked about being sent out, how much do you -- what is the actual achieved rate usually verses what's sent out? How much negotiation is in there?

I talked about this a little bit last quarter, in what we had sent out for the second quarter was in the 6% range, and what was achieved was 5.4%. So, it ends up being pretty close to what we send out. The differences usually end up being mostly related to people wanting different terms. There are some negotiations, if you will, again, mostly related to term, because by giving them a limit, we already figured we had given them -- by capping, I should say, our increase, we have already given a best price if you will.

So, what ends up happening a little bit is, hey, I'd like to get that rate but I'd like to have it on a nine-month basis because I'm moving after that. So, sometimes we'll split the difference with them. They don't get the same best rate. But that's our expectation.

Thanks, guys.

Thank you. The next question is from Paula Poskon of Robert W beard. Please go ahead.

Thank you very much. Good afternoon everyone. Could you give us a little more color on the Valley Village Project? And what do you think the opportunity set is for similar presale type development deals?

It's a small deal, 121 units. We were working on it for about eight months with the developer. There aren't that many out there that make sense. The reason is the developer has to come to the table with a lot of cash to get his deal financed. We're the take out basically for it because a combination of a developer with a take out isn't going to be enough to get a deal financed. In this case, they've owned to the land for a long time.

They have a substantial amount of equity in it but not quite enough to get it over the line. That's where our presale helped to get it financed with Wells Fargo, and delivery is roughly 18 months out. There aren't many of those opportunities. We have looked at other presale options, the problem is if the developer has a deal and wants someone to presale contract do it, it's not going to get done. Otherwise, there would be a lot more out there.

Thanks very much. Clearly you have a long track record of success and being opportunistic with capital deployment. Do you ever think about the friction between acting that opportunistically and trying to maintain a high level of visibility into your earnings streams for investors, or is that just nothing something that enters your calculus?

You know, Paula, good question. We're not here to manage same store revenue. We are not here to manage same store NOI. We would make different decisions if we were focused on those metrics exclusively. For example, you would sell more at the bottom edge of your portfolio to make those metrics look better, and/or you would buy more aggressively at lower cap rates, in other words in order to buy higher growth assets.

So those are not things that we are per se interested in. We are interested in a combination of growth, impacts on net asset value, and cap rate or accretion over our existing cash flow of our own portfolio which generates positive returns. I think that's why we have been able to be as successful as we have been, as we are very careful about the total picture of what we are trying to accomplish and not over focused on any one metric.

Thanks Mike. And then just finally, you mentioned, I know, Yahoo in your prepared remarks. Clearly the challenges for the new CEO have been beaten to death in the national press. What are you guys hearing out there in your proverbial backyard of what the prognosis is for Yahoo?

You know, I don't know, Paula. I am not sure that we have anything that's going to be helpful in terms of that transition of leadership. It's a very significant company, obviously. As I said in my comments, these restructurings are normal and necessary parts of the technology world, because the product is an intellectual product. In many cases, it's not a -- I guess an iPhone is more than an intellectual product. It's actually a product, too. It's some combination of intellectual assets and other types of assets.

So again when you get into these situations where companies don't perform, this is the normal process. They tend to evolve until they come back to a winning scenario. So whether this transition is the right one we'll know. If it's not, there will be another transition afterwards. We have seen it a thousand times out here. It's I think the healthy part of this market in that it's very dynamic. Whereas some companies that have products, don't innovate, everyone out here is forced to innovate. And this is the process that forces innovation.

So, again, I don't know anything specific about the current situation but the process is ongoing. I hope it's successful at Yahoo. But if it's not, the next one may be. I think that's what will happen.

Thanks very much.

Thank you.

Thank you. Our final question comes from Rich Anderson of BMO capital markets. Please go ahead.

Hey, thanks for sticking with us. So, I have a suggestion. Maybe if you drop the rent cap to 9.9% you will start to get some thank you notices.

Rich, you know, we were wondering where you were. Glad you joined the call. Thank you. I appreciate the thought.

So, just on that topic really, is it a public relations thing primarily? Is it something a little bit more selfish in the sense, not in a bad way but you want to kind of keep the engine going a little bit longer over a longer period of time? Is that playing into your decision to provide this lower option?

It really isn't to keep the engine going longer. That is not the motivation. The motivation is partially, look at my constituencies. I have the investment community, I have Essex employees, and I have the residents. It's trying to balance the constituencies appropriately. This is what we think is appropriate.

We think that this will give us a defensible position with respect to the local leaders as it relates to some of the stuff that's going on out there which can be pretty egregious. We are talking about 15% but there are 20% and 25% rent increases going on out there. And they are not well received. In the world of Facebook and electronic media and the ability to publicize these types of situations that are really pretty tough to accept in the normal world, I think there is real exposure.

So, again my feeling about the thing is that the apartment world should exercise some normal self restraint. I give California Apartment Association kudos for trying to do that with this remediation process. We are going to be regulated. I think that's pretty clear. We have all seen that in 100 different ways in other areas. I don't know why we would expect housing and apartments to be any different. There's the motivation.

So, in your mind if you owned a national portfolio, you might be doing the same thing?

Yes, although it could be different. It's different from locale to locale. We'll be sensitive to the local political situations. But again I am telling you 20% or 25% rent increases, they are not accepted. If you publicize them, we're going to look as an industry is not -- as something we don't like. So, again, I am really trying to balance the three constituencies and make the right longer term decision for the benefit of the Company's reputation and its long term health.

I think you're right. We have said this before, that you guys have been the winners in an otherwise losing environment in terms of the economy. I think it's the right and appropriate step to take. I wanted to give you a little credit for that. I won't carry the call on longer. Thank you very much. That's it for me.

Thank you. We have no further questions at this time. I turn the floor back over to management for closing remarks.

Thank you operator. In closing, I just appreciate your participation on the call. Obviously, we are pleased with the progress made during the quarter and believe that our outlook remains bright. And we look forward to hearing from all of you on next quarter call. Thank you again.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.