Essex Property Trust Inc (ESS) 2012 Q3 法說會逐字稿

Greetings and welcome to the Essex Property Trust Incorporated third-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 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, sir. You may begin.

Thank you, Dan. And welcome, everyone, to our third-quarter 2012 earnings call. Before we begin, I would like to acknowledge the tragic impact of Hurricane Sandy. Our hearts and prayers go out to our friends and colleagues that have that been affected by the storm. With that said, I'll begin by noting that Erik Alexander and Mike Dance will follow me with lead comments. John Eudy, John Burkhart and John Lopez are here for Q&A. I'll cover the following topics on the call -- number one, Q3 results and market commentary; number two, investment markets; and number three, an update on what's happening in state of California.

So the first topic, Q3 results and market commentary. We are very pleased to announce another strong quarter in which we reported core FFO of $1.71 per share for Q3 2012. That result was $0.02 ahead of the midpoint in the guidance range announced in connection with our Q2 call. This positive variance would have been $0.02 per share higher if we did not accelerate the timing of our $300 million debut public unsecured bond deal, which lead to higher interest costs versus forecast. We continue to see strong growth in Northern California and Seattle and improving conditions with pockets of strength in Southern California. Same property revenues improved once again to a 7.2% increase over Q3 2011, which was the best year-over-year growth in the last 20 quarters. These results lead us to reiterate our expectation for strong conditions for the remainder of 2012 and continuing in 2013 driven by growing but still limited supplies of housing and job growth that exceeds national averages in Northern California and Seattle and continues to improve in Southern California. We have provided our preliminary market forecast for 2013 on page S-16 of the supplemental package. The weighted average estimated rent growth for our primary metro markets is 6.5% for 2013.

The primary macro assumptions, which are integral to the rent growth estimates are indicated on S-16 and are not materially different from the estimates of our economic data providers. However, some of the expected 2013 supply and job growth estimates and consequently the projected economic rent growth are significantly different from the data providers. As an example, there are around 10,000 apartment homes under construction in the Seattle metro, for which we estimate that 1100, 4100 and 4800 will be delivered in Q4 '12 all of '13 and all of 2014, respectively. Accordingly, the timing of these deliveries can vary significantly based on a variety of factors. We believe that this overview of housing supply and demand information provides the appropriate context to understand our 2013 market rent growth assumptions for each MSA. We will update these numbers in connection with our formal 2013 guidance, which will occur in conjunction with our Q4 earnings conference call.

We also recognized the inherent uncertainty in the US and global economies which could lead to significant changes. We view job growth as the key to the estimates, and, as you know, that is dependent upon forces that can change rapidly and are not easily predicted. I'd like to make two additional point about the 2013 preliminary market forecast on page S-16. First, construction of for-sale housing remains muted on the West Coast, partially due to the hard landing it experienced in 2008, relatively high cost for-sale housing, and mortgage qualification issues. However, median home prices are spiking dramatically and have experienced year-over-year increases as of September of 17% in Northern California, 7% in Seattle, and 6% to 12% in the various Southern California metros. If those median price increases continue, we would expect for-sale housing supply to accelerate. Second, the relationship between jobs and supply is at the core of our economic research effort, John Lopez attempts to quantify housing demand and supply in a submarket basis.

From a broader perspective, it takes on average about two jobs to create a household in the coastal market. In 2013, our forecast indicates the addition of a total of 192,500 jobs, which should produce around 96,000 households. This is sufficient to cover 2.8 times the 33,800 combined expected deliveries of for-sale and rental homes in 2013. Our 10-Q will indicate that the investment in common stock at cost increased to $72.7 million s from $42.9 million, last quarter. Nearly all of that increase related to purchases of common stock of one company that we consider strategic in nature. As such we will not provide additional information about this investment. My second topic, the investment markets. Cap rates continued to be aggressive in the coastal markets and have not changed materially since last quarter. Cap rates range from 4% to 4.5% for A quality property in A locations and 4.5% to near 5% of B quality property in A locations. Page S-15 of the supplement summarizes the closed acquisition through last Wednesday which aggregate $515 million including the buyout of our partners' interest on Skyline.

These deals include properties acquired both by the Company and in the West Co co-investment. We also have three transactions aggregating $186 million in contract with contingencies removed, most of which should close by year-end. You can expect a greater focus on Southern California from an acquisitions perspective in 2013. By the end of 2012, we expect to complete the sale of seven properties representing roughly half of our fund II portfolio for an aggregate contract price of approximately $413 million. Essex owns a 28% limited partnership interest in Fund II and up 20% of profits as its general partner promoted interest. The remaining properties are expected to be sold in 2013 in anticipation of the Fund II term date of September 2013 which is extendable to September 2014. The trailing 12 month cap rate on these sales was less than 4.1%. Development deals on the -- in the West Coast markets underwritten based on today's rents generate development cap rates ranging from 5% to 5.5% or 6.25% to 6.75% upon stabilization.

Our development pipeline did not change materially during the quarter, and, at estimated cost, we have approximately $1 billion under construction. We estimate that the average cap rate of the development deals is about 6% based on current market rents and approximately 7% at stabilization. And finally, my third topic, dealing with the state of California -- we will be paying close attention to the election results this coming Tuesday as California goes to the polls to vote on two ballot measures that propose to raise state taxes in support of education and other needs. Prop 30, which is being championed by Governor Brown, would increase the California sales tax by 0.25% for four years and the state income tax based on a sliding scale for those that earn over $250,000 for a period of seven years. Prop 38 seeks to raise income taxes on those making over $7300 based on a sliding scale that begins with an increase of 0.7% and has a maximum increase of 2.2% and is for a 12-year period. If both measures pass the along with the greatest number of yes votes will supersede the other. It's important to note that none of the ballot measures impact Prop 13.

So, I'd like to thank you for joining us once again. Now, I'd like to turn the call over to Erik Alexander.

Thank you, Mike. Operations performance during the quarter was better than expected. We continue to have strong demand in most of our markets. Rental rates grew throughout the quarter. We finished the period in a strong occupancy position and are poised for a solid fourth quarter. Once again, rent growth reached its highest point in July but remains strong into October. During the quarter we completed more than 4100 new lease transactions and signed nearly 4300 renewals. Portfolio wide, renewal rates for the period were up 5.3%, and were steady throughout the quarter. New lease rates were 6.4% higher than expiring rates during the quarter, peaking at 8.7% in July. October leasing activity has been good.

And we now have seen an average coupon rate for new leases and renewals above $1500 for the past four months. So on a combined basis, achieve rents in October are 11% higher than last year. So while we expect overall rent growth to moderate at some point next year, strong job growth in all of our markets should continue to produce solid revenue gains throughout 2013. Looking ahead, renewal offers for November and December averaged 5% to 6% portfolio wide. At the end of October, our loss to lease for the portfolio was 4%. Turnover remains within expectations and for the quarter was within 1% of last year's move out rate. Given our low availability and expiration profile, the turnover expectation for the year remains in the low 50% range. The reasons given for move out were consistent with last quarter's results, and we saw declines reported in home purchases and affordability. These factors represent a 10.5% and 13% of all move outs, respectively. I think these numbers remain low due to persistent high occupancy in our markets, a steady demand for rental housing, and the affordability and qualifying growths facing home purchasers.

We do expect these reasons for move out to increase in 2013 but should be well within manageable ranges. Expo was our only active lease up during the quarter. This community is in the very popular lower Queen Anne neighborhood of Seattle and is less than 1 mile from Amazon world headquarters. These apartment homes average nearly 700 square feet and rent for almost $3 per square foot. Again this project was delivered six months ahead of schedule, and we had our first move ins during October. Thanks to strong pre-leasing efforts, Expo is already 25% occupied and 38% leased. We expect to stabilize this asset during the second quarter next year. Operating expenses continue to be within expectations and year-to-date are up 1.1% compared to 2011. Turnover and one-time service items drove the typical sequential growth, but there's nothing unusual to note. Next quarter's expenses could be slightly higher, and we continue -- as we continue to improve property presentation and enhanced services for our residents.

Operating expenses for the year should end up 2% higher than 2011 and within our guidance. Now I will share some highlights for each region beginning with Seattle. Essex market rents were up 10.6% year-to-date, and the jobs picture in the region continues to be robust, and we are seeing more tech applicants including employees from Microsoft and Amazon. Our outlook through 2013 is 2.3% job growth. Job growth projections for all of our markets are detailed on page S-16 of the supplement. Office absorption slowed during the quarter to about 200,000 square feet, however, Elo, eBay and Intel are all expanding operations in the region. Additionally, Amazon Phase V is slated to be delivered during the fourth quarter of this year, and a nearly 400,000 square foot expansion will commence next year. Other large projects are scheduled to start in 2013 including Amazons 3.3 million square foot project in the Denny Triangle area of the city. This would be Seattle's largest commercial development in history.

Turning to Northern California, Essex market rents are up 10.1% year-to-date. Job growth expectations remain strong in Silicon Valley with the highest forecast for any of our markets at 2.4% through 2013. Commercial absorption in Silicon Valley also remains strong as another one million square feet were absorbed during the quarter, including the balance of Amazons research unit in Sunnyvale which is expected to add 2000 jobs. The balance of the region accounted for another 600,000 square feet of leasing activity with 230,000 square feet in the Oakland MSA. Commercial leasing activity in this market is increasing, and we expect stronger absorption in the coming quarters with subsequent benefits to our East Bay portfolio. The [sly] expectations for the year remain unchanged, and the new apartment offerings in San Jose continue to lease well. We have yet to see an adverse effect from these projects. Next year's growth expectations include this new competition with contingencies for possible concession activity. Again, it is our view that strong job growth in Silicon Valley and tight occupancies in the submarket coupled with very limited single family home deliveries will allow for the new apartment supply to be absorbed and rents to grow as well.

Finally, looking at Southern California, the jobs picture in Southern California is improving. We have experienced a year-over-year decline in unemployment of 2%. September's jobs report was up 1.8%, 40 basis points higher than the national average. Next year we expect the region to match the national average with Orange County leading the way. Office space absorption for Southern California was positive for the fifth consecutive quarter as another 1.1 million square feet was absorbed during the period. Of note, Orange County accounted for 700,000 square feet of that space. Downtown Los Angeles and the West side remain the best locations for us in Southern California, but Orange County improved in occupancy and rent growth during the quarter, and we remain optimistic that this region will continue to enjoy improved performance throughout 2013. Our performance was strong enough to increase our year-end guidance, but, more importantly, we feel confident about 2013. All indications are that Seattle and the Bay Area will remain strong as Southern California continues to build steam.

With that I'll turn the call over to Mike Dance.

Thanks, Erik. Before I turn the call back to the operator for questions, I will quickly highlight the accomplishments during the quarter from four key activities. First, our same property operating results for both the year-over-year increase in revenues and a year-over-year increase in net operating income was the best quarterly results reported by the apartment REITs. We believe that these sector leading results should continue throughout 2013. Second, the accretion from our 2011 and 2012 property acquisitions and from our Via development is reported in our net operating income from non-same property results on S-7. These results have far exceeded our '12 guidance and are key contributors to our leading year-over-year FFO growth. With the recently announced property acquisition, and the earlier than expected delivery and lease up of Expo, we expect to have sector leading FFO growth continue into '13.

Third, we demonstrated the strength of our balance sheet by executing a $300 million public bond offering at a 3.625% fixed coupon, which is a record low coupon for a public debut of REIT 10-year unsecured debt and within 20 basis points of a fixed 10-year rate from Freddie or Fannie. And, lastly, with the dispositions and expected sales of the Fund II assets, our co-investment activities demonstrate the capabilities of the Essex platform by attracting institutional capital which is deployed into the best apartment market on the West Coast, coupled with better than market rent growth with value creating improvements and property operations that improve the resident experience, enables us to sell these assets and generate attractive returns that meet our investors' highest expectations.

I would now like to turn the call back to the operator for questions.

Thank you.

(Operator Instructions)

Dave Bragg, Zelman and Associates.

I just have to ask, since you've put out there and elaborated a little bit, but can you set some parameters for us in terms of how would you define a strategic opportunity?

That's an interesting question. I don't think I've really have a way of defining it. I would say it is something that is -- what we're trying to indicate that we're not doing is just going out and buying common stocks and making that type of investment. We view this as something that we think there is some strategic fit for the Company, and -- but the problem is if you go down that road and start talking about any part of it, I think it diminishes what we're trying to accomplish. And so that's all I'm going to say at this point, Dave.

All right. Thank you. And then just going over to the 2013 rent growth estimates, I'd be curious just to maybe get some color around the relative outlook for class A versus B assets. When you think about the supply coming on in some of your markets, I'm sure that John would have some thoughts on that, and that would be helpful.

Actually, this is Mike. I'll take that one, and John can add to it if he wants. We view the A's and B's as being fairly similar. It depends on what's going on in the local market. I'll give you an example. Probably the area that has the greatest A would be the area around the Irvine Ranch. Because the Irvine Ranch has the ability of producing a lot of A type product. And so what we try to do is look at the amount of A in the marketplace relative to the broader stock and try to judge whether that's the appropriate amount of A product, again, relative to the high-end renter demand.

And so based on that, we will make a decision as to whether we think the A's are going to outperform the B's or vice versa. So that's how we approach it. We do it on a sub market-by-sub market basis. We don't believe these broad statements about A's doing better than B's or B's doing better than A's really has a lot of merit overall as obviously we're producing more apartments going forward. And, as that happens, we are going almost all of the apartment deliveries are going to be in the A category. We are going to become more sensitive to how much A product is in the market relative to the overall housing stock.

Got it. That's helpful. Mike, one other big picture question for you, when you -- shortly after you took over as CEO, you set forth some thoughts, and one of them was keeping the size of the Essex portfolio in the total capitalization range of $7 billion to $10 billion. Do you continue to think that way, or has that changed?

The backdrop for that comment was trying to balance the external growth component with the internal growth component. And we, Essex, I think, has a reputation for being a very savvy investor and clearly I don't want to lose that. And we want the impact of being a savvy investor to show up in the numbers, right? By not having the base so large that it doesn't matter what we buy or build, because there's so many shares outstanding that it gets diluted in that effort. So what we're trying to do is have a balanced program of internal and external. I'm still -- we are still comfortable within the $7 billion to $10 billion range at this point in time. And we'll look to that, but I will also make a comment that we are spending really considerable time and effort now that the size of the portfolio is $8.5 billion roughly in terms of value, more time and effort as it relates to the asset management and operations automating the operating process, rethinking the platform. Because when you get to a certain size, the relationships between what you spend on new systems and processes and that type of thing are easy to allocate over a broader portfolio, so I think there's with some real opportunity in that area as well. But for now still comfortable in the $7 billion to $10 billion.

Okay. Thank you.

Rob Stevenson, Macquarie.

Sitting with a $925 million development pipeline with your share roughly $550 million or so, how are you guys thinking about incremental starts over the next six to nine months especially given that most of your deliveries right now are ' 14? And so starting anything near-term would probably accentuate that.

This is John Eudy. Everything that we have in the pipeline now, the nine deals, the $940 million you referenced are under construction. Behind that, we don't have a lot in a shadow pipeline, quite frankly. So, I think what you're going to see is most of our product delivers in the second and third quarter next year going in the first and second of '14. And from there it's just a matter of whether or not we decide to pull the trigger on future deals.

Okay. How aggressively are you guys pursuing land for future development today?

It's hard. As you know, the Genesis of our portfolio that we're developing and under construction now we started two years ago, and if you mark the land basis that we are in at theo market, we're about half of market today. And as Mike noted in our current cap rate on the pipeline is in the low 6% range. The same with the current land values would be in the low 5%, range and that's a harder thing for us to make an easy decision on. Really good location, a deal that we can't pass up or some combination from the city on fee waivers, there could be a deal that pops up, but it's going to be difficult.

Okay. And then, Mike Dance, where are you seeing the greatest upward pressure today on the expense side?

Not really anywhere. We continue to manage expenses. They are more timing when they come. Happened to be -- last year our expenses were really low in the fourth quarter as we tried to make some stretch NOI goals for fourth quarter last year. So we have a hard comp on expenses for next year. We do -- I've mentioned in the past, property taxes in California we do have some Prop 8 adjustments. We'll be seeing those in our 2013 numbers likely to start coming in. They weren't -- they were muted for the second half of this year. So my concerns were -- have been alleviated and for Prop 8 adjustments for the second half of this year but should show up in the second half of '13. And then probably one area where we don't have as much cap on or be able to predict property taxes would be in the Seattle area. And in Seattle, assessed values have increased significantly. We haven't gotten the levy rates yet, so depending on what those levy rates are, that could be an area in '13 that could be an area beyond our control.

Okay. And then last question, when you guys look back over the last 5, 7, 10 years, how have you guys historically done versus the overall market and sub markets from a rent growth standpoint?

How have we done relative to our expectations?

No. I mean, if I tell you that San Jose is 4% rental rates growth market over the last 10 years, where are you guys normally in those --

I see, relative to the broader market. We are somewhere within the broader market. And I think that the opportunities to outperform the market are really -- from the perspective of rehab, certainly there's some incremental growth over the market. A number of buildings that we bought have been bought from owners that have owned properties for long periods of time that haven't spent a nickel on them for 30 years, the old syndicators and that type of thing. And the opportunity to both put some money in the building and improve the quality of management I think adds some incremental value as well. And so I think that those are the main opportunities out there. Those of the things that we are looking for when we are buying properties in the marketplaces. Where we have an information advantage and our information advantage can lead to a little bit better performing acquisition, which I think we've pretty clearly demonstrated over the last couple years.

Okay. Thanks, guys.

Jeff Donnelly, Wells Fargo Securities.

Just considering your forecast for 2013, specifically for the Bay area, it looks like you're expecting rent growth to decelerate about 250 to 300 basis points from what you realized year to date. Just trying to understand your assumptions, because with an expectation of what I think is increased net absorption and plus in the forecast you should have the same or better pricing power. So I guess I'm curious is that a degree of conservatism in your forecast around your great rent growth prospects, or are you expecting to hit a ceiling on affordability?

Yes, I think -- this is Mike. Clearly, when you look at the jobs that we are assuming and the broader economic recovery which we think benefits probably the left Coast over other parts of the nation, that would -- I totally agree with you, it looks like we have another under supplied housing scenario. But I guess the other thing that concerns us and tempers that a bit is how much of income -- how much of people's income is being consumed by rent. And so we think we use the metric of rent to median income as an indicator of the point at which people choose to move farther out into the hinterland, let's say, or double up more and/or other things that change the world. In fact, If I go back into our history bank, we hit the all-time high rent to median income around year 2000 in San Francisco. And if you just look at what happens in that scenario, you will find employers moving people to Denver and Phoenix and a lot of things that have a muting impact on what's going on in the local marketplace.

So our view is to try to keep our expectations within the range of rent and sustainable, let's say rent to median income levels. I guess the other related point is that median incomes -- personal income growth has been very substantial over the last couple years. So obviously, that could add fuel to the ability to get a very large increases over a longer period of time. But it's more difficult to predict, and so we're assuming that we're going to hit some resistances and that's in effect what's happening, and that's what's causing us to lower our expectations relative to what we have in 2012.

Where do you think that ratio is today? Can you remind us what the peak was?

Yes. We're a little bit ahead in San Francisco in the low 20%s. The peak was 30% plus. In Silicon Valley, and Oakland, we're a little bit below. In Seattle we still have a ways to go to get there. So it's the one with the most gap to build up. San Francisco is our only market where we're a little bit above, but I think, if you look historically, that expansion period it gets very high.

I guess I had the same question for Southern California, but there I would say that it's a similar dynamic of net absorption, but you're expecting revenue growth to accelerate. Is that because you think it's a little bit more affordable down there if you will? You have a little bit more leeway to push?

Yes. Southern California is in our view, much different position. We've had very limited rent growth in Southern California. It's the last major metro in the country to recover. So where the Northern California, we've had 25% rent growth over the last couple years, we've had a fraction of that in Southern California. And at the same time Southern California has not had nearly the job growth that the tech markets in Northern California and Seattle have benefited from. So it's actually a much different dynamic. And so we just think it's a couple years behind Northern California in terms of its recovery. If you look at rents now to the prior peak in many places, it's still below prior peak rents, where we are well above prior peak rents in Seattle and Northern California. So all those factors combined lead us to believe that Southern California accelerates, Northern California and Seattle are modestly lower.

Last question, could you tell us what the move outs to home purchase and home rental were?

Yes. This is Erik. It was 10.5% for the most recent quarter, down from about 11.5% in the second quarter.

Thank you.

Karin Ford, KeyBanc Capital Markets.

I just wanted to follow-up on that conversation about Southern California accelerating. It sounded like in your comments, Mike, that you guys are really going to be focused there on the acquisition front in the coming quarters. Can you talk about how much of your portfolio you'd like to potentially position in Southern Cal in an ideal world today, and which markets specifically you'd be targeting?

Sure. Well, our Southern California portfolio has been as high as 60%, and we have made an effort to invest more in Northern California and Seattle over the last couple years. Because we've predicted I think correctly, that those markets would experience the strongest growth and it would happen sooner than in Southern California. And so again, with 25% rent growth up North over the last couple years, the natural inclination is to shift more of the acquisition focus in Southern California. Not to say, though, that we won't buy in Northern California. I don't want to create that image at all. Over the long haul, if you look at this 20-year compounded annual growth rates of rent, Northern California has been the strongest market in our portfolio. So we have the long-term in the back of our minds and in the shorter-term, obviously, I think it has to decelerate to some extent. I think it will still remain a very good market, but it's not possible in my opinion to produce 7% to 8% rent growth over a prolonged period of time. So, we'll move to Southern California to get to your -- the specific relationships, I think that Southern California could go to maybe up 10% from where it is now. So it could get in the high 50% range. But again, I think that we are -- Northern California is the area that has the best longer-term growth, and we're going to be protective of our allocation here because of that factor.

And are you equally interested in LA, Orange County, San Diego, or is there one particular area that you're more focused on in Southern Cal?

No. We definitely have sub-markets that we like more than others. And in this case, we like CPD LA; we like the West side; the Marina; we like really the Tri-Cities area -- Pasadena, Glendale, Burbank; the coastal markets through Orange County would be the targets that we're focused on.

That's helpful. And next question is just on development, and it sounds like you're not planning to add much new to that pipeline in the near term. Is that -- I get that part of it is that, as you said, yields on -- if you bought new land today, yields would be relatively low. Is it also that you're starting to see some maturation in the cycle, and, given the long lead time from getting something to get something done, that you're maybe expecting slower growth for new starts if you started anything new today?

The thought process really goes back to how you deal with uncertainty as it relates to the broader markets and the broader economy? And the decision early on to match fund all of our acquisitions, ie not increased leverage on the balance sheet, the decision to use an institutional partner with respect to a lot of our development transactions and the decision to essentially -- the day that we commit very shortly after that, start construction. So not have a long delay period where construction costs can increase, and you're subjected to other risks that can pretty dramatically change your expected results. Which is exactly what happened in the last cycle by the way. And so the combination of uncertainty in the market -- actually in the general economy and our preference to try and have a more risk adverse view of our external growth platform is really where we've come and how our portfolio and our development deals have evolved. So going forward, that uncertainty certainly hasn't abated.

And we're still looking for -- we're still looking at a lot of deals. In fact, John -- what a year ago, set up triage because we had so many deals to go through. And most of them didn't qualify for what we were looking for. We continue to look at a lot of deals. And there's certainly no shortage there. But in terms of actually hitting what we consider the sweet spot of the development program is something that we are struggling with. So not to say we aren't looking at a lot of deals. We are looking at a lot of deals, and we may do some, and we do have a couple of deals that are land banked that we could start in the next couple years. But it's just finding the deals that we think fit our profile and fit our parameters, which is the struggle.

That's helpful. Last question I think there was some talk on the last call about rent control concerns in Northern California. Is there anything new, positive or negative on that front?

No. Nothing new on that front. It continues to be an issue just because of the magnitude of the rent increases and the politicians -- in terms of an issue that they can get their arms around, that was certainly one. But nothing recently has happened. I did talk to the president of CAA the other day, and he was -- he acknowledged that we've been pretty helpful in some of the efforts to mediate between cities and residents some of the rent increases. So I think it's more of the same. I think -- I haven't heard anything new at this point.

Thank you.

Alexander Goldfarb, Sandler O'Neill.

The first question, Mike, goes to the stock investment. When you guys bought the unsecured bonds, clearly there's the ability to underwrite what the cash flows are. When you're doing a stock investment., it's based on how the market interprets a story, which obviously is different than how bonds are priced. So while I understand that you want to keep quiet on the strategic part of it, how do you guys gain comfort -- the same comfort that you have that downside protection?

Alex, the problem with this whole topic is without revealing the nature of what we're doing and how we're going to do it, I can't answer the questions. To answer that question, I would have to be able to talk freely about the nature of the investment and why we are pursuing it. So I'm in a difficult spot with respect to this question and other related questions. I understand that the market would like to understand what we're doing. But let's keep in mind that it's a relatively small investment to the size of the Company. And we will disclose what we can, and we will -- I mean it's our practice I think to be pretty open and transparent as a Company. We will disclose information as we can. We just can't do it right now, because who knows how that could impact what we're trying to accomplish? I can't add any more at this point.

No. I think that's fair. Listen, you guys have clearly, as you said, demonstrated savvy. And the market, certainly gives you guys credit for doing this stuff. It's just help us gain further insight but understand that you want to keep it close to the vest. Let me ask a question for Mike Dance. On the Fund II dispositions and the policies -- I don't have a supplemental in front of me. I don't have working Internet. Do you -- what's the potential for any promotes or chocolate chips, if you will, in '13 versus '14 that we should be thinking about?

There's a possibility for both in '13 and '14 depending on the timing of the last sale. So it's backend loaded because of the promote is very sensitive to how these last assets are going to sell. And if we get the extension into '14, that will either put them in last half of '13 or early '14.

Okay. And if you can't provide any color right now, when you guys provide fourth-quarter guidance would that include a range of potential for those promotes? Or because they're really subjective to when the sale is finalized, even in the '13 guidance provided in the fourth quarter it still wouldn't be in there?

We would provide -- as we have in the past, a range of possible other income. So I can see some wide range of possibilities there.

Okay. And then just the final question, in Seattle, saw a news item that you guys sold Tower 801. Just sort of curious if that's a sub market decision or if that was an asset specific decision.

That was a Fund II decision. And so that was one of our Fund II assets. And as you know, there's a lot of downtown Seattle development that will be coming online so looking at the Fund II assets to sell and the timing, we thought it we're going to have to sell it eventually, if we can own it, we would have bought it from the fund, but that's not our deal. But we just figured it was the right time to sell that asset this year rather than next year when some of the new deliveries will be occurring.

Okay. Thank you.

Michael Salinsky, RBC Capital Markets.

First question, in the guidance page you provided you talked about some acquisition upside. Can you give us a sense of what the pipeline looks like today? And what could close in the fourth quarter? And also just any change you've seen in pricing in the last 90 days would be helpful as well.

No change in pricing in the last 90 days. It's interesting because, obviously, given fed efforts to keep interest rates low and lower, we're seeing some pretty amazing debt rates on 10 years from Fannie, Freddie and certainly the unsecured market. In my comments I noted that we have $186 million in contract contingencies removed. The timing of that will be mostly fourth quarter. There's some loan assumptions and some other things that could impact that timing, but most of it will close in the fourth quarter. There's a lot of product on the market as well. And so our acquisition people are busy now. Every year, there are some tax motivated sellers that need a quick close type of scenario. We're hoping for that this year, it's still too early to tell. But we always like those deals because there's such a strong motivation on behalf of the seller. So $186 million thus far, and were looking at lots of other things. So hopefully that helps.

Okay. That's helpful. Second, probably a question for Erik. In the third quarter of last year, your occupancy dropped and picked up sharply towards the end. I think in October you had a very good pickup. Can you tell us how October trended versus last year and where occupancy is at this point versus last -- versus the occupancy last year?

Better. Seriously, again, it's been smoother. This year. So I think our strategy on pricing particularly on renewals and on the new lease side, we paid attention to some of the relationships between net availability and pricing earlier and again just worked that equation a little bit differently. I think last year I talked about how the pickup really started in September -- maybe second week of September. And then one through the middle of October, and by the time we got to the end of the month, whatever that ending rate was. As of yesterday, physical occupancy was in the 96.3% range portfolio wide. And so that's where we stand.

How does that compare versus last year at the same point?

I don't have that in front of me but I think it's about -- I don't have that in front of me. It's similar. It's either at the same level or it might have been 10 basis points higher as we got after the leasing aggressively to make sure that we got essentially the point that we wanted to be, which is where we are today. We like exactly where we are today in that 96.3% range with 5% availability looking out 45 days. So very manageable supply between now and the end of the year.

And finally, Mike Dance, not to leave you out, on the Fund II sales, did you give what the gain on a gross book value basis was? And can you comment what the IRR on those -- the seven that were sold were penciled to?

Yes. We will have the gain -- Brian gave me the number. I'll have to get back to you on that. It escapes my memory right now. But we do have a number that we can provide. And the IRRs to date are around 10%. So we're expecting the promote to come with the second half sales where some of our bigger gains are in the Bay Area assets we bought. And those will be sold either late '13, early '14. But given the high rent growth we continue to see is on the peninsula, we didn't want to sell those yet.

Can you remind us what the hurdle rate on Fund II was?

It's 10%. So we are now paid out off of the hurdle rate. So everything else that we earn above the 10% will have a promote.

Okay. That's helpful. Thank you.

Erik Wolfe, Citigroup.

I think during your opening remarks you talked about home prices in your markets being up 7% to 17%. So pretty strong on a year-over-year basis. Just curious you look at it it's not your renters and other first-time home buyers that are moving out single-family housing that's pushing up pricing. Is this just a temporary short-term squeeze due to a lack of supply, or do you see these gains as being sustainable?

Well, that is a very good question. And I'm not sure I have the complete answer. I can tell you that, as you start getting these big numbers in home prices, a couple things happen, one good, one not so good. The good part of it is that the affordability, the ability to ship from a renter to a homeowner becomes more difficult to occur. So we like that. But at the same time, as the price goes up, you're going to start seeing more homebuilding in these markets. And our view is that apartments are essentially the shock absorber within the market. So to the extent you build a home, we assume that it's going to be bought by someone, and it's going to absorb a household. So the confluence -- the relationship between the two is number one, for the next couple years I think we're good because we have very muted levels of for-sale housing coming at us, but we're going to be mindful of that, and we're going to track it carefully. Because, again, our view is that to the extent their builds are going to be occupied and they're going to take away from the renter demand.

I just want to add that our affordability levels are returning to more normalized levels we expect to see. So I would believe that these gains are not a temporary jump but sustainable.

Okay. That makes sense. And along the same lines you talked a little bit about supply of single-family homes coming back as a response to these gains, which I guess may not be sustainable, but how quickly do you think that could happen? And do you see it being more of a trickle or a flood, and as it and it is likely to hit more of your peripheral markets versus your core markets?

I think that we don't have the ability except in a couple places where you have massive tracts of land that are ground zero competing against our apartments, I guess one of the notable exceptions would be the South Orange County market where there actually is quite a bit of open space and the ability to build homes, and they can be built fairly quickly. If we use the last cycle as an indication of what's going to come at us, there were a lot of -- 1,000's of condo buildings that were built in the coastal markets. The timeframe for building that type of product is obviously much more like an apartment. It's going to take longer. Our ability to track it and identify it and understand its impact is much greater. So I think that in the coastal markets that we focus on, you're going to see -- you'll start seeing that again, but I think it's a couple years off. And so with respect to the product that can be generated more quickly, which is more like the single-family homes, I think that's going to be muted. But there are a couple of areas that we are concerned will have more of that. San Diego would be the other example of an area that we'd be concerned about in terms of the ability to produce single-family housing.

Right. Great. And sort of a weird question here, but you talked a little bit about strategic position. You wouldn't ever consider some type of positioning a homebuilder or something outside of your core focus. What you're talking about is something that's really more specific to Essex?

Again, I have -- this is the problem -- it's almost like I can't say anything without providing a piece of information that I just can't do. It sort of handcuffs me as a question so I just can't comment. Sorry for the frustration that might cause.

No. That's fine. I was just trying to eliminate one possibility. Thanks.

(Operator Instructions)

Rich Anderson, BMO Capital Markets.

So to what extent that you mentioned the 13% of move outs not for financial reasons, or I'm not exactly sure how you put it -- affordability or whatever it was. You indicated that that might be growing in 2013 as well. To what extent is that influencing your rent growth assumption for 2013 moderating? Does it have an influence on that calculation?

No. It doesn't. Again, I've talked about it before, it's been higher in the past. I think same period last year was closer to 17% or 18% of the move outs we're citing this as a reason. And again basically I'm combining people that tell us that either their apartment is too expensive, or that they are specifically moving out due to a rent increase. And so again we've seen that number stable or even come down. So at this point, it is not impacting how we are projecting 2013.

Okay. Mike, or whoever, you mentioned that you could see Southern California climb 10 percentage points to 50% from about 40% currently. How is that going to accomplish? Will it be through purely through acquisitions or will it also be a time to be a seller following the huge rent growth in Northern California?

I could see, Rich, us selling some assets in Northern California and Seattle. And we would tend to look at the secondary locations. John Burkhart is actually here. He's the keeper of the dispo list, and there are some assets on there that are more secondary areas of the San Jose, MSA and the other Northern California and Seattle markets. So it will be that. And to the extent we can build in Southern California, we still would like to do that. We have a couple of development deals that are under construction in West Hollywood. And so that could be a component of it, but again most of the -- there's so little production of housing in these markets that almost by default, most of it is going to be acquisition oriented. So it will be a combination of all those.

Okay. And regarding some of your past, most recent investment activity, buying buildings that are more better suited potentially for condominiums, Skyline for example, to what degree is that strategy something that you'll continue to pursue? Or is it kind of gone or maybe from a risk perspective, you don't want to go down that path much more? Where are you on that strategy from an acquisition standpoint?

We still like it. We think that the opportunities to execute it are few and far between. Most of the transactions that we did in 2010, 2011 involved a financial institution of some kind, which are great sellers because they are very motivated, and you have certainty of closing. And in some cases, actually in a couple of those cases we had to underwrite the assets and had renewed contingencies within a week, for example, because they are so motivated. So we don't see the motivation of the financial intermediaries to nearly the same extent at this point in time. There are a few transactions that we see that have condo maps, and we give a little bit of extra credit, let's say, to those transactions, in recognition of the scarcity of condo maps within these markets. And so we continue to see some transactions that have that.

But I think most of the real opportunity has been realized on that front. I note that the increase in single-family home prices is obviously a tremendous benefit as it relates to that strategy. So it's a mixed bag for us, because, on the one hand, we know that if housing prices go up significantly, we're going to see more housing, more for-sale housing being delivered. But at the same time, the condo optionality becomes more meaningful on our portfolio. So again, good and a bad.

Okay. And my last question is first I'm hopeful that you won't bite my head off by asking it, but I'm going to ask it anyway. And obviously --

It is your nature, Rich, to do that.

But I think it's been benign enough. And I'm just curious, not on this stock investment issue specifically but just a general rule of thumb, to what degree is it normal course of business for Essex? How often do you make stock purchases as a general rule of thumb? And is it something that isn't so far afield from what you've done in the past?

It's a good question. Obviously, most people know that we were pursuing Town & Country several years ago. I guess the other factor that's a little different now is we self-insure. We've got an insurance captive with somewhere around $30 million in it. And so we tranched that by a very safe tranche and then less safe tranches. And so, as you get more money in the captive -- we are going to be making investments, and they will be by their nature liquid. Mostly bonds, probably but there is a chance for some for the -- for some common stock investments within that entity. But I would view this as being very unusual and something that we think we could add value. I think we have a reputation as being a very value-oriented Company, and try to be opportunistic. And at the same time, I think we're also pretty darn risk averse as well. So certainly that's the influence of George Marcus for many years, being both sides, opportunistic and sensitive to risk.

So where we see opportunities that sort of fit within that box, we feel compelled to move on it. I think the other bias of our board is, let's not do things that are so large and such a large debt that's that we undermine the good thing that we have going. That comment is something that is often stated at the board level. And so within that discussion, I would expect us to be within that same vein. There's an opportunistic element. There's a strategic element. There's an element that says, don't make it so large that it could affect the good thing that we have -- the good things that we have going. And I think that's what we're doing. It will all become clear down the road as we all know.

Okay. Thanks very much.

Andrew McCulloch, Green Street Advisors.

Just back to the common stock investment sorry to beat a dead horse here. But I think one of the things that makes investors a little uneasy, in addition to the fact you're not letting anyone know what you're investing in, is that you're also issuing common stock at the same time. When you issue common stock at a big premium to any of you to buy apartment assets, that arbitrage. But when you issue common stock to buy common stock in another company, unless it's another apartment REIT, that's pure speculation. My question is, why would investors want Essex issuing common stock to make purely speculative investments in other common stock?

I don't necessarily agree with your characterization. We're issuing common stock, and we've got a very robust acquisition and development pipeline. And so I don't think you really know that's exactly what we're doing. Having said that, I think you know who we are. We have a 20-year track record. And I don't think we have too many crazy things that we've done over that period of time, so I would ask that you see it through with us. And in the end, I don't think that anyone will be disappointed or think that it's something that's hugely speculative or out of character. So again, I go back to what I just said, which is we have -- we provided the opportunistic. I think you all want us to be opportunistic within the bounds of let's not do anything that's going to undermine the great things that are happening out here. And I think this fits nicely within that. I think if we were talking about an enormous investment, I would agree with you, Andy, but in this case, I think we're making too -- making much out of something that this really is not all that large.

Okay. Thank you.

Tayo Okusanya, Jefferies.

Just a quick question on the development side, if you could talk somewhat about developing costs and where you see that trending?

Sure. This is John Eudy. Fortunately, of the pipeline that we have, the nine deals, $134 million, all but the last probably 10% have been bought out. And we priced it for the most part on average about a year ago. And we don't -- we're pretty safe there. And we're trending on the portfolio to come in at or better than budget. At present, there has been some moves. We have the recent Sandy event which is going to probably give a little spike to some of the material costs. We do think that costs are increasing. Not as substantial as the recent Wall Street Journal seemed to indicate in gross, but they are going up. And that's one of the risks that we're being averse to. Better to have your land from two-year ago prices and your cost in from a year ago then going forward. And that's why we're moderating our forward-looking activities carefully.

Okay. That's helpful. Then just going back to the comment about rents to income ratios, I do get this idea that the rent to income ratios are nowhere close to where their historical highs have been, but I'm just curious with everything you're seeing in regards to job trends and overall market trends, whether you actually expect rent to income ratios to get as high as they were in the dot com era or in the last real estate boom of 2004, 2005, 2006?

This is John Lopez. Only San Francisco is above its long-tun trend, and so I would say that most of our markets are still below the long run average. Not anywhere near the highs. In San Francisco where it's at right now, is not at the level you would expect to see in a very hot market. The second thing I'd like to add is we look at Seattle as a market where it was hit pretty hard in that it's becoming more of a market like our Northern California market and we expect that long run average actually increase over time.

Okay. That's helpful. Thank you.

Paula Poskon, Robert W Baird.

Just one big picture question. Given how strong the fundamentals have remained, are you surprised that the apartment sector has not done better, has really under performed year-to-date?

Wow. That's a great set up question. Thank you. Thank you, Paula. I'll send you a check. (laughter). Obviously we're disappointed in the performance of the stock. I think the multi family REITs are the poorest performer stock-wise this year, which was true about a week ago I think but maybe changed a little bit. So, obviously, yes, but, at the same time, we view our jobs as putting numbers on the board, growing cash flows, doing smart real estate deals. And we believe that the stock price will follow that effort. So we remain optimistic, and we're happy with lots of things that are going on, and we hope that the stock reacts appropriately over time. And I think it will.

Do you think that investors -- that the concerns particularly around the return of homeownership have been overdone? Or do you think those are warranted given what you're saying in your comments earlier around housing prices and your fear that inventory will increase?

The comments that we've made are in no small part trying to put that issue into perspective, because I think that there's sort of a homogenization of America in terms of the data. And I think the regional variations are very significant. And so I think that's what works as a general theme may not work as to every company and every location. We recognize this as being a very local business, and relationships that may apply on a national basis will probably ultimately apply to us, but there can be a couple years of lag between them. So I think in this case, there's a couple of key points that really matter here. Number 1 is our rents fell further than most from our prior peak to the trough was off 15% as a company. And so we expected a strong bounce, and we got a strong bounce from that, but we started at a very low point. We were about two years later to recover given the fact that the tech companies proved they can restructure very quickly, and so we had very significant job losses for a period of time, which led to the rent reductions. But it also set up the opportunity to add jobs quickly when conditions were better.

So our view is that if you have those two things in context and then you also look at what happened in the for sale area where you had all these vacant condo buildings, really demonstrate the distress within the for sale markets, and again, which we were able to buy eight of them over that period of time. And it just shows you how much of a stressor it was. Again, that will recover as well. But it's not happening yet. So I think you have -- you've got to look at regionally with respect to the different elements of supply and demand, and you'll see why we are as optimistic as we are in our comments.

Thank you, Mike.

Andrew Rosivach, Goldman Sachs.

Really quickly in the call you guys have done a lot of transactions both on the buy and the sell site in California. I'm just curious, have you've been able to have any kind of efficiency in terms of Prop 13 when you're entering or disposing of assets?

No. When you buy or sell an asset, which is different than development they're going to use your purchase price, and whatever adjustments we do from GAAP accounting, they kind of ignore. They just use what is recorded in the purchase sale agreement. Development is more of an art. They try to come in and assess the fair value. They can't markup the land, but they can market the improvements on the development. So there, we have had some success on the development side, but acquisitions and dispositions, it's pretty black-and-white.

So even in the history of the Company like way back when you sold the funds straight to UDR, even if you do an entity level transaction, you're still going to get a markup?

An UDR, you'd have to talk to them. But I imagine if there were assets outside of the state, they would have tried to change the allocations like -- I can't remember all the assets in the fund, but there might have been some allocations for the purchase price, they had some flexibility and ability to allocate within or without the state of California to maximize their tax position. But you'll have to check with them on what they did.

Right. And then one thing. This is indirect to the share purchases. You increased your interest in other income guidance by $600,000. Is that because you're carrying the additional common stock which is producing a dividend?

I think that falls under Mike's previous comments. We're just not going to go there, Andrew.

Okay. Thanks, guys.

Ross Nussbaum, UBS.

I guess there's a lot of talk about the common stock investment. While you've been on the phone, your stock's down $1. BRE's stock is up $1. So, I don't know why everyone is beating around the bush here. Can you at least tell us what this is not as opposed to what this is? If this is BRE can you -- do you have any intent -- are you buying BRE Stock? Do you have any intent of merging with BRE? Are you in discussions with BRE?

Ross, you know I can't answer those questions.

If I asked you if you had any intent of merging with IBM, you'd answer the question. So I guess you guys opened the door by making a strategic investment. You've told us nothing about it. You won't tell us if you're going to be buying the entity, selling the position, and I guess the big question then becomes, how long do you plan on keeping us all in the dark for on this?

Well, I would argue that your' re really in the dark -- we have disclosures that we have made. And you know with the relative size of the investment -- and you can judge that relative to the size of the Company. And there are laws that concern other disclosures that are out there. So again, can't say anything more.

All right. I hope you can understand there is a sense of frustration out there, because I think people are concerned that this isn't just a small investment, that it is going to be something bigger, and they don't want to get in front of that until they know more.

I understand.

Thank you.

Michael Billerman, Citigroup.

Michael Schall, you mentioned Town and Country in your response to a question. I guess what is your thoughts on new markets and markets outside the West Coast and your interest level?

Michael, you we continue to be interested in markets outside the West Coast. The fact pattern of Town and Country is I think important ad maybe instructive in that, at that time, West Coast was I'd say marginally ahead of the East Coast in terms of overall asset pricing and cap rate and just overall attractiveness in terms of where the West Coast was in the cycle and the East Coast. We view this business as good strategy is great and important, but only when coupled with good decisions with respect to timing and value creation pieces. So in this case, I would say the reverse has happened, which is at least to this point, the East Coast was ahead of the West Coast in terms of recovery and in terms of asset pricing and valuation. So hopefully that gives you some idea of how we think about these things.

Okay. And then the $73 million that is in marketable securities, the $43 million that was there as of the second quarter and the $30 million that you added to it, the entirety of that is one single position and one single security? Or is there multiple positions in there?

The vast majority of it is one position.

And then has anything been added to that position during the fourth quarter? Or is $73 million the current standing position?

No.

And then I guess from a disclosure perspective, there's obviously your own disclosure which you've made. And I guess once you reach 5% of the entity, you would have to disclose a shareholder perspective, correct?

We will comply with the law, correct.

So therefore, the target has a minimum market cap of $1.5 billion because you haven't reached 5% yet and essentially is going to be at $4.9 billion. And with normal leverage the entity would be greater than $2.5 billion. And I think that goes to Ross's question about, it's a small position relative to the current size, but clearly as a totality, if you were to move forward on the security, it obviously is a large investment at some point.

Can't argue with your math.

And then the last question, in a lot of M&A type scenarios, a lot of situations people use derivative, puts, calls in order to get their stake up. Do you have any of that today? Or is your position entirely built up of shares of common stock?

We have no derivatives.

Great. Thank you very much.

It appears we have no further questions at this time. I would now like to turn the floor back to Management for closing comments.

Thank you very much for the spirited debate this morning. And we appreciate your participation on the call. Obviously, we're pleased with the results of the Company during the quarter and our outlook for next year. And we look forward to seeing many of you at NAREIT in San Diego in a couple weeks. Thanks so much for being with us today.

This concludes today's teleconference. You may now disconnect your lines at this time, and thank you for your participation.