Essex Property Trust Inc (ESS) 2012 Q4 法說會逐字稿

Greetings, and welcome to the Essex Property Trust, Inc., fourth-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 made on this conference call regarding expected operating results and future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made based on current expectations, assumptions, and beliefs, as well as information available to the Company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found in the Company's filings with the SEC.

It is now my pleasure to introduce your host, Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, Mr. Schall, you may begin.

Thank you. I'd like to start by welcoming you to our fourth-quarter earnings conference call. Mike Dance and Erik Alexander will follow me with comments. John Eudy and John Burkart are available for Q&A. I'll cover the following two topics on the call -- fourth-quarter results and the outlook for 2013, and cap rates and the investment market.

So, on to the first topic. Yesterday, we reported core FFO per share of $1.81, an increase of 20% over the prior year, and near the high end of the guidance range that we presented last quarter. For the year, we exceeded the high end of our initial 2012 guidance range for core FFO by $0.02 per share. We're very pleased with these results, which required the relentless and disciplined execution from the entire Essex team. I both congratulate and thank the E team for this accomplishment.

Our economic research discipline is designed to create an investment thesis that we utilize to guide our acquisition, development, and disposition activities. We back-test our conclusions when we later receive the actual data, to evaluate the process and look for insights that can improve future investments. We believe that success in the real estate business requires timing and execution, which are aided by the research effort.

A significant accomplishment over the past couple of years was predicting the surge in tech employment, which precipitated a greater portfolio weighting in northern California and Seattle. We've been rewarded for that insight.

However, there was room for improvement with respect to our forecast for southern California, which lagged behind our recovery forecast, largely because of the implicit assumption that the recovery from the Great Recession would be similar to prior recoveries. That is, the trajectory of the recovery period would resemble the rate of decline. That clearly didn't happen. The recovery was slow and lumpy with muted growth from a few sectors including tech. As a result, southern California, which is a more diversified economy without an abundance of tech, has under-performed our expectation.

However, as I will discuss in a moment, that appears to be changing.

What does this mean for 2013 and beyond? Our overall market outlook is on page 16 of the -- S16 of the supplement, and is based on US job growth of 1.6%, and 2.3% US GDP growth. Both of which are at the high end of the range provided by our data vendors. This information updates the same document that was part of our Q3 2012 supplement, although it generally assumes greater job growth, consistent with that reported over the last six months, and more apartment deliveries.

We continue to see tech, life sciences, and energy as leading sectors in 2013. Throughout 2012, we saw the breadth of the jobs recovery increasing as more economic sectors contributed to job growth. Private sector job growth is now broad based, with jobs being added in trade, business services, leisure and hospitality. The consumer, especially those at higher income levels, are rebuilding their balance sheets, are gaining confidence. We are in a world with a growing disparity between workers with skills and education, and those without, and that will affect the types of jobs being created and the potential income. That's the good news.

Lagging sectors in the recovery had been manufacturing and government, both of which will continue to have less employment in 2013 as compared to the pre-recession period. Many economists believe in the resurgence of manufacturing in the US following huge losses suffered during the Great Recession. While that may occur, we believe that the impact from manufacturing will be muted in the coastal California and Washington markets, with perhaps a few exceptions like Boeing near Seattle.

There are other factors that have a bearing on our market forecasts, such as benefits from demographic factors, including an aging population that requires housing without necessarily having a job, the estimated 23 million young adults living with parents that would like to become renters, and the trend of postponing marriage and children.

Finally, we are not seeing the strong resurgence for for-sale construction in the Essex investment markets, although the median price home has increased 21% in San Francisco, 25% in San Jose, 13% in Seattle, and 15% in Los Angeles. Large increases in housing prices will lead to more for-sale housing down the road, but it also makes the transition from a renter to a homeowner more difficult. Apartments and home building can co-exist without major problems, absent artificial demand created by lax mortgage-lending standards and other anomalies.

We conclude that new apartment deliveries will be absorbed with moderating, but still strong, rental growth. Once again, we expect the best job growth to be in northern California and Seattle. New jobs and supply deliveries may not align perfectly throughout the year, leading to some volatility in rents in areas with the greatest apartment supply, principally downtown Seattle and north San Jose.

Our outlook for southern California continues to improve. This expectation is supported by the continued acceleration in job growth. In the second half of 2012, the Los Angeles MSA produced twice the number of jobs as compared to the first half of the year -- the best since 2009. And outpaced the US with 1.8% job growth. Again, the growth was broad based, led by business services, leisure, hospitality, education, and health services.

Los Angeles also has the least amount of new supply of housing compared to all of the Essex MSAs, projected to be only 0.2% of stock in 2013. San Diego also reported a significant improvement in job growth. The remaining southern California MSAs have less job growth and more supply, and thus, lower expectations for rent growth. Erik will comment further on each of these sub-markets.

While we remain confident in our outlook, it should be noted that economic and political uncertainty has greatly widened the range of outcomes that are possible for all businesses and the US economy. A shock from the Middle East or a new chapter in the Euro debt crisis could derail the scenario that we just outlined.

Now on to my second topic, which is cap rates and investment markets. Cap rates ranged from 4% to 4.25% for A-quality property in A-quality locations, and in the mid-4% to low-5% range for B-quality property in A-quality locations. Cap rates increased from there for lesser locations and property quality.

To add value, we have become more targeted with our acquisitions, looking for sub-markets with rental growth rates that exceed the average growth rate of our portfolio. Our preference is finding value-add opportunities. As always, market selection and timing is critical to accretive investments.

We completed approximately $800 million in acquisitions in 2012, and expect solid transaction volumes in 2013. With tax rates increasing, we hope to find sellers desiring OP trade transactions. As we enter 2013, we expect around $400 million in acquisitions, with greater emphasis on well-located B property and on southern California.

Our development pipeline is now mostly under construction. We will likely start two additional development projects in 2013, aggregating from 200 to 300 apartment units. We have become more selective for new apartment development opportunities, and are looking for locations that we expect to improve with rents that have strong growth potential.

There are many deals being discussed, although many of the merchant builders need equity to satisfy lender requirements. Other impediments to new apartment construction include concerns about the economy, future rent growth expectations, construction cost increases, and concessions from reluctant local governments that are needed for projects to achieve financial hurdles. With this in mind, we believe that new apartment deliveries will peak in 2014, and return to muted levels thereafter. Development cap rates based on current market rents continue to be in the 5% to 5.5% range, or around 6.25% upon stabilization.

Before turning the call over to Erik, I want to note that the press release summarizes the sale of $74.4 million in marketable securities, representing the strategic investment that I referred to on the Q3 2012 earnings call. The decision to sell followed communications with a company that enabled us to conclude that we could not expect to achieve our strategic objectives.

Thank you for joining the call today. I'll now turn the call over to Erik.

Thank you, Mike. Operations performance during the quarter was solid, as expected. We enjoyed strong demand in all of our markets, continued to grow scheduled rent on robust renewal activity, and we finished the period in a favorable occupancy position and are poised for another year of strong performance. New lease and renewal activity remained strong during the seasonally slow fourth quarter.

2013 is off to a good start, with rents and occupancy improving each week throughout the month of January.

Combined rents in January generated 7.8% growth over January of 2011. Renewal rates in January were 5% above expiring rates, while expectations for February, March and April are anticipated near 5% as well. We also expect pricing on new leases to continue to rise on strong demand and limited availability.

As of yesterday, the portfolio was 96.9% occupied. So, while we expect overall rent growth to moderate this year, we see acceleration in southern California, and expect strong job growth in all of our markets to drive revenue gains for Essex throughout 2013.

Turnover was within expectations, and we ended the year with a portfolio-wide ratio of 52%. The reasons given for move-out by residents were consistent with last quarter's results, with affordability accounting for 13% of all move-outs, and home purchases representing 12% of move-outs. Home purchases were slightly up for the quarter, but flat compared to the fourth quarter of 2011. We expect these rates of move-out to increase modestly in 2013, but manageable and well within historical levels. With several sub-markets introducing new product, we do expect to see turnover rates increase to the mid-50% range for 2013. Some of this turnover will be related to expanding our interior renovation program in an effort to meet market demand for fresh product and new features.

Expo remains our only active lease-up during the quarter. Our early delivery continued to pay dividends, as leasing remained strong throughout the period. Leasing activity remains ahead of plan, and Expo now stands at 55% occupied and 64% leased. We were also pleased to see that many new competitors in this lively sub-market are leasing apartments at a brisk pace as well. As called out in our economic forecast, we anticipate strong job growth to continue in Seattle, and be more than sufficient to absorb the increase in new supply this year. We look to stabilize occupancy at Expo at 95% during the second quarter.

Now I'll share some highlights for each region, beginning with Seattle. We're calling for overall market rent growth of 6.5% in 2013. However, our expectations are segmented. We expect growth of 2% to 4% in downtown Seattle, and 7% to 9% in Bellevue in the east side. This is an important distinction, given that 70% of the new supply will be delivered in the city of Seattle, while 80% of our portfolio lies outside the Seattle CBD, including more than 50% on the east side.

The jobs picture in the region continues to be strong, and shows no signs of letting up. We increased our outlook for 2013 from 2.3% to 2.8% job growth. Amazon continues to hire new employees at a furious pace. Boeing is ramping up production in an effort to reduce their backlog, and Microsoft currently has 3,400 job openings for computer scientists and engineers.

Office construction in the region continues to be about 1% of total inventory, but the pipeline is very large, and major projects that we previously commented on, including Amazon's expansion downtown, remain on track.

Turning to northern California. We believe that this region will again lead the way in rent growth for Essex in 2013. The primary reason is that job growth expectations continue to be strong in the Silicon Valley, with 2.7% projected in 2013, and a healthy 2.4% for the broader Bay area. Office absorption in Silicon Valley also remains strong, as 800,000 square feet was absorbed during the quarter, with another 850,000 square feet leased in San Francisco, Oakland, and on the peninsula. So, all total, more than 6 million square feet of office space was absorbed during 2012, or nearly 3% of inventory. Vacancy for the region is below 15%, and nearly 4 million square feet of office is under construction or renovation.

Largely due to timing, our multifamily supply projection for San Jose has increased slightly for 2013. But the total new housing supply for this sub-market and the region remain below 1% of total stock. As we continue to make timely progress on the development of Epic in north San Jose, competing new projects are reporting strong absorption, stable pricing, and normal concession activity for lease-ups. We continue to believe that the impressive job growth in the region will support the delivery of all of these projects. Our nearby Via bears this out, as the property continues to perform well.

In southern California, we expect Los Angeles to lead the results for the region. Already in January, we are occupied above 96.5%, and new lease rates are 6.5% higher than last January. The jobs picture in southern California continues to improve in all sub-markets, as new employment accelerated during the second half of the year. Hospitality, professional, business, and health services led the way. But there were also gains in entertainment during the past year, with total jobs for this sector nearly returning to 2008 levels.

Additionally, unemployment in Orange County fell below 7% for the first time in five years, while personal income growth in Los Angeles and San Diego reached nearly 4% during 2012. Job growth expectations for the region are ahead of the national average, with Los Angeles and Orange County approaching 2% rate of growth for 2013.

Office space absorption for southern California remains modestly positive, with nearly 400,000 square feet leased during the fourth quarter. The West Side and Tri-City areas continue to see the most activity. Office vacancy is hovering around 17% for the entire region, and there's nearly 2 million square feet of space under construction or under renovation, mostly split between Orange County and San Diego.

The region continues to plan for further growth as both the Los Angeles International Airport and the Port of Los Angeles have advanced their expansion plans. Both transportation hubs saw increased traffic during 2012, and are expecting further growth in volume in 2013. Downtown Los Angeles and the West Side remain the best locations for us in southern California, but Orange County continues to show improving rent levels.

So, consistent with our view last quarter, we remain confident about growth and performance for 2013. Seattle and the Bay area will still lead the way for Essex, but southern California will be a more significant contributor to our overall results this year. Thank you for your time, and I will now turn the call over to Mr. Dance.

Thanks, Erik. Today I will highlight some of the key assumptions for our '13 forecast. Our detailed assumptions are on page 5 of the press release and S14 of the supplemental. For '13, we expect consolidated same-property NOI to grow by 7% at the midpoint. The '13 same-property portfolio will include the five properties we acquired in '10, which required substantial lease-up activity, the three properties acquired in '11, and the Via development in Sunnyvale.

Our acquisition strategy focuses on allocating capital to the markets we believe will have the highest rental growth. The acquisition properties being added to the '13 same-property portfolio are forecasted to grow net operating income by 8% compared to the average of 7% for the entire same-property portfolio.

Operating expenses during the fourth quarter and for the year ended were at the low end of our guidance. Over the last four years, the same-property operating expenses have not grown by more than 2%. Clearly, our portfolio benefits from the 2% limits on property tax increases in California.

However, for the '13 midpoint of same-property operating expenses, we are estimating property taxes will increase by $2.2 million or a 5% increase. This estimate is based on new assessed values in Seattle, and in California we have assumed the temporary Proposition 8 benefits will lapse and property taxes will revert back to their Proposition 13 valuations.

Our '13 guidance assumes we'll complete the dispositions of our Fund II portfolio by the end of the third quarter. For the first three quarters of the year, we are estimating $500,000 per quarter in Fund II management fees. In the fourth quarter of '13, we expect a reduction in core FFO of $2.1 million from the loss of management fees, plus our share of Fund II's FFO after the liquidation. We expect we will receive between $3 million and $6 million of promote income in the fourth quarter.

During '13, we plan to begin leasing at Epic and the Dublin California development, and complete the lease-up of Expo. The net increase in dilution from the developments in '13 compared to '12 will be $1.8 million related to these projects. This dilution is the result of expensing all operating expenses once we begin operations, and the cessation of capitalizing interest as apartments become available for rent, and to the extent our lease-up incentives include free rent, it is our accounting policy to start recognizing rental income after the free rent period is complete.

Expo is expected to contribute to FFO in the second half of '13, when it yields approximately 7% in Q4. We are forecasting a 5% increase in general and administrative expenses, including acquisition costs due to general wage increases and additional hiring as a result of the growth of the Company over the past few years. That ends my comments.

Operator, we are now ready for questions.

Thank you. We will now be conducting a question-and-answer session.

(Operator Instructions)

David Toti, Cantor Fitzgerald.

Good morning, guys. I have a couple -- just a couple of small detail questions. Looking at the metrics for Santa Barbara in the quarter, it appears you had pretty good occupancy gains, rent growth was pretty flat. Was that a deliberate effort to build up occupancy and if so, why so aggressive in that particular market?

This is Erik. Yes, it was basically. That building's a student dominated building and so the leases that you see in the fourth quarter are essentially the leftover from the pre-leasing done during the summer. So the better we get -- the sooner we get those, the better we are for the rest of the year.

Okay. So that's just defensive specific to that market, not an overall expectation for the portfolio in general?

No, absolutely. It's totally specific to University of Santa Barbara.

Okay. Going back to NAREIT, you guys were talking about capping or potentially capping rent increases in Northern California. That doesn't seem to have happened. Have things continued to improve above expectations since that time?

Yes, this is Erik. We actually do cap the rents at the majority of the properties, the stabilized assets, including Northern California.

On renewals.

Yes, on the -- thank you, on the renewals. But again, depending on what the resident chooses for a term will dictate what the rent increase or the rate is.

Okay. And then I suspect you're not going to give us too much detail on the investment that was made, but can we expect more of those going forward? Is this something we'll see this year?

This is Mike. I'm assuming that you are referring to the strategic investment and, yes, I really want to prevent this from being a discussion, a lengthy discussion about strategic investments.

We do not expect many of them over time. We have not had many of them over our history. But I do maybe want to add one additional thought, which is that we promised the investment community that we would be disciplined throughout that process, starting from the accumulation of the position and essentially the decision and execution of the sale when the strategic objectives were not considered possible. So from our view, that closes the chapter on that discussion and, again, I'm not going to make a lot of comments about what happened and the blow by blow type of stuff because I just think it would be inappropriate to do so. So I'd like to move on. We have a lot of great things happening internally. We need to focus our effort on the things that we can control and that's what we're doing internally and would like the call to sort of follow that same pattern.

Okay. Great. Just one last quick one. The land parcel that you sold in Palo Alto, what was the thought process there, given the ramp-up in development overall?

I didn't hear the last part of your question, I'm sorry.

In the context of rising development agenda, what was the rationale behind selling that particular parcel?

It was a great location, obviously but it was very small, it was only 50 units. We were offered a price that made sense and we executed on it.

Self storage operator, potentially? Thanks, guys, appreciate the detail.

Thanks, David.

Alex Goldfarb, Sandler O'Neill.

Good morning out there. Mike, I appreciate your comments in not wanting to make the investment a big part of the call, but just one question because it's something that constantly came up with investors. If you guys were to do this again, how would you weigh just putting out a public -- like a public bid? Do you think that would be helpful? Do you think that would accelerate a process or as you look at what happened you guys are pleased with how it went? It's sort of a Monday morning quarterback thing if you will.

Alex, I think that every situation is a little different and to make any generalized comments about what we might do differently will depend I think on the situation.

These things happen once every five years, let's say, and each scenario is a little bit different. They all have periods of activity preceding them and then the activity itself. It really depends. Your strategy's going to depend on that whole sequence of activity. So I think it would be really difficult to make a generic statement about what might be different in the future.

And again, what I'm hoping we don't do is turn this discussion into about the strategic investment. Because again, from our perspective, we need to focus our efforts on the things that are really important to us. And we have a lot going on and we have a lot of opportunity in front of us. So rather than talk about something that is a closed chapter in the book, we'd really rather focus this forward on to the things that we're doing and the results and 2013, all the stuff that's happening out here.

Okay. That segue's well into my second question, then. You guys have made a number of recent deals including Pacific Electric. Were any of these deals sourced through your mez portfolio. As you guys look at making new mez or financing investments at this stage in the cycle, is your view that those are more loan to own, the hope that you do get the property or at this point in the cycle most of those are more just getting attractive financing where you assume that you'll probably just be paid off in the end?

We did not source that through the mez portfolio and the purpose of the mez portfolio, both legally and practically, is to get the rate of return that we expect on the loan or whatever form it might take.

Having said that, it does lead to a discussion. I mean, you have relationship with the owner and that could lead to a transaction down the road, and in a number of cases it has at least led to a negotiation about whether we wanted to acquire the property. In all those cases part of the sort of strategic aspect of that is to make loans on things that we would like to own that satisfy our broader criteria and, therefore, we have had some situations where we've been engaged in a discussion about buying a property. But up to this point we've not been able to actually make that acquisition.

Just last thing, as you guys ramp up the renovation program, are there any changes, are there any differences in tenant tastes, this time maybe more price sensitive now versus pre-credit crisis or are the renovations sort of what we were seeing pre-credit crisis as far as the granite and stainless and all that stuff?

I think people want the nice, new, modern finishes and in a number of these communities we're also adding the washer and dryer, which I think is important, as an enduring feature and so, again, modest changes in taste but there doesn't seem to be any pricing pressure. People want to pay for the nice units and the nice locations.

Great. Thanks a lot.

Thanks, Alex.

Ross Nussbaum, UBS.

Hi, guys. Good morning out there. I'm going to ask one quick one on the strategy front.

I knew you would. I knew you would. I remember what happened last call. Go ahead. (Multiple speakers)

Now that the whole thing is over, can you actually tell us what company it was in?

No.

Is that because you're subject to a [confer] in NDA or you're just choosing not to?

This is the good old slippery slope, isn't it Ross? No comment.

Okay. I'll move on.

Sorry.

Prop 13, on Camden's call an hour ago Rick decided to throw Prop 13 on the table as a risk if the state of California can't get its act together. What's your view at this point?

I'm a little surprised that Rick had that position. California, given Prop 30, just got what was estimated as $6 billion in additional revenue, and there have been recent statements that the state of California actually may have a surplus, which I tend to discount personally, but that is the -- that's what's out there.

Now, also with respect to just the political reality, I go back to some of the conversations we've had with California Apartment Association and others who, they have a process that tries to find moderate Democrats that are concerned about business as far as their endorsements and the candidates that they support. And there are actually several or many moderate Democrats and so the presumption that just because there's exactly two-thirds Democratic control of both parts of the government, it doesn't necessarily mean that the moderate Democrats are going to vote in favor of a Prop 13 overhaul. So I guess I wouldn't agree with Rick on that. I think that there will be less support for that than you can imagine, given the number of moderate Democrats that are out there.

And I also think that the voters have sort of given the politicians a mandate which is fix the state's budget problems and they gave them $6 billion to do so. And I think that they expect that to be sufficient for the time being, not that there won't be some other proposals for tax increases and other things. But I go back to Prop 13 has been here for 30 years and it's been challenged in a number of different ways, all the different ways can you imagine from judicial to legislative and other. And it's pretty much survived that period of time. So I think there will be more resistance than you might think.

Okay. To be fair to Rick I think his point was that if the surplus goes away that there's increased risk that Prop 13 gets revisited. That was his --

I would agree, I guess I would agree with that. There's other discussions about vehicle license fees going up and a variety of discussions that are candidly easier to accomplish, perhaps, than a Prop 13 overhaul.

Okay. Next question is San Francisco related and I think your comments on the office construction and the jobs picture is particularly relevant. I'm curious, we're certainly seeing a resurgence in the South of Market area and we've certainly seen more tech companies going downtown than really we saw in the last tech cycle if you will. How does that influence your view of where you want to be invested over the next 5 to 10 years within San Fran? Does it push you to say we want to put more dollars downtown?

It does. We think San Francisco is a place that we need to be. We for many years had a very small presence there, given the difficulty of finding property there that satisfied our broader criteria.

But we have been more active. We bought a couple deals in the Soma district and actually other parts of San Francisco and our interest continues there. So over the 20 year horizon, the CAGR of rent growth in San Francisco is highest in our portfolio. So the difficulty has been trying to find transactions that hit our yield thresholds and our overall return thresholds while recognizing it's a very strong rent growth market.

Okay. Last question from me. Are you able to give us some sense of what the IRR on Fund II is going to end up at, both to you as well as your partners since I recognize those would be different numbers.

Yes, this is John Burkart. We're in the 10% zone on that invested since '04 through '13 overall.

To Essex.

Overall for the fund.

Overall, so your numbers would be a little higher with fees and (multiple speakers)

Yes, of course.

Okay, that's 10%. Okay, got it. Thank you.

Thank you.

David Harris, Imperial Capital.

Hi. If I look at your year end balance sheet, it's got $93 million of marketable securities. $20 million went out after the year-end, so if I'm doing the math right, there's $73 million left on the balance sheet today plus or minus, could you care to comment as to what those marketable securities are today if the strategic stake is gone?

Hi, David. This is Mike Dance.

Hi, Mike.

After Katrina we started a captive insurance company. That insurance company has over $30 million in marketable securities. That has worked out very well for us. And then back in 2009, 2010, we made some investments in the Freddie Remax type or the mortgage backed securities that are also in those numbers. So that's the bulk of it.

Okay. Is that number likely to stay fairly stable now as we go forward?

There is some accrual of interest on the Freddie securities so that will grow just as we accrue interest on it. And we get about $4 million a year in payments that the operating properties pay for the captive insurance. So that grows $4 million to $5 million a year with premiums and investment returns. So it probably grows on a magnitude of $10 million a year.

Okay. If I look back at this time last year, we're a couple of weeks away from you declaring what your dividend is. It seems to be you've set it for the year on your first quarter. You're one of the few REITs that did not cut in the downturn so your dividend record is obviously quite outstanding. But could you give an indication as to what the level of growth we might look for this year or you might be recommending to the Board, shall I say?

Sure, David. It's Mike. We do our dividend increase as part of the next upcoming Board meeting and so that will be a topic for discussion. We expect that we'll make a recommendation in the 8% to 12% range. I'm sure there will be a discussion and -- but we're pretty confident that it will lie somewhere within that range.

How much of that is discretionary and how much of that is being driven by rise in net taxable income, Mike?

It's pretty much I would say most of it's discretionary. We had a return of capital this last year, so most of it will be discretionary based on cash flows.

Okay.

Apartment REITs get a much shorter life on depreciation so we have much more of our income sheltered by depreciation expense.

Okay, I think you've got one of the heaviest stock prices in the sector. I know this is a subject that's come up before, but any thought as to splitting the stock to make it a little bit more manageable for folk?

Yes, David. Again, it's Mike. We've evaluated that several times over the last couple years and we concluded that with the very high institutional ownership, and typically the selling of stock is on a per share basis, the commissions are whatever are on a per share basis and the listing fees and ongoing fees of the New York Stock Exchange make it unlikely that we're going to split the stock.

Okay. This is Berkshire envy, isn't it?

Yes. Not exactly, but yes.

(Laughter) All right. Thank you, guys.

Thank you.

Eric Wolfe, Citigroup.

Hey, guys. Forgetting about the strategic investment for a little while and maybe thinking about M&A more broadly, most of the multifamily stocks really haven't performed very well over the last year or so. Your stock's obviously been one of the bright spots. But wondering if you think the fact that your peers are trading at sizable discounts in NAV makes public-to-public M&A more likely or maybe less likely. Or public to private M&A. Just want to get your thoughts on that.

Broadly speaking I think the sector has an issue with M&A. Because there's just very little that you can do to make transactions work. You have I think a combination of impediments with respect to the tax rules that affect M&A. You have relatively similar pricing. Some premium -- small premium or discount to NAV, all the stocks trading within a band that really doesn't allow large premiums, and you don't have -- I don't think you have motivation in some cases with the management teams and Boards.

So I think you have a variety of impediments that really prevent M&A transactions from happening. So I don't see anything changing that in the near term, and thus, I'd say our appetite for M&A is pretty limited because it seems like a bit of a futile effort.

Right, right. So it doesn't really -- I mean I guess the answer then is it really doesn't matter where the stocks are trading because the same issues are going to be there no matter what?

Those are pretty much generic issues from our perspective, yes.

Okay. And then just changing topics. One of your strategies over the last couple years has been to buy condos that were trading, before at least, at big discounts to replacement costs and converting them to rental. Now that you've seen condo prices increase pretty significantly in a number of your markets, people sort of clamoring to buy in certain areas, could you see yourself selling any of these assets or are you better off holding them as multifamily?

Yes, Eric. It's Mike. No, the intent was to acquire condo properties at apartment prices and when a condo premium, which throughout my career I'd say is close to 40% over a comparable apartment property, that we would intend to try to realize that benefit.

In the case of Skyline, which is probably the largest and most notable example, it's really a lot better condo than it is an apartment building. And when you have wine lockers and snake skin couches, it's just really not an apartment building. So we would definitely seek to try and realize the gain on that from that investment activity when the time is right and when you have -- it's amazing how quickly the median price home has moved on the coast. When you're at 20% plus or minus increases in the median priced house, you become -- it gets you closer to that day. I don't think we're quite there yet but I think it gets you closer.

Got you. Could you venture a guess as to how long away you are from that or is that not -- sort of not worth the effort?

I think we're in a position that we have two good outcomes in life. If you have scenarios where you have a choice, both of which are good for you, it gets no better than that, right. I think in this case it's exactly that, that we have two good outcomes and we're just going to wait for the right moment.

It could vary from property to property and situation to situation because they're not all alike. In the case of Skyline, for example, I think there's great potential and actually some optionality because we have the ability to convert one tower and not necessarily the other tower and a variety of choices along the way.

So I think it's just a great business problem to have and we'll look to realize or maximize the proceeds on those transactions and we're very excited about them.

Great. Thank you.

Jana Galan, Bank of America.

Thank you. Good morning. I was wondering if you could comment on your expectations for your development yields and the Expo project came in nicely under budget, is there opportunity for some of the other projects to have some construction savings?

On Expo, I think Mike mentioned the stabilized will be in the 7% range in the fourth quarter this year, and the balance of the pipeline as you know we built over the last two years before the big spike in land costs and before construction costs started moving up, we expect the entire thing to stabilize in that 7% range, $930 million that we have under construction currently.

Okay. And when I look at your same store revenue guidance mid-point at 5.75% and compare that with your estimated rent growth forecast for the markets overall at 6.1%, I'm just curious, are you expecting occupancy declines or are these numbers not really comparable?

Actually, this is Mike speaking. I think our loss to lease was somewhere in the 4% range when we were going through that final budgeting process. So you start with the loss to lease back then and effectively S16 is market forecast so these are market rents, and obviously for a market rent to be converted into a scheduled rent or into cash flow, we need to sign a new lease in effect or renew someone or sign a new lease.

So there's a lagging part of the process there as we convert what happens at the market into what is going on in the portfolio. So it's really just recognizing that lag.

Thank you.

Tayo Okusanya, Jefferies.

Good afternoon. My question is focused really on Southern California, LA and Orange County. You did make some very positive comments about that market turning around, but I think you also kind of mentioned that it's taken a while for this to kind of happen in LA, much longer than anticipated. I'm just curious how confident you feel about LA really turning around or whether this is just a temporary thing and later on in the year there may be some downside risk to some of those forecasts.

This is Erik. I think we're more confident this year than last and the year before that, and I think the reasons are because the acceleration of job growth in the second half, as Mike had mentioned, is one factor. The stability of occupancies and the rent levels, both on the renewal and the new lease side is also a factor, and over the last several weeks including part of December, we see improvement, maybe a little stronger given the slow time of the year than we'd normally expect. I mean, it's not massive, but again, we're in a good spot. We're at almost 97%, and so we've got a lot of pricing power. We expect to be able to grow scheduled rent particularly on the new side over the next couple of months, and so I do have confidence and we're looking for it to hold up this year.

Okay. So what's the key risk to LA slowing down again?

I think key risk is always jobs. Number one. And supply number two. And since you have visibility or longer visibility on the supply, given the numbers that we're looking at, we don't see that as a big risk. It would take some bigger decline in jobs for it to hurt us there.

Okay. Thank you very much.

Thank you.

Buck Horne, Raymond James.

Thanks. Good morning, gentlemen. Could you give us an update on your rent to income measures across the different -- kind of the three big markets there, relative to what's either normal or a typical cyclical peak? And then I guess also are you seeing continued increases in terms of are you seeing rising incomes in your new tenants versus the ones that are moving out? Is the average income of the tenant base still increasing?

This is Erik. The answer to the second part of your question is yes, we have seen incomes go up. It's hard to measure the ones that are moving out because I don't know what they make after they move in, they don't share that with us. However, the ones coming in obviously we have from the application data and those levels are higher in all three of our markets.

As to the percentage of income relative to the rents, the relationships have all remained the same. In Seattle, I don't have the exact number in front of me so I can tell you it's below 20%. It's like in the 17% to 19% range. And in Northern California it's closer to that 24% range. And then Southern California, in between those two.

Okay. And just for context, so how much further do you think that could be, could you go comfortably on some of those ranges in terms of your pricing power?

My opinion is it can go a long way, particularly if we're doing our job and people like where they live, I think it's one of the more important decisions folks make about their life and where they spend their time, and when you look at some of the other markets in the United States where that ratio is much greater, people choose to continue to be in those locations.

And I think we see that the most in San Francisco. So I gave you the feedback on the three major markets but obviously if you separate that out by sub-market you're going to have people spending less percentage of their income on the east -- in the East Bay, compared to some of the people in downtown San Francisco. All things being equal on average, again, you get some of these applications that come in and they have pretty phenomenal incomes and they could be spending less than 10% on their rent. But I think there's -- to the point of your question, I think there's a lot of room to grow.

Okay, great. Thanks, guys.

Karin Ford, KeyBanc Capital.

Hi. Good morning. Just remind me on Prop 13 to make a modification to that, does that require a general election or is that just the legislature that can make changes to it?

You can change it with a two-thirds vote of both parts of legislature which is why the concern is out there now that the Democrats control both legislatures by the two-thirds majority.

Got it, okay. So no general election needed.

No.

Okay. Second question is just on your expectations for rent growth in 2013. It looks like renewal rates are continuing to stay relatively constant, between 5% and 6%. New lease increases sort of peaked at like 8.7% last July. Is your expectation that those new lease rates will peak back up around the same level, go higher, and do you also expect renewal rates to continue to stay in that same range?

This is Erik. I expect it to follow the same pattern. We'll see increases in both renewals and new leases as we go into the second and the third quarter.

I'm pleased with where the renewals are now, and as I mentioned earlier, with the strong occupancy and limited availability, we held pricing power for the foreseeable future, February, March for certain. So when we start sending out those increases for the next groups, which would be the back half of April and May, those are likely to go up as the new lease or the offered pricing goes up.

Okay. Great. My other question is just on Seattle. It looked like you lowered your rent growth forecast for the market from 3Q to 4Q. But Erik, your comments were relatively bullish today on the call. Do you see potential downside to the forecast in Seattle?

Actually, this is Mike, and let me just make a couple of comments because we -- on the third quarter call we had fewer units in 2013, fewer delivery units. I talked on the call about 10,000 units under construction in Seattle, but we thought we had I think somewhere around 4,000 to 4,500 in 2013. We ended up pulling a bunch of the 2014 deliveries into 2013 and that softened the rent growth expectations for the downtown and that's why you saw that change.

Okay. That makes sense. Last question is just on San Diego. It seems like we've gotten a couple of positive momentum prints out of that market from the public company reports recently. Do you feel like San Diego may have turned the corner?

Hard to say. I'm not scared about it but unlike Los Angeles or Orange County where you've seen some sustained momentum, it's probably early to call that for us. So I mean, we're optimistic about it, but as the forecast shows, we're looking for modest rent growth there.

Okay. Thank you.

Richard Anderson, BMO Capital Markets.

Thanks. Good morning out there. Sorry to keep you on. I do have a question, Mike, about the commentary you had in the earlier question about public to public merger. It's a quite different tone from you when I asked the question first quarter 2012, same question, what you thought about M&A in this space and you said it's sounding interesting now. That was call it 9 months ago. So what happened? What changed your tune to today?

I think we both know, Rich.

I was trying not to laugh when I was asking that question.

(Laughter) I think it's really troubling that you would use my own words against me. How dare you. I mean, this has been a little bit of an evolution in terms of thought process. I still think that there are some things that make sense from a broader perspective. But actually realizing them, and we can negotiate with ourselves all we want but the real world comes into play. So I think you got me on that one, Rich.

Okay. I'm sorry. I knew you wouldn't mind. Back to some more relevant quick questions here. You talked about spending more time from an acquisition standpoint in Southern California versus Northern California. Did you provide a cap rate differential between those two markets if you kind of had similar assets in similar locations, but in the north and the south, what the difference would be?

We haven't. But we run essentially a model that tries to look at the relationships between growth rate, our portfolio versus what we're acquiring, cap rate or cash flow, portfolio average versus what we're acquiring and our view on NAV and that's what really drives our expectations.

In this case, the really controlling factor typically has to do with the growth rates. So for one of the top growth rate markets, and we share with you what we think they are, so you kind of know, we will be pretty much weighted into those markets as it relates to opportunity. We don't see a big difference in cap rate from Seattle to San Diego. And actually we see pretty significant differences in growth rates over that period of time. In fact, I'd say Seattle maybe has the lowest cap rate just because there's some very wealthy people up there that like apartments, and so I think that the determining factor is typically, and it will be no different in 2013, is going to be where can we get the best growth rates projected out for a few years.

Okay, noticing that you're going to do $400 million of acquisitions or whatever the number is and your acquisition cost line item says call it $1.6 million. It seems like people are getting a lower number on that line item lately. Have you been able to manage acquisition costs down from what I think as rule of thumb being 1% of total cost? Is that a process under way or am I just imagining things?

Yes, it's a little artificial to a certain extent because in that case, there was, we agreed to pay a brokerage fee on a specific acquisition, that normally brokerage fees are paid by the seller. If it's paid by the seller it doesn't show up in there, it shows up in costs somewhere. It's really geography on the financial statement and yes, we try to make it so it doesn't go in that line item, but in this case we were unable to do that. It won't typically happen again.

Okay. Last question. You said development returns starting at 5.25% and stabilizing at 6.25%. What is the 100 basis point increase, is that just trending rents once they stabilize or is that something else?

That's comparing -- you've got it exactly right. The 5.25% is based on rents today. The 6.25% is rents a couple years from now. It's just the normal trending of rents.

Does the 5.25% apply any concession?

No, because the concessions we think are pretty artificial. The concession is really to get the volume during a lease-up.

Okay.

To be two times the normal turn that you would have on a stabilized apartment building. We view that as essentially a cost of development.

Okay, great. That's all I have. Thanks.

Thank you.

Michael Salinsky, RBC Capital Markets.

Good morning, guys. Just to go back to Prop 13. What is the Prop 13 exposure in the portfolio you estimate today (multiple speakers)

Probably in the ballpark of $30 million to $32 million.

$30 million to $32 million. Okay. Helpful. Second of all, Mike, you talked about cap rates in the transaction market. Just haven't been so active right now. What are you seeing more in the coastal California markets, more kind of core or value-add type property and what does the buyer pool look like? Has the competition increased in the last 12 months or are you seeing some people start to back off a little because of low cap rates?

You know, Mike, it's a good question. These markets are big enough that you pretty much see a little bit of everything. In the case of the Fund II sales, our Studio City asset had 50 something confidentiality agreements and other assets had -- we had to actually mark to get 10. Not that they were poorly located or anything else. It just varies by market. The institutional investments in the REITs tend to be very focused on that super high end location, the corner of Main and Broadway, let's say, figuratively and are willing to pay the price to get that. And so we see the greatest competition there.

I'd say as a general statement, cap rates -- cap rate spreads are pretty wide right now. In other words, there're very aggressive cap rates in the let's call it Main and Broadway type location and then as you get further out in the periphery it's a pretty significant spread.

And the interesting part is when you look at it relative to the cost of debt, for example, there's not that -- there's still positive leverage even at a 4 cap relative to a 10 year loan or a 7 year loan. As you get out into the peripheral areas, you could have an enormous amount of cash. You could have cash on cash return assuming interest only debt of somewhere in the 6.5 to 7.5 range. So it's a very unique period of time, I think. But I'd say a lot of the money's driven by the institutions. The institutions are very focused on location and typically pretty willing to pay for it.

So our acquisition approach and development approach is to try to find the locations that you get an appropriate balance between cap rate and growth. We want most of the growth, but we want a little bit higher cap rate and so we're probably not going to be competitive at Main and Broadway. We're going to be competitive somewhere else. We've used the example of Fremont of in Northern California. For example, because you had so much rent growth in the north San Jose area, Fremont is five miles away, hadn't really experienced quite the same rent growth. Therefore you target that as an acquisition opportunity. That's how we think of the world. That's how we try to implement our acquisition strategy.

That's very helpful. Final question, little bit bigger picture. When you think about JVs at this point many of your peers have been reducing their JV exposure. You're in the process of unwinding one and you also I believe started a West Coast III as well. How do you think about JV allocation at this point? Is it more a function of where returns are versus where your cost of capital is today? Or is it just at this point in the cycle -- how do you look at that today?

Exactly what you mentioned. We like having diversity of capital. It's not like if you decide you want to have JVs after not having any JVs you can just go out and quickly raise the money and therefore having the relationships are important. We've been able to balance them with some other activities that are beneficial to the Company. For example, as we're trying to build our unencumbered pool on balance sheet, if we need to assume a loan we can do so in some of the JV formats, which keeps our secured debt on balance sheet at a relatively low level. But the broader point is to have different types of capital so that as conditions in the economy change and we see opportunities, we can react to it with different types of capital which hopefully will help us create accretive investments.

Fair enough. Thank you much guys.

Thanks.

Paula Poskon, Robert W. Baird.

Thanks very much. Two strategy questions also. One, if out-migration accelerates, how inclined would you be to follow those folks to new markets outside California?

Paula, probably not real excited about following them, principally because we're looking for a couple things. The broader strategy of the Company, and I think the success over time, has been going to areas that have relatively expensive single family housing, not a lot of housing production over long periods of time. We like the constraints represented by mountains and waterways and difficult political structures and that type of thing. I think that, that is what really creates the opportunity in California. We like really expensive single family homes so that the transition from a renter to a homeowner is a difficult one.

And we ultimately like job bases. I talked in my comments about the highly educated and highly skilled are doing very well in this economy and those that don't have those skills and education are not doing well. And I think that the tendency's going to be the areas with the highly skilled jobs are going to continue to draw highly skilled people and high income people into those locations. I don't think you're going to see, for example, a mass exodus of engineers leaving Silicon Valley because this is kind of the hub and collaboration among engineers and talent pools are so important in this world. So I think that there are certain pieces of what we have here that are not easily replicated elsewhere and so we're happy in these types of markets. If you ask me are there some other markets that have the same conditions or the same attributes as the coastal markets we're in, in California and Seattle I'd say yes, there are some, and they're typically on the East Coast.

Thanks, and then I guess that sets up a segue to my second question which is given your comment in your prepared remarks about the growing income disparity, would you be more inclined to broaden or focus your product offering across price points?

We are pretty open to broadening price points. We've become more active in -- again, if we get the location right, we want to own from B or even B minus that we can make into a B to an A product. We've been pretty active developers and to try -- which will almost by definition all be A in very high quality locations. And so we broadened a little bit on, again, the B versus the A side, again trying to get location right. The Cs are just tough because the issue there is you're dealing with a variety of tenant issues and occupancy issues that we really want to avoid.

Thanks very much, Mike.

Thanks.

Dave Bragg, Zelman & Associates.

Hi. Good morning. Just a follow-up on an earlier topic. I think over 2011 and 2012 during the peak leasing season your new move-in gains were about 150, 200 basis points above that of renewals, but as the cycle matures, should this continue or should that spread narrow as you start to work through new supply?

This is Erik. It can continue. I would expect, again, depending on the rate of growth that you see some narrowing as we capture that loss to lease, but clearly in areas where we expect higher growth like on the east side of Seattle and San Jose and so forth, I still think that you could have decent spread there.

And Erik, one other one. Just on your earlier comments on Seattle with the supply pressure downtown and the relative health of the east side, how competitive will that supply be with the east side over a longer time horizon? I think many of us have been to the market and the distance itself is not that significant.

Yes, you know, it's -- maybe it's a little hard to say but I can tell you that we're tracking it all last year and we track it from where the people are coming from at Expo and we have nobody that we have put in a category of moving from the east side so far yet, not one person. They're all coming from out of the area to take their job at the Gates Foundation or Amazon or Nordstrom or any number of those places. Could that change? I suppose, if stuff became super attractive. Again, I think there's a lifestyle issue that people want in downtown and there's a lifestyle situation that people want on the east side and they're different. You're right, I mean, it's a short distance. It's not necessarily a short commute in the morning, given the congestion. And so I think that plays a factor as well.

That's interesting. Thank you.

Thanks, Dave.

Eric Wolfe, Citigroup.

It's Bilerman speaking. You didn't get to the 5% threshold, did you?

No, Michael, and we didn't use derivatives either.

All right. Just going back to just thinking about privatization's rather than public to public M&A, if you go back to '06 and even '05, '06, '07 time frame when you had the stocks trading at bigger discounts to NAV. I can sort of appreciate your comment that, look, if two apartments talked about trading at the same discount to NAV or one is a couple of percent higher than the other, it's hard to negotiate that from a public to public perspective. But I would imagine that when you look across the screen at the apartment stocks, just given how they have performed combined with the increases in same store, that isn't that a recipe for privatization's in this environment?

I think it could be. And I think that might make sense. I think -- but I also think we had recent transaction here, the Archstone transaction, I imagine that, that was considered at some source. So I think as these companies become larger and larger, I think you have a capacity issue to some extent in terms of the transactions just require an enormous amount of money. And so I think that it was probably difficult in that case and I think that some of the other transactions would be difficult just because of their sheer size.

Right, but the majority of the companies are in that $5 billion to $8 billion zip code, even some below, versus a $17 billion Company. Just it would seem as though the private market is still extraordinarily active. The debt financing market has only gotten better. Rates are extraordinarily low and fundamentals continue to get better. You have the publicly traded apartment sector trading at almost a 6% implied cap rate. Something doesn't feel right about that.

No, I totally agree with you. I think you're on to something there for the more bite size companies, yes.

Okay. Thank you.

Thanks.

At this time I would like to turn the call over to Management for closing comments.

Thank you, operator. So in closing, we want to thank you for joining the call. We appreciate your interest in the Company. And we're really excited about 2013 and finally we look forward to speaking with you next quarter. Thank you.

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