Essex Property Trust Inc (ESS) 2015 Q1 法說會逐字稿

Good day, and welcome to the Essex Property Trust Incorporated first-quarter 2015 financial results conference call.

Today's conference is being recorded.

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

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

Thank you.

I'd like to start today by welcoming you to our first-quarter earnings call. Mike Dance and Erik Alexander will follow me with comments. John Eudy, John Burkart and Angela Kleiman are also in attendance.

I'll cover the following topics on the call. First, our quarterly results and market conditions. Second, a merger integration update. Third, investment activities.

On to the first topic. We were pleased to report continued strong operating results consistent with robust demand for housing on the West Coast. Our guidance for 2015 contemplated slightly lower rent growth compared to 2014 based on modestly higher levels of housing supply, in particular in Seattle.

Our housing supply expectations remain unchanged, however, we have experienced better than expected demand from job growth. As a result, our reported 7.7% revenue growth exceeded the high end of our guidance range, equal to Q4 2014 and Q3 2012 for the highest same-property revenue growth achieved since the great recession.

The March jobs report supports that out performance with US job growth of 2.3% versus our estimated 2%, and the West Coast dramatically out performing the nation in March year-over-year job growth of 4.3% in Northern California, 3.4% in Seattle, and 2.8% in Southern California.

Demand from job growth is significantly outpacing our 2015 housing supply growth expectations, expressed as a percentage of housing stock, of 0.8% in Northern California, 0.6% in Southern California and 1.4% in Seattle. As noted on previous calls, a persistent housing shortage is ongoing in our coastal California markets.

For several years our theme in Southern California has been for slow and steady recovery from the great recession, which now is picking up steam as market occupancy improvements lead to better pricing power in selected sub-markets. For the quarter, this was particularly apparent in Orange and San Diego Counties. The typical seasonal slowdown we experience in the fourth quarter abated faster than normal this year leading to stronger expectations for the rest of the year, which Mike Dance will review in a moment.

Concern about rental affordability has rekindled rent control proposals in several cities in which we own property. Certain landlords are pushing through renewal increases well in excess of 10%, resulting in political pushback with the threat of rent control. Essex follows a voluntary guideline that generally provides our customers with at least one longer term renewal option at no more than a 10% increase.

Now onto my second topic, merger integration, April 1 was the one-year anniversary of the closuring of the merger with BRE. Last quarter, we outlined a three-phase process for BRE merger integration with most of phase one already completed. We made significant progress implementing the second phase, including the relaunch of the combined corporate, property, and mobile website, a significant increase in renovated apartment homes, 484 this quarter versus 353 in Q4 2014, due to the expansion of redevelopment to the legacy BRE properties, and an approximate 50% increase in resource management initiatives designed to conserve water and energy consumption with a positive financial contribution to the Company.

With phase two well underway, we are now focused on completing the planning process for the transformational opportunities to comprise phase three, capturing the benefits of scale and property locational synergies. The goal is to complete that plan this summer with implementation beginning shortly thereafter. Once again, I thank all the E-team members for their relentless effort to improve the Company.

Finally, third topic, investments, in the first quarter, we experienced a sharp increase in stock price with really attractive debt rates, allowing us to improve per-share cash flow, NAV and the growth of the portfolio through acquisitions. We used this capital advantage to buy out our partner's ownership interest relating to three Southern California co-investment properties, following our match funding approach.

We also acquired 8th and Hope, a high-rise community in downtown Los Angeles, which was approximately 50% leased upon acquisition and is now 68% leased. More recently, our cost to capital has increased, making acquisitions more challenging. Our ability to react quickly to changing market conditions is a key part of our success in our acquisitions program.

The importance of our co-investment program can be demonstrated by the recent buyout of our partner's interest Reveal Apartments in Southern California. We estimate that the use of co-investment format upon the purchase of the property in 2011 followed by the recent buyout of our partner resulted in approximately 155,000 fewer Essex common shares issued relative to the pro forma acquisition of 100% ownership of Reveal by Essex in 2011.

Overall transaction volume of properties that meet our criteria is relatively thin, and we are frequently outbid. Anecdotally, broker contracts tell us that they are becoming more active and so transaction activity could increase through the summer.

Including the pro rata buyouts of our partner's co-investment interest, we expect to achieve the high end of our acquisitions guidance of $600 million in 2015. Our preference continues to be properties located near public transit throughout our coastal portfolio as well as properties near urban areas of Northern California and the stronger sub markets throughout Southern California.

As noted in the last quarter's call, the limited transaction volumes in institutional quality apartments in the recent past do not support definitive comments about cap rate trends. We spoke last quarter about modest declines in cap rates. Our best estimate is that the highest quality property and locations trade around a 4% cap, while B quality property and locations trade around a 4.5% cap rate. Lesser quality property trades at higher cap rates and periodically a trophy property will trade in the high 3% cap rate range.

With respect to development, we continue to make great progress completing and leasing up our development pipeline detailed in the press release and on page S9 of the supplement, we have three, possibly four projects scheduled to start in 2015. We have seen some moderation in construction costs growth after increasing approximately 10% in 2014.

Before passing the baton to Erik Alexander, I'd like to note that it is with mixed emotions that we announced the retirement of Mike Dance. I thank Mike for his spirit, wisdom and friendship, and I acknowledge his many contributions to the Company's success over the past 10 years. Keep an eye out for Mike on the nation's roadways, as he promises to spend a considerable amount of time on his bicycle.

I also welcome Angela Kleiman to her new CFO role. Angela has been working alongside Mike for the past year. You'll be hearing from Angela each quarter beginning with our Q3 earnings call.

This concludes my comments. Thank you for joining our call today. Now, I'll turn the call over to Erik.

Thank you, Mike.

I'd also like to extend my appreciation to the Essex team for turning in another strong quarter. As Mike pointed out, we exceeded initial expectations with out performance in all regions. While occupancy levels remained in line with our plan for most of the sub markets, lower turnover and stronger scheduled rents have set us up for a very good year.

Spurred on by higher than expected job growth, the market conditions in each region remain strong and have allowed us to grow rents while maintaining occupancy above 96% in all regions. We look for these favorable conditions to continue, while we approach the summer months. As you would expect, market rent levels have moved in line with these strong demand conditions, and we have seen our economic rents increase nearly 6% portfolio-wide since the beginning of the year and more than 9% over last year.

Oakland and the East Bay have seen the largest year-over-year gains in economic rent, but San Jose and San Francisco are a close second. Seattle remains in good shape, as well, but we continue to manage assets in the downtown carefully as we work through the peak of new deliveries.

Also encouraging was the sustained improvement in Southern California. This is the second quarter in a row that year-over-year revenue growth has eclipsed 6% and is the 10th consecutive quarter that year-over-year revenue growth has accelerated. Growth in Orange County and San Diego led the way, but I believe we have a lot of upside in Los Angeles.

Once again we expect renewal activity, portfolio-wide, to support strong revenue results in the coming quarters. Renewal rates for the first quarter were above 6% across the portfolio, and offered rates through June are also north of 6%.

We also worked through the over exposure condition that existed in the BRE portfolio this quarter, and the expiration profile for Essex and BRE is now within 1% of each other for the rest of the year.

Earlier this week physical occupancy for the combined portfolio of same-store properties was 96.1% with the net availability of less than 6%.

Now I'll share some highlights for each region beginning with Southern California. Orange County and San Diego were the strongest sub markets this past quarter, thanks to job growth above 3% in both counties. The employment picture continues to improve in Los Angeles, as well, with the unemployment rate decreasing 130 basis points year over year.

Commercial activity, leasing activity for the broader region has muted in the first quarter and office vacancy rates continue to hover between 13% and 16%. One of the more significant developments in Southern California was announced this quarter as Broadcom broke ground on a 1.1 million square foot headquarter building in Irvine, with approvals to add another 1 million square feet to this campus.

On our last call I laid out some challenges with the BRE portfolio in Southern California that resulted in a revenue gap when compared to Essex. We were able to make strides at some of those under performing assets in the BRE portfolio, and overall leasing activity in the region was strong.

We were also able to work through the additional lease expirations in the BRE portfolio that I referenced earlier, and created a more stable profile going forward. However, this exposure condition did contribute to higher turnover, lower occupancy and ultimately tempered our rent growth this quarter in the BRE portfolio. The carryover for Essex's successful renovation programs also added to the revenue gap between the portfolios during the first quarter.

However, we believe the performance of the BRE legacy assets will be much more similar as we reduce turnover, expand our renovation efforts, and optimize the use of a single-revenue management system. We are making progress in all of those areas, and, based on the overall strength of Southern California market, I'm confident that the BRE assets will make a valuable contribution to our revenue growth this year.

Turning to Northern California, the Bay Area continues to post the largest job gains in the portfolio and be the impetus for strong revenue growth. March year-over-year job growth in San Jose and San Francisco was 5.4% and 4.4% respectively. Once again the information in professional and business service sector represented the lion's share of the new jobs created this quarter, with nearly half of the employment growth coming from these high-paying jobs.

Commercial leasing activity was robust during the first quarter and appears to be on pace to match last year's impressive absorption rate. 1.9 million square feet was leased during the first period, with the Silicon Valley accounting for more than 60% of that activity. HCP's co-project at Oceans Point in south San Francisco broke ground this quarter and will add nearly 900,000 square feet of life science office space once completed.

Economic rent levels continue to be strong and are up 8% since the beginning of the year, and there are no areas of weakness on our radar. On a year-over-year basis the economic rents at our same-store properties are up 13%. This is a function of the Bay Area being the most occupied region in the portfolio. Currently the combined portfolio stands at 96.6% occupancy with less than 5.2% availability. Based on these results, we are looking forward to another strong leasing season.

Finally in Seattle, employment growth in this region is also very strong and ahead of our forecast. The information and professional business service sectors accounted for 25% of the job growth, while construction represents another 25% of these job gains. After absorbing 2 million square feet of office space in 2014, the first quarter results were actually negative by just over 200,000 square feet. This is largely a function of timing, and we expect to report much more favorable results next quarter. Given that companies in the market are actively searching for nearly 4 million square feet of space, we still estimate annual absorption to be around 2 million feet in 2015.

Of note, Expedia announced the acquisition of the old Amgen campus in Queen Ann and plans to relocate by 2018. Facebook will double their footprint and consolidate in to a single building in the Lake Union area of downtown.

New apartment supply is a potential risk to revenue growth this year, and we will have to carefully monitor to new competition this summer. The average absorption rate for the 26 active lease ups in the region was 18 units per month in March. Given the time of the year, I'm encouraged by the strength of demand.

Economic rent growth in our portfolio through April has been ahead of our forecast overall and was strongest in the north and south ends of the region. These sub markets are now realizing the benefits of the job growth in CBD Seattle and the East Side. Our properties in CBD and on the East Side have seen 5% and 6% economic rent growth respectively on a year-over-year basis, but have only increased modestly since the beginning of this year. As we move in to the peak leasing season with occupancy nearly 96% and availability just over 5%, we expect economic rents to press higher.

We are very pleased with the results so far this year, and I think we're set up for a terrific summer. I am confident that property operations will be able to achieve the underlying results that are driving our higher guidance.

Before I turn the call over to Mr. Dance, I would like to congratulate Mike on a successful career, wish him well in retirement, and thank him for 10 years of friendship and counsel.

Thanks, Erik and Mike, for your kind remarks on my retirement. I hope today's out performance in the Essex stock price is in reaction to our great operating results and not the announcement of my retirement. (laughter) I appreciate all the congratulatory correspondents from Essex shareholders, the Board, associates, the sale side and REIT peers. It has been a privilege to have served as the CFO the past 10 years.

For over a year now, Angela and I have been working together on building a strong team that is well prepared to perpetuate the Essex track record. I am also personally committed to assist in a seamless transition of my responsibilities.

I will now comment on the first quarter's results and the changes to the 2015 guidance. Based on higher than expected job growth in all three regions, the Essex first-quarter same-property portfolio revenue growth is tracking at the high end of our revenue guidance for the year. As a result of the strong first-quarter results, we have increased our full-year same-property growth rate by 50 basis points at the midpoint, to 7.25%, and by 25 basis points for the combined legacy and BRE portfolios for the next three quarters.

This revised revenue guidance reflects only the first-quarter results and we will await for the second-quarter leasing activity to occur, before revising guidance to reflect the higher markets rents that we expect to occur if demand continues to outstrip the housing supply.

We reported a favorable variance in same-property operating expenses resulting in an additional $0.02 per diluted share of FFO in the quarter. The majority of the favorable operating expense variance is timing-related and is expected to increase with the higher resident turnover activity expected in the April through August peak leasing season.

Operating expenses also benefited from levy rates lower than forecasted on our Seattle properties. This favorable property tax expense variance resulted in a reduction to the legacy Essex same-property guidance by 25 basis points at the midpoint for the full year. We have not decreased the operating expense guidance for the combined BRE and Essex same-property portfolio due to the uncertainty of future supplemental property tax assessments related to the legacy BRE California portfolio.

We also reported core FFO in the first quarter of $2.29 per diluted share and have provided second-quarter guidance for core FFO of $2.31 per diluted share at the midpoint of our range. The $0.02 net increase at the midpoint projects sequential growth in the consolidated and co-investment net operating income of approximately $7 million as a result of expected rent growth in the same-property portfolio, accelerating lease-up activity at the communities recently completed, and the acquisition of the three stabilized communities acquired from our co-investment partners.

The 8th and Hope acquisition will be dilutive in the second quarter, as it was only 55% occupied at the end of March and will not reach stabilization until the third quarter.

In summary, the $0.10 per share growth expected from the sequential increase in net operating income will be offset by $0.07 per share related to the cost of capital required to fund the external growth, which includes the additional interest expense related to the $500 million bond offering that closed in mid March and a $0.01 per share increase in general and administrative expense expected in the second quarter as we continue to fill open corporate positions.

In closing, a quick highlight on delivering the debt to EBITDA ratio we outlined in the merger financing plan. To fund the cash consideration of the 2014 merger with BRE, we contributed nearly $900 million of unencumbered assets to 50/50 joint ventures, which increased the Company's debt to EBITDA the 7.4 times. A year later, as a result of stabilizing the legacy BRE development pipeline and growing net operating income, the ratio has improved by 1 full turn and now stands at 6.4 times.

I will now turn the call back over to the operator for questions.

(Operator instructions)

Nick Joseph, Citigroup.

You acquired the two land parcels in the quarter, I think to deliver in 2017 and 2018. I'm wondering if you could talk about the role of development at this point in the cycle and your appetite to continue to back fill the pipeline?

Hi, Nick, it's Mike Schall and John Eudy is also here. He may have a comment. We continue to be interested in development. And as I noted, we have three, possibly four, starts this year. We did not believe that the parcels that we sold would for future development sites met our criteria in terms of going-in yield or expected yields. There was some complications in terms of the entitlement process and so we decided to sell them. So I wouldn't view that as indicative of our overall appetite for development.

I've commented on previous calls that as we go through the cycle, and now our view is we're mid cycle-plus, we will de-emphasize development at some point. Obviously, we don't know when the end of the cycle will occur, so we'll never exit development, but we will slow it down as we perceive that we're closer to the top of the cycle.

Thanks. Then you mentioned an increase in potential rent control initiatives. Where are you seeing this push? If it actually comes to fruition, what's the process and timing of the actual implementation?

That's a good question. I don't have the specifics. I think it will vary from location to location. We're talking about, at this point, cities and local jurisdictions taking on this rent control issue. Obviously, they're concerned about the affordability of the rental stock within their communities and the ability of people to live and work within the same community. With all the rent growth we've had, it's obvious some of those issues are going to become more extreme.

During this last quarter there was one specific city that was threatening a rent control ordinance, but negotiated with the major owners and ultimately concluded that if the major owners would agree to a 10% cap on renewal rents -- and as you know we give out a variety of renewal options. So in our case we try to give longer-term renewal option subject to a 10% cap, and as long as we're willing to do that and commit to that, which we have done, that they would not pursue the rent control ordinance. So there is an ongoing process here.

We're also very active with the California Apartment Associations, when some of these really egregious rent renewal are given out, not by us but by anyone in the marketplace, we try to be active in helping CAA mediate and work with them to try to make sure that the market polices itself to the extent it can.

Just quickly, in terms of that example you just gave, what was the ordinance the city was talking about? What was the rent cap they were going to put in?

It was much lower. I don't think there was a specific number at this point in time. Again, this is the nature of the beast, to the extent they feel that affordability within the city is being affected to a great extent, they will use this as leverage to try to moderate rent bumps on existing residents. I think it's just an example of how the local jurisdictions are reacting to the large rent increases or large market rent growth within these marketplaces. We see it everywhere. There was some discussion in Seattle and a variety of the Bay Area cities and even in Southern California, so again, we see it throughout our portfolio.

Thanks.

Ian Weissman, Credit Suisse.

Hi guys, this is Chris for Ian. Congrats on the great quarter. If you were to think about changes in rent growth forecast for the course of 2015, would it be fair to broadly assume that moderate deceleration in Seattle, maybe a little bit of acceleration in Southern Cal and then steady in Northern Cal? Secondly, what markets do you see the biggest moves in 2015 on the upside and the down side?

Chris, this is Mike Schall. Good question. Erik may have a follow up. If you go back to S14, I think it does a good job of outlining the apparent issue. If, for example, Los Angeles has 84,000 jobs being produced in 2015, and we assume a 2 to 1 ratio of jobs to household, that's 42,000 households. The total supply, that's multi-family and for sale is 16,000. Basically, demand exceeds supply by a 2.5 to 1 ratio, if you believe these numbers. The only one that's reasonably close is Seattle.

I guess I would pose the question back, because from our perspective these conditions are ideal for the Company. Because, if you're producing less than 1% of stock in these markets that have very substantial revenue growth, it's unclear where that net excess demand is going to go, and that's what's pushing rents higher and it's pushing for-sale housing prices higher. It is a great scenario for apartments and for apartment owners and property owners within the markets that we're in.

And I agree with you, Seattle is the one question mark. It's a relatively small part of our portfolio, and we're somewhat concerned about it. But having said that, it looks like we're going to have strong revenue growth for the foreseeable future. I don't know how long that's going to last.

Okay. Great. Makes sense. Then following up on Nick's question on those large land acquisitions you made in the first quarter, is it too early to talk about stabilized yields for those projects? Then, you also commented that you de-emphasizing development in this stage of the cycle, but it looks like you have one of the largest capital budgets, at share about $1.3 billion. Would it be fair to assume that you're going to sell off one of the projects to a JV partner? Are you going to be looking for the Station Park Green, a partner for that one?

Let me comment on both of those. We did joint venture the high rise in San Francisco near the Transbay Center, and we did that because it's a 42-story high rise. High rises have, I think, a greater risk profile from the perspective of it takes you a few years to build them and then you have a vacant building that you have to fill up, so a lot can happen within that period of time. As a risk mitigation strategy, we thought it made sense to bring in a partner in that context.

Having said that, we still believe that it met our basic underwriting criteria of cap rate today, based on market rents now, of somewhere in the low 5% range. We would, certainly, expect that to grow to somewhere in the 6% to 6.5% range by stabilization, or maybe a little bit higher on that one because the construction process is longer.

As it relates to Station Park Green, that is a different product. It's actually a four-phase project and therefore that phasing allows greater flexibility with respect to how we manage through the process if conditions change. Therefore, I think we're less likely to seek a joint-venture partner on that, but we have not finalized that decision at this point.

That's great. Thank you very much.

Jordan Saddler, KeyBanc Capital.

Hi guys, it's Austin Wurschmidt here with Jordan. Erik, I was just a little bit curious on your comments. You mentioned that there's lots of upside potential in LA. I was just curious what gives you the confidence or what are you seeing on the ground there?

I think that the leasing activity at some of the properties, in West Hollywood for example, and the activities downtown give us confidence that things were going to heat up there. Downtown has become much more attractive place to go, and we're actually seeing people moving from some of the other areas around downtown to be downtown. We just haven't seen that before.

The west side continues to be strong, so the Marina Del Ray, the Playa Vista where we have properties there. We're encouraged. We've seen 8%, 9% increase in economic rent growth since the beginning of the year in those locations.

As we said earlier, Orange County and San Diego have done better than expected out of the gate. If you look at where our forecast was, we thought for the year that LA was going to lead the pack, and in the first quarter, San Diego and Orange County are. Since those are really pressured by supply, if we get that kind of job growth going forward, there's no reason that we can't continue growing revenue there. I'm just encouraged, overall, and I don't see why virtually all the properties shouldn't share in that better market condition.

Thanks for the color there. Then just, Mike, in terms of mentioning earlier about the cost of capital increase, you guys were pretty active on the investment front. But given your comments on competition and what you're seeing, do you expect that the investments will be more second-half loaded given the slowdown in the pipeline?

We do have a couple of deals that we're looking at now and one of them is in contract. I think that it will be fairly equally balanced. There's a little bit of uncertainty as to what is going to come out this summer in terms of product. It's been fairly thin at this point in time, but I would hope that we will be pretty close to the $600 million by late summer. That would be my expectation. Then it'll probably slow down again as you go in to the more seasonal period of time in the late third and fourth quarter.

In what markets are you seeing the best opportunities today?

I think the only market that we remain somewhat concerned with is the Seattle market. Northern California and Southern California, again, given supply/demand relationships, both look very strong to us, so we'll focus there. Southern California, the absolute rent level is lower than Northern California, and over a long period of time that relationship is -- rents are a little bit higher in Northern California than they typically are in a relative basis to Southern California. If you look at, for example, rent to median income statistics, Northern California is above, not by a tremendous amount, but above the long-term historical average, where Southern California tends to be slightly below the long-term historical average.

So we think that even though the economy is certainly better in Northern California, Southern California has more affordability, and therefore we're interested in both geographies.

Great. Thanks for the time.

Rob Stevenson, Janney.

Good day, guys. Erik, did I hear you say that renewals were up 6%? If so, does that basically imply with the 8% on rental rate growth that new leases were up 10% in the quarter?

New leases were in the 9% range, so yes, it's pretty close. I think that renewals, going forward, are going to be in the high 6%s. April came in higher than the first quarter, so it's moving in the right direction.

Okay. Does that consciously have you guys thinking about driving more turnover to take advantage of the higher new lease rate than the renewals? Or are you worried -- or does that feed back in to Mike's comments about rent control that has you worried about doing that too much?

I think a little of what you said there, but again, we like the low turnover equation. More of that occurs in the second quarter in the summer, anyway, and so when you have that availability tied down, it does allow for upward growth on the new rent side. We would rather capture it there.

Okay. What are you tracking as the current opportunity between the legacy Essex portfolio as well as the BRE portfolio in terms of redevelopment? I think Mike said 484 units that you guys did in the first quarter. What are you expecting in the back half of this year, and what sort of a run rate going in to 2016?

Yes, we expected with the addition of the legacy BRE assets through the redevelopment program, we've increased about 50% the number of units subject to redevelopment. I think our target for the total year is around 2,100 to 2,200 units, so there'll be a modest acceleration relative to what we did in the first quarter.

Okay. Then just lastly, is the same-store portfolio, is BRE going in there because of the April 1 close, or are you guys January 1 same-store portfolio?

Generally speaking, we're a January 1, but given the magnitude of the merger, we will bring in the BRE portfolio in the second quarter. So the second-quarter same-store comparison will be a combined versus a combined, but then the year to date will be an Essex only. We'll have two different unit accounts for the year to date versus the quarter over quarter.

Given how that's tracking, how the difference between the BRE portfolio and you still have some stuff that you're correcting there, is that going to cause any abnormality when we look at first quarter versus second quarter, just thinking about our run rate? Is that going to wind up having the combined Company lower in the second quarter than what we'd otherwise see?

I think that's spelled out in the guidance. If you go back to last quarter's guidance, you see a slight moderation in growth because of that. Again, it's tracking very favorably, so I would go back to the guidance we provided last quarter that shows the moderation that occurs by combining the two portfolios.

Okay. Thanks, guys.

Jana Galan, Bank of America Merrill Lynch.

Thank you. I was wondering if you could comment on the five assets in lease-up in terms of what's the pace of lease-up? Are there any concessions at all out there? How does this compare to a normal healthy lease-up that you see?

This is Erik. The lease-ups are tracking very favorably. The one that we're paying attention to the closest is because it's new, is the One South Market asset that's about to have its first occupancy this month. We've already leased, I think, as of today 50 units, a little bit more even since yesterday. That's a really healthy absorption before we get started there.

In the projects in San Francisco, Mosso and MB360 are coming up on stabilization, so their absorption was a little bit slower over the quarter but well within expectations as you come towards the end. The Emeryville project's been clipping along at 9, 10 leases a week, so we're just thrilled with that.

From a concessions standpoint, you probably have anywhere from zero concessions, so the first 30 leases at One South Market, I think, were done with no concessions on 24 of those, and 0.5 to 1 month on certain floor plans, so again better than expectation there. Then at the other properties, it would be four to six weeks on some of the floor plans. Pretty consistent with what's going on in the markets to get 25-plus leases per month.

Thank you, Erik.

John Kim, BMO Capital Markets.

Thank you. Good morning. I wanted to ask a followup on your assessment that your cost of capital is increasing. Your cost of debt is the same. Your stock prices performed well this year. Can you just clarify what you meant by this comment?

Sure, it's Mike Schall, speaking again. I think the stock went over $240 earlier this year. There was a pretty significant rally in the 10-year treasury as well. So we try to match fund our acquisitions. Again, what we try to accomplish is capture the arbitrage between our blended cost of funds and the cap rate on the asset, trying to hold portfolio quality constant and try to improve the growth rate at the same point. At that particular point, with the stock trading at $240 and the 10-year, I think it got down to $170 or something like that, was a -- I don't think it's ever been better in my 30 years, almost 30 years here. That was an extraordinary period of time.

Then, we tried to execute match-fund transactions against that and, again, try to capture the arbitrage. So every quarter that goes by that we're generating somewhere around 10% to 15% core FFO growth works against the cost of capital because you have greater cash flow coming out of the existing portfolio. Again, multiples are declining from that force and from the stock price moderation and from interest rates increasing, still attractive, but increasing. Again, as it relates to acquisition, development is different, but as it relates to acquisition, we're looking at that, whether there is arbitrage and trying to capture at a favorable moment.

Got it. Okay. Right now your stock price is trading at an AFFO yield of about 4%, and a pretty significant premium to consensus NAV. Can you just remind us what metric you look at in terms of utilizing equity for acquisitions?

Sure. We follow a fairly standard program of looking at the impact of NAV and core FFO, core FFO on a per-share basis, what is the impact of the acquisition? Again, we're looking for some sort of arbitrage between those two numbers, or else, all things being equal, if there's zero arbitrage in those numbers, and we're generally not inclined to do another acquisition.

More recently, we've seen that arbitrage somewhere between 25 and 50 basis points. Again, when our stock rallies and debt rallies, we get closer to that 50 basis point type of number. Then, of course, we're interested in growth rates. So we want any acquisition that we make to outgrow the average growth rate of the portfolio. We have a process that we've developed internally that measures each of those things, and if we can add value on the acquisition side, we do. If we can't, then we will pass.

Speaking of market movements, there's been a correction in some of the major tech company stock prices. Have you observed in the past a correlation between asking rents in Northern California and the way that some of these tech companies trade?

I think on the margin, there is not a great deal of impact. If there's a shock to the system and/or something happens that's more pervasive, then absolutely we see an impact. When the Internet boom of the late 1990s and early 2000 ended and the companies that were consuming huge chunks of cash had no access to capital, that obviously had a tremendous impact on hiring within the Valley; went negative by somewhere around 10% in Silicon Valley. On the margin, we're not anywhere close to that type of scenario, and I don't think they're all that sensitive to stock price as it relates to growing their business. Most of these businesses, especially the social media businesses and a lot of the other businesses, are very well financed and are not reliant on stock issuance in order to grow.

Great. Thank you.

Alexander Goldfarb, Sandler O'Neill.

Good morning. Mike, we'll definitely miss your conservative guidance.

Alex, I think Mike taught Angela well.

Then that means that the guidance will be even more conservative going forward. (laughter) Along those lines, Mike D, it sounded like in your comments that you're anticipating bringing further boosting 2015 guidance. Assuming that the market doesn't suddenly crack here, rents are very strong. That was the correct interpretation we should expect numbers to come up further when you guys report second quarter?

Basically, all we've done is change our guidance to reflect the results already achieved. So basically bringing in our budgets to the scheduled rents and the occupancies we have today and moving it forward. We haven't gone back and revised market rents to reflect this demand/supply imbalance that Mike mentioned and Erik mentioned in their remarks, that we're seeing more jobs coming in than supply. That imbalance continues, yes, you understood me correctly.

Hey, Alex, you recognize the irony in your question, because you accuse him of being a sand bagger and then you ask him if he's going to raise guidance. (laughter)

Well, maybe in his waning moments he's feeling weak as he heading out the door. (laughter) The next question is, as you guys look at the Bay Area and, obviously, visiting out there you can see it firsthand, the amount of growth and also people starting to spill more in to East Bay. Are you guys more inclined to invest further away from San Francisco to get acceptable returns? Or your view is that when the cycle does correct, those further away areas are going to collapse more and therefore you'd still rather pay up a lot more to be either in the peninsula or hugging the East Bay coast versus going out further east?

Yes, this is Mike. One of the strategic limitations that we place upon ourselves is commute patterns. Because people in general are willing to commute a certain distance from their jobs. Trust me, commutes have become much worse out here than I think they've ever been in my career. We think that limitation is somewhere around a half hour, a half hour commute for a renter. We realize that homeowners will commute longer distances, to be sure, probably typically an hour. That limitation and the increased traffic has meant that to get to your job -- the jobs are very concentrated in certain places. To get to your jobs is more challenging than ever. We think that the high-density residential alternative, be it condos or apartments is going to be the overwhelming preference of the cities in order to meet the housing need within the area.

Interestingly, this last quarter there was a single-family development proposal that was at least put off and maybe canceled because of water use. Because single-family residential homes consume more water than condos and apartments do. Again, I've commented previously on the impact of AB32 and SB375. These are California's global warming initiatives, which have the effect of trying to become much more resource oriented and resource and conservation of resource oriented. And I think that has a bearing on where housing is going to be located. Hence our preference for transit-oriented sites and areas that are fairly close to the urban cores or the job centers.

Okay. Thank you.

Dan Oppenheim, Zelman & Associates.

Thanks, very much. Mike, given those comments in terms of the locations and the scarcity of properties on the market right now, what do you think about the other communities in Riverside and Chino right now? Could those potentially be up for sale? Would you think about that given the focus in terms of the more core locations?

Dan, that's a good question. I think the plan will be to continue what we've done over the last several years. We will be selling the non-core assets, which certainly Riverside would be included in, at the appropriate time and try to cull the portfolio. We're not in any particular hurry. We think the portfolio is as good as it has ever been, and therefore we're happy with the portfolio. But if we see opportunities to dispose of those secondary locations, yes, we're going to do that.

Got it. Then in terms of the 10% with the longer-term leases, I guess what are you seeing in terms of the renewals on that? I imagine that tenants aren't exactly thrilled saying, oh, gee, 10% for an even longer time. I'll sign up for that right away. Do you think that is something that can reduce turnover even further? Do you think it would benefit from that where it does -- you keep the tenants longer versus ending up getting a little bit in the way of less rent for that?

Yes, Dan, it's, actually, we've had that a 10% or some type of renewal cap in place for some period of time, so it really isn't anything new. Part of the reason why we do it is it sets up a great discussion with your resident, because, yes, you're right, they don't like a 10% renewal increase. However, the next step in that conversation is, hey, go out and look at the other properties in the area, and we think that you'll come back and conclude this is a rental value, a good rental value, and we think we will keep you as a result of that. I think it does act as a reward for being an Essex customer, which is important to us.

And at the same time there are these benefits that you don't really see, which are lower vacancy, lower turnover cost. If you have X amount of traffic coming in the front door, you now have fewer units to lease to that fixed amount of traffic, and obviously, it can push rents for the people that are coming in off the street a little bit harder. I think it actually works really well, and we've had great success with it over several years. We're happy with it. We think it's a great program.

Great. Thank you.

Haendel St. Juste, Morgan Stanley.

Thanks for taking my questions. First, Mr. Dance, best wishes on your next endeavors. You'll be missed. I guess a bit of upside here is that there will be less confusion on these calls going forward when someone simply directs a question to Mike. (laughter)

Thanks, Haendel.

Question for you Mr., well I guess, Mike Schall, a question on capital allocation and a bit of a twist on an earlier question. Help me better understand a bit better the decision to acquire assets in LA while developing assets in San Francisco given how far along the San Francisco recovery is in what is still a relevantly nascent but sustained recovery in Southern California as you guys described it? Do your recent capital allocation decisions in the region reflect what you believe are the best available returns or opportunities today? How do LA acquisition IRRs compare to development IRRs in San Francisco today? When can we expect to see more So Cal development starts?

Okay, you may need to remind me of some pieces of that question (laughter) because that was one of those multi-faceted ones. I think what we said was that we like both. I don't know when Northern California is going to turn. If you look at the basic numbers, if Southern California generates 2.5% job growth and Northern California is closer to 3.5%, that means the demand is stronger. The supply is not all that different, of total housing I'm talking about, between the two markets. So you'd say the stronger overall supply/demand imbalance still favors Northern California.

However, as I said earlier, the absolute coupon, the rent levels are higher in Northern California relative to Southern California. I don't know how to handicap which exactly is better. I can say that we like both, and I think both will lead the nation in terms of the overall results over the foreseeable future. I just saw some Axiometrics data that seemed to come to a similar type of conclusion, so I don't know.

As to development versus acquisition, that's more a function of the deals that we see and where they're located and whether we like them. John Eudy is here. He may have a comment on that and what he's seeing in terms of deal flow. Generally speaking, I think both Northern California and Southern California are going to be leading metros for some period of time. John, do you have any comment on deal flow?

In Northern California, just to comment on the two starts we've just announced recently, both of those were negotiated and started the entitlements in 2011 and 2012 respectively. We had some wind at our back on our land basis in the exactions on the entitlements that would be tough to match if we were out trying to compete for the same sites today. Put us in a better start position.

In terms of the going-in yield, we think they're in the low 5% cap rate, obviously. If the land was higher and the exactions were greater, that would change. I think on the margin, it's tougher and tougher to do deals in Northern California than it has been, ever and given the fact of where we are in the cycle.

When you go to Southern California, the problem on the development side is the acquisitions that we've done are at or below replacement cost as a general rule. So, any time you can do that, why go through the brain damage of developing unless you can find the right site with the right metrics to make it work. So that's the challenge we have down there. We haven't seen the rent move that we've seen up here, and granted it's coming, but the velocity isn't where we think that it's a slam dunk to find development deals.

How does the math go for the IRRs for acquisitions in LA compared to, perhaps, the developments in San Francisco?

The IRRs, the typical acquisition IRR, which again, let's go back to basic strategy. If we're buying on balance sheet, we are really more focused on the impacts to NAV per share, core FFO per share and the growth rate of the portfolio. In the co-investment world, we're more focused on IRRs. I think generally speaking the IRRs on the typical acquisition are somewhere in the 7% to 8% range, and the development IRRs are in the 9% to 10% range un-levered.

Got you. Appreciate that. Sorry, if I missed it earlier, but did you explain your concern on the Seattle market? I assume it's a function of the supply that's predicted to hit belt's view over the next year or two. If that's right, can we perhaps see you cull some of your exposure there, and maybe reallocate it to another region like maybe So Cal?

It's a good question, Haendel, and we're debating it at this point in time. I note that less than 19% of our revenue is coming from Seattle, so it's not a huge amount. We are looking at the possibility of culling parts of that portfolio.

I want to be clear. I don't see a problem per se up there, because the jobs growth has been so good. The issue is if there's something broader that happens, more broadly to the US economy, which could be geopolitical or international in scope or whatever, that has an effect on the economies around the world; if you have a couple percent supply growth in that environment, you can find yourself over supplied relatively quickly. That's the risk that we're focused on. But I think things look good, based on the numbers that we have in terms of job growth, relative to supply, I think Seattle is still fine.

Great. Thank you.

Drew Babin, Robert W. Baird & Co.

Thanks for taking my question. As you're out there looking around for acquisitions and competing in the market, are there any new players you're running into or any private equity or international money coming in and looking at the space? Is there a preference for location or the newest, brightest, shiniest assets?

Drew, that's a good question. We have plenty of competition from all the above. From some foreign investment, which I'm hoping a strong dollar might lessen that, but we haven't seen that thus far. Other REITs provide plenty of competition. Private equity is in the mix. Everyone has their own little template that they like and that they're pursuing.

You see a variety of different requirements or mandates out there with respects to the types of property, newer versus value add and locational differences. Some investors we've seen recently are really trying to focus on yield, so they're willing to go to an area that maybe not be in the CBD, for example, or an urban area, maybe go a little bit further out in order to get 25 or 50 basis points higher cap rate. Again, I think it varies from investor to investor. I'd also say that we're not seeing that many transactions out there, so the transactions that come out tend to be aggressively bid.

Right now, there's quite a few merchant built properties that are being delivered and will be sold in several of our sub markets. There's also a demand for value add. In our discussion about value add, it seems like so much of the benefit of the value add is already being priced in. It's difficult for us to make those deals work.

So, you see a variety of things, but the bottom line is a relative dearth of well-located property and plenty of capital chase event.

Does that get you in a position, or I guess I should say, how close are you to being in a position where it might make sense to start selling some assets that you would consider core at the right price?

Again, we will cull the portfolio, but what I said about acquisitions a few minutes ago, that they're accretive to NAV cash flow and growth rate. To make that work in reverse, because at disposition you need somewhere to put the money. It's funny, most of my career, the option of leaving money in a money market account or in short-term bond was not that painful. It's, obviously, incredibly painful now because interest on money is 20 basis points or something like that, so you don't have that option.

Acquisitions are still working, so that would imply that broad-based disposition probably is not going to be part of our plan until those forces change.

Thank you very much.

Rich Anderson, Mizuho Securities.

Thanks. Mike, I hope you dance in your retirement like no one's watching. (laughter)

Thank you.

(laughter) -- he's a pretty ugly dancer.

I just crafted that one just now, by the way. I just have one quick question for maybe Mike Schall or whomever. I can recall many years ago, I don't even remember when, when your Company was underperforming your peers, and I don't know about dramatic fashion, but certainly meaningful. You had a situation with the state of California, obviously, driving that unemployment up. What is it that could happen here? Is that situation any way, shape, or form repeatable in your mind in the foreseeable future, as it relates to you relative to the rest of the country?

That's a good question. I'm hoping someone around the table here has a crystal ball, because I don't have it. (laughter) Rich, I would say that things look as good from a supply/demand standpoint and in terms of what the state is looking to accomplish as it relates to housing in terms of higher densities, more urbanization, public transit, getting people out of their cars and reducing the impact on commutes. All those things are incredibly positive for us. So I think --

I'm just trying to create a road map of where it could go wrong?

It's gone wrong before, so that was my next point. One thing that's certain about the world is it will change. And people -- businesses make good decisions. In the late 1990s when Northern California became very expensive, you saw movement of businesses and back-office operations, pieces of businesses to Southern California, and it was the beneficiary of the tech boom in the late 1990s and early 2000s. The tech community is, I would say, sensitive to broader economic conditions, and Northern California from my mind is -- there's more volatility, but at a higher overall growth rate.

Northern California generates the highest CAGR of rent growth over a long period of time as compared to any of our other markets, but there's more bouncing around, more volatility within that number. Housing is very economically sensitive, and to the extent you've got large supply pipelines that are undelivered, it becomes even more sensitive. We saw that in the last cycle in Seattle, where we had 3% supply that went to -- jobs declined something like 10% and that 3% supply hit the marketplace and decimated rents in that marketplace.

So those are the types of things that we're concerned about. That enters in to our thinking, though, and we try to react to it. People ask us, why do you joint venture your development pipeline? Part of the reason for that is that we commit to a cap rate on day one, and we don't know what the yield is and we don't know what our cost to capital is until the deal is finished. Therefore, it exposes us during that period that we're building it and leasing it up to the forces that could change in the marketplace.

Part of the reason our balance sheet remains at a very conservative level, so we try to build the model of the business and react to some of the forces that you're talking about in a thoughtful way, so that over the long haul we outperform. I would say that the answer to your question is dislocation in the economy will affect us and affect everyone at the same time.

Okay, thanks.

Dave Bragg, Green Street Advisors.

Thank you. Good morning. Mike Dance, congrats and thanks for the update on your leverage progress earlier. Can you just review where you stand today relative to your long-term targets?

We're about 6.5 times turns. With the growth that we continue to see in the sequential NOI and the continued success in leasing up the co-investments, it could be low 6%s by the end of the year and continuing in to the high 5%s next year. Basically, to Mike's point, preparing for the times when things may change, and we don't have that luxury. I think continuing to build up that capacity for the rainy day is where we're headed.

And that leads to the next question. Essex was uniquely active during 2009 and 2010. I might be wrong, but I think your leverage in 2006 and 2007 is pretty comparable to where it is today. What would you say is the reason why you didn't do even more during that time? Were you capital constrained or opportunity constrained?

I remember it vividly. It's because the world was coming to an end. Remember that, Dave? It was a very uncomfortable time to make big commitments because, no one knew where the bottom was. I think that was the driving force that we were trying to focus on, let's maintain the dividend. Let's do a thoughtful job of operating the portfolio, and let's not make any big bets in a very uncertain time.

Given that, to what extent do you debate internally the idea of taking leverage even lower than those targets that you just walked through?

We have discussions about the 100-year flood, and how well -- and we did pretty well during that period of time. Obviously, the stock didn't do well, but we raised the dividend very marginally each year and we paid the dividend in cash every year. We think the model for our balance sheet has been pretty well tested in the 100-year flood and has done pretty well. That factors into our thinking.

Obviously, everyone wants to deleverage at the top of the cycle. No one has certainty with respect to where that is. We're debating it, and we're trying to get that right. We still think that we have at least a couple and maybe more pretty darn good years ahead of us, given the supply/demand relationship. Our hope is that we continue to, just naturally deliver via growth, and we end up somewhere in the 5%s.

This is Mike Dance. The other change that we've made dramatic improvements on since the last recession, is most of our assets were encumbered, and so the ability to sell those assets was limited. If that were to reoccur, we're in a much better position to sell assets and use those proceeds to buy back stock, so that's the other motivation for continuing to de-lever as we are in these good times.

Thanks for that. That's very interesting. Then the next question just rewinds the clock even further. Back in 2005 and 2006, Essex pursued several mid-atlantic portfolios and most notably the Town and Country portfolio. At the time you talked about your views that DC was quite like California, and Baltimore was quite like Seattle over the long term. Do you retain those long-term views? Clearly, that hasn't played out over the last 10 years. Your markets have done much better. What's your long-term thinking on that?

We do believe that there are certain East Coast markets that are similar to the West Coast markets. I think the thing that's changed, though, since then is there are already four companies that are bi-coastal in nature, and we are the only ones that have this particular, and I think very appealing, piece of geography. I think the uniqueness, in this case, makes us favor a West Coast centric company. I think that we've gotten pretty good credit for being the local sharp shooter out here, and I think that adds some value. So, we're happy where we are, Dave.

Okay, thank you.

Tom Lesnick, Capital One Securities.

Hi, thanks for taking my questions. First, I guess with so many jobs coming from the tech industry and VC-funded start-ups, employees are often compensated not just with salary but with equity as well. In the context of that, how are you guys thinking about equity comp and how close we are to approaching an upper limit, or so to speak, on what people are willing and/or able to pay in rent? Are you factoring equity comp into your rent-income analysis or just base salaries?

No, it's mostly base salaries. If you look at the base salaries in San Francisco and throughout the West Coast, I think they're high. One of the things that's a little bit different about our markets is that personal income growth is pretty substantial. I think that there's some 5%s and 6%s in personal income growth -- and I have a chart here. 2015, personal income growth, I think that San Jose is the leader at 6.2%, and a lot of 5%s throughout our West Coast portfolio. So if we're growing rents at 7% and income levels are growing at 5% to 6.5%, it's not really pushing that rent to median income level to a great extent, so we still feel pretty good about it.

Anecdotally, I was talking to a young 26-year-old professional that was renting, with a couple roommates, a place near the beach in Southern California and paying $3,300. And I said, how do you think about that, $3,300? Which to me that's a king's ransom in rent, but she thought, you know, that seems pretty good, seems like a pretty good deal. I think we forget that each generation re-prices and as long as the relationships are okay. So I think because we are in high income areas that the pushback from rent, which there certainly is some, but I think it's manageable.

Thanks. Then my second question, following on that, I guess historically, when liquidity of events have picked up pace, did you see any correlation to move outs to purchase a home? Did the realization of the equity kicker influence renter behavior in that regard?

It's hard to tie it exactly to that. We hit an all-time high move out to buy homes in 2008, which you would expect before the crash. That was something like 17% or 18%. And an all-time low in 2009, that was about 7%. The recent trends have been a little bit below the long-term average, which is 11% to 12%. I think for the last quarter we said it was 9.8% move out to buy a home. We're not seeing a big move out push to buy homes at this point in time. But again, as I've commented on prior calls, there is a very limited supply of for-sale housing. That is having a great deal of impact on the overall housing supplies within our markets, and it's helping us a lot.

Thanks.

Tayo Okusanya, Jefferies.

Hi, this is George on for Tayo. First off, Mike Dance, congrats on the retirement and enjoy the bike riding.

Thank you.

My questions, in terms of your JVs, you're continuing to do JVs on the development side and you're buying out some JV interests. Just overall, what are you seeing from current and potential JV partners in terms of doing anymore potential JV by outs and then also interest from the JV partners to do more investments? Additionally, are JV partners having interest to go in to other markets where you guys currently are not present, where you might be influenced to go into a new market because a JV partner would like to allocate capital there?

Yes, this is Mike answering this question. Generally, speaking we're in the markets that we want to be in, and we would not enter a new market because there was financing from a JV partner. In general, we're 50%, around 50% of these ventures. We believe that the co-investment option is important to us because there are certain times where if our cost to capital changes and stock price goes down and debt rates go up, it may be more advantageous to use a joint venture to buy a property when we can't make it work on balance sheets.

It's really a diversification program with respect to having different capital options so that we can optimize the opportunities that we see. Generally, speaking that's how we view it. When, as I mentioned on the call, our stock price rallies very nicely and debt rallies as well, we see opportunities to potentially buy out some partners, we're less excited about that today than we were early in the first quarter, so I think that's less likely. But I think it's still the on balance sheet cost to capital is marginally better than the co-investment capital in terms of just the overall cost to capital equation. So, we'd probably prefer to execute on balance sheet still.

Okay. Thanks. It's a long call, so I'll leave it there.

Very good.

That concludes today's question-and-answer session. Mr. Schall, at this time I will turn the conference back to you for any additional or closing remarks.

Very good. Thank you, operator. In closing, I just want to note that we appreciate your participation on the call. Obviously, we're very pleased with what's going on out here and the results last quarter and our outlook ahead. We look forward to seeing many of you at NAREIT next month. Good day.

This concludes today's conference, and thank you for your participation.