Essex Property Trust Inc (ESS) 2021 Q2 法說會逐字稿

Good day and welcome to the Essex Property Trust Second Quarter 2021 Earnings Call.

As a reminder: Today's conference call is being recorded. Statement made -- 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 on the company's filing with the SEC.

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

Mr. Schall, you may begin.

Thank you for joining us today, and welcome to our second quarter earnings conference call.

Angela Kleiman and Barb Pak will follow me with prepared remarks, and Adam Berry is here for Q&A.

On today's call, I'll start with our second quarter results, which were driven by a strengthening economy and positive fundamentals that underlie a robust recovery on the West Coast. I'll also discuss the status of reopening the West Coast economies and related factors, concluding with an overview of the West Coast apartment transaction markets and investments.

Our second quarter results were ahead of our initial expectations entering the year as the economic recovery from the pandemic occurred faster than we expected. With a strong economy and high vaccination rates, we are now confident that the worst of the pandemic-related impacts are behind us. As noted on previous calls, our strategy during the pandemic was to maintain high occupancy and scheduled rent, both necessary for a rapid recovery. To that end, net effective rents surged during the second quarter, along with year-over-year improvement in occupancy, other income and delinquency. The recovery in net effective rents continued unabated in July. And we are now pleased to announce that July net effective rents for the Essex portfolio have now surpassed pre-pandemic levels, with our suburban markets leading the way, while the downtowns are improving but still generally below pre-pandemic levels. Obviously, these higher rents will be converted into revenue as leases turn. And Angela will provide additional details in a moment.

Having past the midpoint of 2021 and looking forward, we made a second set of positive revisions to our West Coast market forecasts, which can be found on Page S-17 of the supplemental. Driving the changes is an increase in 2021 GDP and job growth estimates to 7% and 5%, up from 4.3% and 3.2%, respectively, from our initial forecasts. As a result, we now expect our average 2021 net effective rent growth to improve to minus 0.9% from minus 1.9% from the beginning of the year. To put this into perspective, consider that our net effective rents were down about 9% year-over-year in Q1 2021. Given our current expectation of minus 0.9% rent growth for the year, year-over-year net effective market rents are now forecasted to increase about 6% in the fourth quarter of 2021.

Cash delinquencies were up modestly on a sequential basis at 2.6% of scheduled rent for the quarter and well above our 30-year average delinquency rate of 30 to 40 basis points. The American Rescue Plan of 2021 provides funding for emergency rental assistance, which was allocated to the states for distribution to renters for pandemic-related delinquencies. During the second quarter, collections of delinquent rents from the American Rescue Plan were negligible, as the pace of processing reimbursements has been slow since the program launched in March. We expect that to improve in the coming months. We expect delinquency rates to return to normal levels over time as more workers enter the workforce and eviction protections lapse on September 30 in both California and Washington. At this point, only about $7 million of the $55 million in delinquent rents shown on Page S-16 of the supplemental has been recorded as revenue. Given uncertainty about the timing of collections, no additional revenues are contemplated in our financial guidance.

Even with the approved job and economic outlook, the reopening process was gradual through the second quarter, with full reopening declared in mid- and late June for California and Washington, respectively. The unemployment rate was still 6.5% in the Essex markets as of May 2021, underperforming the nation. Through Q2, we have regained about half of the jobs lost in the early months of the pandemic. Employment in the Essex markets dropped over 15% in April 2020, and while job growth in our markets outpaced the nation in the second quarter, we are still 7.9% below pre-pandemic employment compared to 4.4% for the U.S. overall. We see the gap as an opportunity for growth to continue in the coming months as we benefit from the full reopening of the West Coast economies. We believe that many workers that exited the primary employment centers during pandemic-related shutdowns and work-from-home programs will return as businesses reopen and resume expansion that was placed on hold during the pandemic.

As we proceed through the summer months, we edge closer to the targeted office reopening dates set by most large tech employers in early September. As recent reports about Apple and Google suggest, the COVID-19 Delta variant could lead to temporary delays in this reopening process. Our survey of job openings in the Essex markets for the largest tech companies continues to be very strong, as we report 33,000 job openings as of July, a 99% increase over last year's trough. New venture capital investment has set a record pace this year, with Essex markets once again leading with respect to funds invested, providing growth capital that supports future jobs. Generally, economic sectors that fell the furthest during the pandemic are now positioned for the strongest recovery in the reopening process, led by restaurants, hotels, entertainment venues, travel and filming. Return-to-office plans, which remained focused on hybrid approaches, will continue to draw employees closer to corporate offices. Given that many workers won't be required to be in the office on a full-time basis, we expect average commute distances to increase. As we highlight on Page S-17.1 of our supplemental, this transition has already started in recent months, as our hardest-hit markets in the Bay Area once again experienced net positive migration from beyond the NorCal region. In particular, since the end of Q1, the submarkets surrounding San Francisco Bay have seen positive net migration that represents 18% of total move-outs over the trailing 3 months compared to minus 8% a year ago. These inflows are led by residents returning from adjacent metros such as Sacramento and the Monterey peninsula; as well as renewed flow of recent graduates arriving from college towns across the country, a notable positive turnaround from last year. In Seattle CBD, we've seen similar or even stronger recent inflows and we're likewise experiences -- experiencing a strong market rent recovery.

On the supply outlook, we provided our semiannual update to our 2021 forecasts on S-17 of the supplemental with slight increases to 2021 supply, as COVID-related construction delays shifted incremental units from late 2020 into 2021. We expect modestly fewer apartment deliveries in the second half of 2021, with more significant declines in Los Angeles and Oakland. While it is still too early to quantify, recent volatility in lumber prices and shortages for building materials may impact construction starts and the timing of deliveries in subsequent years. Multifamily permitting activity in Essex markets also continues to trend favorably, declining 200 basis points on a trailing 12-month basis as of May 2021 compared to the national average which grew 230 basis points. Median single-family home prices in Essex markets continued upward in California and Seattle, [growing] 18% and 21%, respectively, on a trailing 3-month basis. The escalating costs of homeownership combined with greater rental affordability from the pandemic have increased the financial incentive to rent. We suspect these trends will continue, given muted single family supply and limited permitting activity, and believe these factors will be a key differentiator for our markets in the coming years compared to many U.S. markets with greater housing supply.

Turning to apartment transactions. Activity has steadily accelerated since the start of the year, with the majority of apartment trades occurring in the low- to mid-3% cap rate range based on current rents. Generally, investors anticipate a robust rent recovery, especially in markets where current rents are substantially below pre-pandemic levels. With the recent improvement in our cost of capital, we have turned our focus once again to acquisitions and development while remaining disciplined with respect to FFO accretion targets. With respect to our preferred equity program, we continue to see new deals, although the market is becoming more competitive. Lower cap rates from pre-pandemic levels have produced higher-than-anticipated market valuations, which in turn has resulted in higher levels of early redemption.

That concludes my comments. It's now my pleasure to turn the call over to our COO, Angela Kleiman.

Thanks, Mike.

My comments today will focus on our second quarter results and current market dynamics.

With the reopening of the West Coast economy, the recovery has generated improvements in demand and thus pricing power. Our operating strategy during COVID to favor occupancy while adjusting concessions to maintain scheduled rents enabled us to optimize rent growth concurrent with the increase in demand, resulting in same-store net effective rent growth of 8.3% since January 1. And most of this growth occurred in the second quarter. A key contributor of this accomplishment is the fantastic job by our operations team in responding quickly to this dynamic market environment.

While market conditions have improved rapidly, during our second quarter -- driving our second quarter results to exceed expectations, I would like to provide some context for why sequential same-property revenues declined by 90 basis points compared to the first quarter. The 2 major factors that drove this decline were 50 basis points in delinquency and 50 basis points in concessions. Delinquency in the first quarter was temporarily lifted by the onetime unemployment disbursements from the stimulus funds. As expected in the second quarter, delinquency reverted back to 2.6% of scheduled rent versus the 2.1% in the first quarter. On concessions, the nominal amount increased from higher volume of leases in the second quarter relative to the first quarter of this year. To be clear: Concessions in our markets have declined substantially and are virtually nonexistent, except for select CBD markets. Our average concession for the stabilized portfolio is under 1 week in the second quarter compared to over a week in the first quarter and over 2 weeks in the fourth quarter. Although concessions have generally improved in the second quarter, they remain elevated, ranging from 2.5 to 3 weeks in certain CBDs such as CBD L.A., San Jose and Oakland.

Given the extraordinary pandemic-related volatility in rents and concessions over the past 1.5 years, I thought it would be insightful to provide an overview of the change in net effective rents compared to pre-COVID levels. As of this June, our same-store average net effective rent compared to March of last year was down by 3.1%. Since then, we have seen continued strength, and based on preliminary July results, our average net effective rents are now 1.5% above pre-COVID levels. It is notable that this 1.5% portfolio average diverged regionally, with both Seattle and Southern California up 5.8% and 9.3%, respectively, while Northern California has yet to fully recover, with net effective rents currently at 8% below pre-COVID levels. On a sequential basis, net effective rents on new leases have improved rapidly throughout the second quarter. And preliminary July rent increased 4.7% compared to the month of June, led by CBD San Francisco and CBD Seattle, both up about 11%. Not surprisingly, these 2 markets were hit hardest during the pandemic and are now experiencing the most rent growth.

Moving on to office development activities, which we view as an indicator of future job growth and, accordingly, housing demand. In general, the areas along the West Coast with the greatest amount of office development have been San Jose and Seattle. Currently, San Jose has 8.1% of total office stock under construction, and similarly, Seattle has [7.7%] of office stock under construction. Notable activities include Apple leasing an additional 700,000 square feet. And LinkedIn announced recent plans to upgrade their existing office in Sunnyvale. In the Seattle region, Facebook expanded their Bellevue footprint by 330,000 square feet. And Amazon announced 1,400 new web services jobs in Redlands. We expect in the long term areas with higher office deliveries such as San Jose and Seattle will have capacity for greater apartment supply without impacting rental rates. While these normal relationships were disrupted during the pandemic, we anticipate conditions to normalize in the coming quarters.

Lastly, as the economic recovery continues to gain momentum, we have restarted both our apartment renovation programs and technology initiatives, including actively enhancing the functionality of our mobile leasing platform and SmartRent home automation.

Thank you. And I will now turn the call over to Barb Pak.

Thanks, Angela.

I'll start with a few comments on our second quarter results, discuss changes to our full year guidance, followed by an update on our investments and the balance sheet.

I'm pleased to report core FFO for the second quarter exceeded the midpoint of the revised range we provided during the NAREIT conference by $0.08 per share. The favorable results are primarily attributable to stronger same-property revenues, higher commercial income and lower operating expenses. Of the $0.08 beat, $0.03 relates to the timing of operating expenses and G&A spend, which is now forecasted to occur in the second half of the year.

As Angela discussed, we are seeing stronger rent growth in our markets than we expected just a few months ago. As such, we are raising the full year midpoint of our same-property revenue growth by 50 basis points to minus 1.4%. It should be noted this was the high end of the revised range we provided in June. In addition, we have lowered our operating expense growth by 25 basis points at the midpoint due to lower taxes in the Seattle portfolio. All of this results in an improvement in same-property NOI growth by 80 basis points at the midpoint to minus 3%. Year-to-date, we have revised our same-property revenue growth at the midpoint up 110 basis points and NOI by 160 basis points.

As it relates to full year core FFO, we are raising our midpoint by $0.09 per share to $12.33. This reflects the stronger operating results partially offset by the impact of the early redemptions of preferred equity investments, which I will discuss in a minute. Year-to-date, we have raised core FFO by $0.17 or 1.4%.

Turning to the investment market. As we've discussed on previous calls, strong demand for West Coast apartments and inexpensive debt financing has led to sales and recapitalizations of several properties underlying our preferred equity and subordinated loan investments, resulting in several early redemptions. During the quarter, we received $36 million from an early redemption of a subordinated loan, which included $4.7 million in prepayment fees, which have been excluded from core FFO. Year-to-date, we have been redeemed on approximately $150 million of investments and expect that number could grow to approximately $250 million by year-end. This is significantly above the high end of the range we provided at the start of the year. However, this speaks to the high valuation apartment properties are commanding today, which is good for Essex and the net asset value of the company.

As for new preferred equity investments, we have a healthy pipeline of accretive deals. And we are still on track to achieve our original guidance of 100 million to 150 million in the second half of the year. As a reminder: Our original guidance assumed new investments would match redemptions during the year. However, the timing mismatch between the higher level of early reductions, coupled with funding of new investments expected later this year, has led to an approximate $0.10 per share drag on our FFO for the year.

Moving to the balance sheet. We remain in a strong financial position due to refinancing over 1/3 of our debt over the past 1.5 years, taking advantage of the low interest rate environment to reduce our weighted average rate by 70 basis points to 3.1% and lengthening our maturity profile by an additional 2 years. We currently have only 7% of our debt maturing through the end of 2023. Given our laddered maturity schedule, limited near-term funding needs and ample liquidity, we are in a strong position to take advantage of opportunities as they arise.

This concludes my prepared remarks. I will now turn the call back to the operator for questions.

(Operator Instructions) Our first question comes from the line of Nick Joseph with Citi.

Maybe starting, Barb, on the comments you just made on the preferred equity and the mezz loan. In terms of the pipeline today, are you seeing any compression on yields or expected returns or any changes to the computation there?

Nick, this is Adam. To answer your question: Yes, we're seeing compression on cap rates. We're seeing it's a much more competitive market now with proceeds going well above where we're typically comfortable and rates going significantly below where we've been in the market. So to sum, yes, we are seeing absolute compression on valuations.

So then in terms of the early redemptions that you've seen, I mean, is there a risk of further early redemptions that could at least create an air pocket on the earnings side?

Nick, at -- this is Barb. At this point, I think we've factored that all in based on what we know today. And we're already almost in August. So I think we've factored that into the current guidance, so I'm not expecting any more redemptions at this point for the rest of the year.

Our next question comes from the line of Rich Hill with Morgan Stanley.

I wanted to just come back to sort of the trends that you're seeing in your markets. And I appreciate all the color and commentary you gave us, but I'm hoping you can compare and contrast what you're seeing in your market specifically versus maybe what someone typically thinks about in San Francisco, Los Angeles, the broader West Coast urban markets. So specifically, are you seeing people still continue to migrate in? Are you seeing people migrate out? What are those trends in your markets that give you confidence relative to maybe some of the urban market trends?

Rich, it's Mike. I think I'll handle that one. And others may want to comment as well, but I think we feel really very good about what's happening here, noted in my comments that we're fully recovered with respect to market rents versus pre-pandemic levels while only recovered about half the jobs, so far. So that -- I think that's a powerful place to start. And if we look around the West Coast, we feel great about what's happening, and we expect good times to continue. The consumer is super optimistic. They've saved money via COVID, versus COVID by not traveling and a variety of other things; millennials forming households. And there's a lot of hiring here on the West Coast, so that's why we talk about the top 10 tech companies and how many open positions they have. They've come a long way in the past year. And after what we perceived as them pulling back mid-COVID on their expansion plans, I think that they're now turning that corner or have turned that corner, hiring more people, pursuing things that they put on hold a year ago. And so everything feels like it's in good order at this point in time.

As you go to the cities, the main driver of job growth at this point in time has been the recovery of all the industries that have been so dramatically affected a year ago, including the leisure, hospitality, restaurants, filming in Southern California, et cetera. And as we look at the world, we're looking at whether we believe these industries are poised for future growth. And we think absolutely they are. We think that we're in affluent areas. Affluent areas demand services. You're starting to see those services come back in terms of restaurants and a variety of other areas, and so we see this turning around nicely. And again I wouldn't have expected to be fully back with respect to rents at a time when we've only recovered about half the jobs that we lost. Makes sense?

Yes, it makes perfect sense. I was just waiting to see if anyone else was going to follow up. That's perfect, Mike. As we look forward and at the risk of asking you to guide, which I'm not, we had this obviously pretty significant trough that came late last year and early this year. Is it sort of reasonable to think that 2022 will be the mirror image of that and then maybe we can -- we maybe even continue to push rents above a normal trend over the medium term?

It's a good question. And Barb will look at me very strangely if we start talking about '22 at this point in time, so -- and you know how we are. We tend to be pretty careful in terms of guidance. And so we don't want to go too far out there, but I would say that I would expect certainly the return to office to be a good thing for the downtown locations because most of the top 10 tech companies or most of the tech companies in general have announced a hybrid type of approach which means that people are going to have to be closer to the offices to show up, let's say, plus or minus 3 times per week. As a result of that, the people that moved to the hinterlands or the most suburban parts of our portfolio probably are going to need to come back. And I think about Ventura. I don't want to pick on Ventura because it's done great, but it's a long way on a commute pattern from Ventura into the -- where the jobs are in L.A. And I don't think people are even going to want to do that 3 times a week. So I think that kind of frames the dynamics. The -- those that had a year, given the pandemic, to make a different choice about where to live, I think, will likely make a different choice going forward now that there's more clarity about what the -- what companies are going to do with respect to their work-from-home or return-to-office programs.

And -- this is Barb. The only other thing I would add is leases we're signing today will have half the impact to the rents this year to our rent roll, and that will carry forward into next year too. I mean, look, [as Angela has mentioned], we had a strong July. And so that is going to only affect part of this year's numbers, so (inaudible).

Yes, I got it. I'm not sure that's entirely what I wanted, but I appreciate the response.

Well, maybe Barbara (inaudible) -- that's -- sorry. Continue...

Our next question comes from the line of Joshua Dennerlein with Bank of America.

Just kind of curious what your mark to market is in your portfolio; and maybe if you have it by region, like Seattle, Northern California and Southern California.

(inaudible)...

Are we talking about loss-to-lease numbers?

Loss to lease.

Yes.

Yes, loss to lease. Sorry.

Yes -- no, that's all right. That's all right. Well, in terms of the loss to lease, we actually are in a much better position and in a level even better than pre COVID. So if we look at July loss to lease for the Essex portfolio, it's now at 7.4%. And so -- and that, of course, varies: Seattle at the highest at about 12%, Southern California in the middle of the pack at about 8% and Northern California at the lowest at about 3.5%.

Okay, awesome. And in your guidance range, what are you assuming, as far as like a recovery for the rest of the year and rate for the Northern California market?

I'll start. In the second half of the year, you -- as each -- we have to turn leases in order to impact our same-store or our revenue. And so you -- as you get toward the end of the year, it becomes less relevant and more relevant obviously next year. So take a transaction in October. You only have 3 months of that new lease in 2021. The rest of it is going to be in 2022. So there is an inherent lagging concept with respect to what's going on with market rents, which Angela just talked about, versus how it shows up on the income statement. So I think that's important. In terms of just looking at market rents, we've tried to provide a little bit of color on that. And with respect to S-17 is what we're trying to get at, that overall our economic rent growth on S-17 is at minus 0.9%. And that's 1/12 of every month throughout the year. So January 2021 versus January 2020, plus February, through the year, divided by 12 is what that number represents. So we started the year at a -- in the minus 9% to minus 10% range. That implies, to get to 0.9% -- minus 0.9%, on S-17, that the fourth quarter will be plus 6%. And that does not anticipate a lot of rent growth between now and then, which is pretty typical. We typically hit the peak of market rents in July, at the end of the peak leasing season, and then it flattens out for the rest of the year. So that's what's assumed in those numbers.

Our next question comes from the line of Austin Wurschmidt with KeyBanc.

It seems possible that your markets could experience an extended leasing season. It's certainly come up on other calls. And some seem pretty optimistic about the prospects, but clearly as you identified, there are some risks to take into consideration, so just wondering kind of how you went about your back half guidance. And did you assume typical seasonality or sort of that another leg up in demand in the late summer-early fall time frame?

Yes. This is Mike. And I agree with you. We did not. We assumed more or less the typical trend with respect to market rents, so kind of peaking in July and not a lot of growth for the rest of the year. If -- as we think about it, however, there are some things that are different. For example, will the tech companies continue hiring? Normally what happens is hiring tails off at the end of the year. Companies give business plans at the -- towards the third and fourth quarter and then they start implementing them in the first quarter. That's what really drives the peak leasing season. So the question here is will companies continue hiring at a higher level, given COVID, than they have in the past. I think there's a very good chance that, that could happen. I also -- this work-from-home and return-to-office concept could have an impact on that as well. If more people are, yes, moving back into the more urban areas from -- the people that were displaced as California and Washington were shutting down a year ago, if those people continue to come back later this year, that could possibly push rents higher in the second part of the year. So we've, again, assumed based on our experience and what typically happens a normal curve with respect to rents, but there are some things that are different here and so we could end up with [being a] surprise to the positive side.

Great. That's very helpful. And then Angela, I think you mentioned that you're restarting the redevelopment program. Could you give us kind of the scale of that or the annual run rate and then maybe offer up some additional details on sort of the economics? That would be really helpful.

Sure thing. We -- normally, pre COVID, our run rate was about -- in terms of units about 4,000 units a year. And what we did was scale back significantly last year. So second half of last year, we only renovated about 600, a little over 600 units, 650 units. So the target to -- the restart for the second half of this year is to double that, so to achieve close to 1,300 units this year. We are looking at a couple of large developments for future -- for next year that will have greater opportunities, but in terms of just the return on investments, we're actually looking at ranges [pretty darn] consistent with pre-COVID levels. And so while -- cost has gone up, but rents have gone up as well concurrently. So we think we're in a pretty good spot.

And what are those numbers on the economics?

They tend to range depending on the asset and the scope and the market, but I'll give you a range. That might be a little bit better than a hard number. They tend to range, stay in the high single digits to the high double digits, so it's a pretty wide range.

Our next question comes from the line of Amanda Sweitzer with Robert W. Baird.

[Following up] on some of your comments on ramping up your development spending, can you just provide an update on areas you're targeting for those potential projects as well as underwritten yields you think you could achieve?

Amanda, this is Adam. Were you referring to redevelopment or development?

I had thought you mentioned ramping up development along with acquisitions earlier in the call, but I could be mistaken.

Okay, yes, I'm happy to take that one. So on development, yes, given where our stock is trading and given some opportunities that we're seeing out there now where we can make sense of accretive transactions, we are definitely looking at ramping up the development pipeline. I'd say our main areas of focus would be primarily Northern California, Seattle. Those, I see as probably the 2 best markets in that respect, but we're looking throughout our portfolio and throughout our footprint for deals.

And then any change in terms of underwritten yields you think you could achieve on those projects versus pre-COVID levels?

So yes, good question. So what we're seeing, we've underwritten several dozen deals over the last few months. The deals that we see going down primarily, cap rates have definitely compressed. So on the development side, we're seeing on untrended rents return on costs at about 4 to 4.25 basically. So still a gap between where existing deals are trading, which are in the, call it, 3.25 to 3.5. We're going to look at numbers higher than that. We've not -- we wouldn't transact at a -- call it, a 4 development yield, but we're going to -- we would be looking in the 4.5 to high 4s.

Our next question comes from the line of Rich Anderson with SMBC.

So I'm interested in this 17 supplemental -- or S-17.1, I should say, the migration trends that you referenced in your prepared remarks. Is that everything? Or is it predominantly kind of close-in like Monterey, Sacramento type of net migration or in-migration? And does it net out people that are leaving California entirely? Is this the full number, number one? And number two, what do you think about this 18%? Is this like a sort of a knee-jerk response to working remotely but closer to the office and that probably this is peaking out at that -- this time and it starts to come back down? What's the feeling on this graph, do you think?

Rich, this is Barb. Yes, on S-17.1, the 18% is a net number. So if you look back a year ago, we did have out-migration, and that's what's showing in the negative 8%. And now we have people moving back. And they're really coming from Sacramento and some of the outer-lying areas within California, but we're also noticing people moving in from college towns, some people -- recent college grads are coming here for jobs and it's really geographically dispersed. I mean it -- there's no discernible pattern from where they're coming from. It's kind of all over. And we do think that it does speak to the strength of our markets and people coming back and returning after the services have reopened and the economy has reopened. Now we're seeing the people return, and so we think it's a good sign and a good leading indicator. You should note that this -- Seattle in our portfolio looks similar as well. We're seeing a big in-migration in Seattle as well. So we didn't show it here, but it's Bay Area and Seattle both have a similar chart where there is a big influx. And I think you're seeing it in the rent growth that Angela spoke to and San Fran being up 11% in the CBD. And NorCal and some of the other suburban markets in NorCal having bigger sequential rent growth more recently is partly due to this in-migration.

Rich, I have a -- Rich, can I (inaudible) make a broader comment? And I would say -- the broader comment is that the migration out of the West Coast, our view, was largely driven by businesses being shut down and putting people in the position of not having a paycheck and effectively forcing them to move to somewhere else. And I know that sort of it doesn't fit the narrative. The narrative is that all these people wanted to leave California. I think the reality is completely different from that. And therefore, I go back to my basic comment, which is do we feel comfortable with the businesses that are here and with job growth going forward. And when you look at the components of that: Okay, the hotels are now mostly open here on the West Coast. The restaurants are opening and -- but we were still at 50% of capacity a month or 2 ago. So we opened completely on June 15, but that process has been relatively slow. And I think that's why job growth has lagged the U.S. as we've come out of the pandemic. And -- but I guess the key point here is most of the migration that occurred was not voluntary migration. It was caused by shutting down businesses. And then if you look at the flip side of that, are those businesses likely to reopen given COVID is mostly behind us? And we feel 100%, absolutely convinced that, that will occur.

And so when we look -- we have some more broader information on migration in general. And a lot of the same things that we talked about a year or 2 ago are still in place. The inflows into our markets tend to be the high-cost East Coast metros, and the outflows tend to be into lower-cost Western areas. So those trends really haven't changed all that much, but Barb, this -- S-17.1 is trying to address specifically the cadence of what's coming in and what's going out. And to your point, yes, of course, everything is in there. We're not here to try to push a narrative that is not reality because, if we do that, we're just going to shoot ourselves in the foot. So there's no evidence, I think, of Essex trying to be overly optimistic. And so we're trying to communicate what's really happening out there and what we're really seeing. So I guess that would (inaudible) -- yes.

Yes. I wasn't implying that. I just -- you mentioned sort of [near and] areas with in-migrations. I just want to make sure I was looking at the same thing. So the second question: 15, 20 years ago, Mike Schall and Keith Guericke were the heroes with 10%-plus growth, and California was the place to be. Now if you had at that point made some investments in the Sunbelt, you'd be a hero. So the torch is passed, at least for now, but I assume your reversion of the mean is your mindset certainly sounds like what you're saying. And do you see now as a particularly interesting time to be investing in your markets for all the reasons you just described but also particularly special because of what's happened outside of California and Washington and what you think might come back and that there will be sort of a narrowing of the performance gap over the next several years?

Yes, no -- hey. It's a great question, Rich. And our Board is pretty focused on this geographic diversity issue and some of the challenges that we've had more recently with respect to regulation and other things, but we don't want to get too far away from sort of this longer-term pattern because we -- it isn't like we're going to grow every year the same. Conditions change, but we remain focused, in our analysis, on which areas have the highest CAGRs of rent growth over time. And it may surprise you because you can say the West Coast has dropped off of that. More recently, yes, but if you look back, let's say, 15 years because I have these numbers right out of our strategic plan in front of us, Seattle led all the major markets by -- with a 5.6% 15-year rent growth CAGR from 2004 to 2019. So to the pre-COVID level. And Northern California was pretty close to that. And we start going down the list. And certainly Boston and Miami are pretty attractive in that respect, as is Northern New Jersey, but then there are a lot of markets that really have fallen well below that. And so our whole thesis here has been let's try to identify the things that promote long-term rent growth and let's invest in those markets. And we can -- as you know, we've looked at some things on the East Coast before, and we'll continue doing that, but I guess, as we think about things, let's -- let me just make a simple comparison. Let's compare San Jose with Austin. And there are cities of about the same size, same population.

Austin has about 28,000 multifamily units in construction, whereas San Jose has about 8,000. We also don't produce very much housing or for-sale housing in San Jose, and the median price is well over $1 million. So as an apartment owner, we look at that and say, are we better off being in San Jose or in Austin? And we conclude that it's better to be in San Jose. I mean Austin has to get extraordinary amounts of growth over and above San Jose, which of course is driven by the tech companies which are doing really well. And they hire a lot of people, so I guess I would say the bloom is not off the West Coast. Yes, we grew really fast from 2011 through 2016, when by the way, we had job growth in the 4% to 5% range on the West Coast. And then it slowed down because of affordability issues, because you can't have rents grow twice as fast as incomes over long periods of time without creating affordability issues. So there is a long-term approach to the business, and I think that making vast portfolio decisions based on -- with all the unique circumstances in COVID would be misguided.

Our next question comes from the line of Neil Malkin with Capital One Securities.

Just first, Mike, Angela, it seems like in a lot of your prepared comments the risks of COVID or the Delta variant [throwing rents into the recovery] seem like -- maybe I'm understanding wrong, like lower or something that you're really not maybe weighting a lot. And I guess my question on that part is are -- have you thought about the Delta variant, how it's spreading a lot quicker? I think I've just seen some studies that say like vaccinated people can also spread it as well, like, as easily as unvaccinated. And the markets that you're in are most likely to re-shut down and reimplement restrictions if cases rise, hospitalizations rise, et cetera, so given that that's likely to happen as the fall comes, what kind of weighting do you kind of give to that notion of a potential hiccup from reimposed restrictions?

Yes, it's a good question and an important question. And I guess I would say, unfortunately, we have no way to really figure out what COVID might do going forward and -- but we're definitely aware of the risks. And one thing that I think is a little bit different in California, clearly we've got population densities that are pretty high, and so the risk of COVID is perhaps greater given that. And I think the government actually has done a very good job here of trying to promote vaccination rates in the Essex markets. And I think our vaccination rates are pretty high relative to the rest of the world. So the information I have is that the people with at least one shot and are 12 years and older were in California and Washington about 82% vaccinated versus 67% for the U.S. So I think that what's happened here is we've tried to -- the government has tried to react to that risk by really pushing the vaccination rate, and they've done a very good job of that. So I think that lowers our exposure, to some extent, but no doubt areas with high population density have a different COVID risk than some of the other areas. And in this case, I think it's been dealt with effectively.

Okay. That's a really helpful stat. Other one for me is in your previous comment you talked about not making, I guess, rash decisions or thinking about things on a historic level. And I guess, if you look [at a few] large peers -- people don't like to say names, but coastal players have recently announced pretty significant capital plans in Raleigh, Charlotte, Atlanta, Dallas, Austin. And I would imagine they have Boards and a lot of stakeholders that they probably consult it with before they allocate a lot of capital, so kind of with that being said, does that -- I mean, do you give credence to that at all? I mean, does that -- does it make you think maybe a little bit more about that? I mean you referenced that permitting is down in your markets, and maybe that isn't like a good thing. Maybe that's like a bad thing of people are focusing their growth prospects and capital elsewhere.

Yes. I -- it's a good question and very valid. And this is why we spend so much time in our prepared remarks talking about what's going on with the top 10 tech companies. We created that index so that we could keep our eye on where are the open positions for the top 10 tech companies. Are they moving more to some of these other locations? And if so, what do we do about it? So yes, I didn't mean to imply actually that we're so focused on 15-year CAGRs of rent growth. So definitely the historical information is important, but we're trying to supplement that in a hundred different ways with a ton of data sources that are either confirming or raising questions about what the future looks like. That's why Angela is talking about how much office construction. If you're going to build office buildings, presumably there are going to be employees in there and we're going to need to build apartments to house those employees. I mean these are all indicators of what's happening in the future. Keeping our eye on the top 10 tech companies and their hiring trends, again both within California and outside of California, super important in that regard.

Again I go back to the industries. What are the driving industries? What are the industries that sort of drive the entire machine? We can -- it's certainly not the hospitality and the restaurant workers that are driving it. They are really the result of affluent, wealthy areas [demanding those] services. And guess what. They pay a lot more than in other places of the country because of that. And so I think what's happening here is we're in the process of -- all those people that were displaced from shutting down restaurants and other services, we're going to need to draw them back into the area, but I think that, given the demand for those services and given the wealth that has been created here by the tech community, by motion pictures in Southern California and other people that want to live near a beach, let's say, those services are in demand. And they're going to come back. It's -- it will take a little bit of time perhaps to do that, but again, we're trying to say, okay, let's stay focused on what are the drivers of the economy here. And again as I look at it, and hopefully, everyone will agree, tech is not going away or hasn't gone away. Certainly all the information that we've given out with respect to the tech companies over time confirms the thesis that they're here. They're not going away. They continue to invest in our markets. Motion pictures in Southern California: You can't shoot, film where you require 50 to 100 people on a set during COVID. Completely shut down. Demand for content, not going away anytime soon. Therefore, there's a very good chance that, that is going to resume. And I can go on beyond that, but I think that, that sets the point.

If the drivers are intact, the things that follow, the demand for services, restaurants, et cetera will follow. And the thesis of the company in terms of job growth remains intact. And then if you don't produce enough housing supply, I would view that as a good thing.

Our next question comes from Alexander Goldfarb with Piper Sandler.

So Mike, 2 questions. First, the data on S-17, that is super. So if -- like if we were out in the Bay Area like a month ago and saw San Francisco sort of empty, are you saying that -- with this 18% increase that now like San Francisco will be active? And all of the apartment REITs that have reported this quarter who have all shown that -- San Francisco to be the weak link, that will -- you're saying that we will see that change substantially over the next few quarters.

So you're referring to the -- this movement back to the inner Bay Area portfolio on 17.1.

Yes, yes.

Well, we're saying that the trend has reversed and the movement back to the Bay Area has begun. I would -- yes, I'd caveat that. I think most of that is the service businesses, restaurants. And leisure and hospitality is the leader in terms of jobs coming back. It -- that was the area that was most severely disconnected during the pandemic, but -- and then we have coming at us in the not-too-distant future the tech companies and the return-to-office programs. So I think that, that continues that trend. And again there are a lot of restaurants that converted to a takeout-only mode. I think we'll go back to a more normal type of situation where those restaurant workers continue to come back as well. So yes. I think it's [meant being] not as fast as we want to. Again I go back to the initial premise, which is we've gotten all the rent back -- all the rents back to where they were pre COVID with half the employment. I think that's a pretty powerful statement.

Okay, but I'm just trying -- I guess my -- if you look at like Manhattan. I know you guys are not in New York City, but the city came back a lot quicker than many expected even though work from home -- only, whatever, 20% of the buildings have people in them, but city rents and the occupancy rates have rebounded strongly, whereas San Francisco and Seattle downtowns, respectively, were still lagging. So I guess I'm curious if your view is that within a few quarters we will see the downtowns of San Francisco and downtowns of Seattle rebound strongly like we've seen in New York, based on what you guys are showing in this attachment S-17.

Yes, no, it's a good question, Alex. So New York: If you look at trailing 3-month job growth in New York, it was 10.2%. San Francisco was 5.2% and San Jose was 5.2%, so you have a pretty dramatic underperformance with respect to overall job growth. So -- and I'd attribute that to the -- again the West Coast needing to open up. We were still, well into June, at like 50% of capacity in restaurants and that type of thing, whereas I'm assuming that New York -- I don't know exactly what they did, but they did something that caused a fairly dramatic difference in terms of their resurgence [and] employment that hasn't happened yet on the West Coast. I think it's coming, but we're just a little bit slower than some of the other metros, including New York.

Okay. And then the second question is, Barb, on the guidance you said that, because of the mismatch in terms of accelerated debt and preferred equity redemptions versus what you guys can put out, there is about a $0.10 drag. So is that $0.10 only in NAREIT FFO but not in company FFO, or is it in both?

It's in both. This is because, the prepayment penalties or fees that we receive this year, about $7.5 million, those are only in total FFO and not in core FFO, but what I'm referring to is just a timing issue. We've been redeemed, gotten money back early, so we don't have any of the interest income from those investments. And we haven't put any money back to work. And so that's the $0.10 that I'm referring to.

(inaudible) we're looking at -- since that prepayment penalty has really compensated us for having our money outstanding for a certain period of time, I'm advocating with Barb to change that so that it's not a noncore item because we -- it's really we have a minimum earned preferred return, and unfortunately it's showing up in the noncore category rather than core.

Yes. That -- Mike, that was going to be my point, is you guys are very productive on this. And whether you get paid out over time or you get redeemed early but they pay up and pay you a penalty for that, that is core part of your business. So that was my question, is why you would exclude the positives that come from this platform. And I mean it sounds like you guys are having an internal debate, but I mean you're successful at it and no point in not really showcasing the earnings potential there.

Yes. It's we're -- we have looked at it. We obviously have to follow GAAP accounting rules. And so it's more complicated than it appears on the surface, but yes, there is an internal -- debate internally. But what we've booked year-to-date has all been noncore for the prepayment fee.

Our next question comes from the line of John Kim with BMO Capital Markets.

Regarding Northern California and the recovery. I think Angela mentioned in the prepared remarks that July effective rents are still 8% below pre-COVID levels. And I'm not sure if that was a market rent concept or for Essex, but I was wondering if you're going against easier comps, given you were more aggressive on concessions beginning of third quarter last year, and if the recovery could be faster than we think.

Yes, I'll let Angela comment on the number for San Jose, but I would say what's happened here is -- and we had callers on previous calls that have said, "Hey. With negative job growth, how are you able to maintain high levels of occupancy in the cities?" And obviously a great question. And the answer to that was, of course, that we drew people because the price point was lower. We drew people from other places into some of the better locations. So they improved their location given lower rents. And so now you look at this equation that we're 96% occupied. People are starting to come back and there's no availability, and therefore market rents are doing what they're doing. So I think a lot of this is really driven by our strategy during the pandemic. And now it'll be interesting to see what happens over the next couple of years because market -- with market rents now back to where they were pre-pandemic levels, what is the movement within the portfolio both in and out of those locations that have much higher rents? So in the case of San Jose, San Francisco and Oakland, they're still substantially below the prior rents, so there's still reason to believe that those -- the people that moved in given lower rents will stay, but that may uncouple over the next several years.

And so was -- that 8% figure that Angela quoted, was that for Essex or for the market overall?

That was for Essex.

Okay. Mike, you mentioned cap rates in your markets are low to mid-3%, which sounds like it's compressed about 50 basis points at least from last quarter. Can you comment on the assumptions that you think the market is placing now that's changed, whether it's rental growth or exit cap rate; and whether or not you agree with those assumptions or believe they're rational?

Yes. I'll start with the comment and the comparison to last quarter and then flip it to Adam to talk about cap rates more generally, but I think, last quarter, what we said was in some of the hard-hit areas -- that buyers were pro forma-ing some rent recovery. So it probably wasn't a whole 50 basis point reduction. It was really that they weren't using really the current net effective rents. They were assuming a bit higher rent level. So that reconciles part of that, but Adam, do you want to talk about cap rates in general?

Yes, sure. So I think the general assumption that buyers are making is that there will be a full recovery. And by that, I mean with rents greater than pre-pandemic levels. And we're already seeing those rents that we've already talked about during the call. So yes. It's in the low 3s. I think pretty robust rent growth over the next few years and then probably mellowing out is what I -- is -- the various people that I have talked to, that's what they're modeling. And then on exit caps, I think it's as aggressive as ever. So I don't think there is much assumption that there is a big expansion on the exit side. So it -- underwriting has definitely gotten more aggressive.

Is there a big difference between your markets or urban versus suburban?

Yes. Good question. So going kind of North to South: Seattle, we've seen, we've actually seen a pretty big pickup in transactional volume. And that's probably amongst the most aggressive markets that we're seeing. In the CBDs, on kind of current net effective rents, we're seeing high 2s to low 3s. And in the markets that really didn't do too much of a hit on rents, we're seeing those like maybe in the 3.25 to 3.5 range on the much more suburban outer markets. And then going down, very little in Northern California is traded, so it's hard to really opine there, but it's in that probably low 3s range. And then down to like San Diego, Orange County and -- those markets performed better from a rental aspect. So those cap rates on current net effective aren't quite as low as what we've seen in those harder-hit markets. So it's probably closer to that 3.4, 3.5 kind of range. And very little in L.A. is traded as well. So it's down in the kind of low 3s, but there's very few data points.

Our next question comes from the line of Brad Heffern with RBC Capital Markets.

On the federal funds, I think you mentioned in the prepared comments that there was a negligible amount received to date and that there really isn't much in the guide either. I was curious if you had any figures around maybe what you have applications out for or some sort of risk assessment of what you might receive on that.

Yes. It's Angela here. So out of -- I think we reported that we have about $55 million of delinquencies out there, and we've applied for about $18 million. And to date, we've received $4 million, so that's still about a 20-some-percent recovery rate. As far as we could tell, it's really more of a slow going because California just has a more complicated and slower reimbursement process. So in our view, that $18 million, we don't view that $18 million as having significant risk from that perspective. The reason we didn't bake it into our guidance for this year is really the timing is the question and just given that the rate of reimbursement has just been much slower. And so that's really the key driver of why it's not in this year's guidance.

Okay, got it. And that $4 million, I assume that's largely been this month just given you said there wasn't -- it was sort of negligible in the first half. Or is that right?

Yes, yes, for the most part, this month.

Okay, got it. And then just one administrative sort of one, if I could: In the press release there was a 6.3% blended rate number for July, but then in the commentary I heard a 4.7% number. I just wanted to verify what those 2 things we're talking about.

Sure. So the 4.7% is a sequential month-to-month. So what I was trying to do is provide a real-time picture of what's happening in our markets. So comparing July to June of this month, it's already up sequentially 4.7% on a net effective basis. And so what's in our supplement, that blended lease rate is a year-over-year. So that compares July of this year to July of last year.

Our next question comes from the line of Alex Kalmus with Zelman & Associates.

Looking at your Southern California occupancy. It's quite high. And we've heard a lot this quarter from others that the delinquencies are -- in their portfolios are sort of concentrated in this part of the country, so I'm just curious. What would happen if -- once the moratoriums are up? Does that affect the occupancy levels on a physical basis, in your mind? Or how do you see that playing out there?

Yes. This is Mike. It's a good question. Yes, we agree with the others that Southern California and really specifically Los Angeles is a big part of the delinquency, the largest part of the delinquency. And therefore, there's some question about what might happen, but it's not a huge percentage. And we expect to work with our residents to the extent we can and so I don't think it will have a huge impact on occupancy overall. So -- but it remains to be seen because we can't envision exactly what that scenario is going to look like. And so we -- but it's just not enough, I think, to really severely impact us.

Got it. And just thinking about the regulations on rent increases that are in place and when you're sort of internally discussing the difference between holding occupancy or pushing rate, is there any momentum to say you'd rather keep the base rates pretty high to then expand a little more there and maybe lose a little occupancy as a sacrifice? Or is it -- it is still hold occupancy as a primary driver.

Yes. It's different by -- in each region. And so there's a thousand different pieces to that equations because there's been so much movement in rent. And so we're going to -- so the answer is going to vary by region and so it's difficult to generalize throughout the portfolio, but we think that we will be able to work with residents. We've tried to do that in the past. That will continue going on in the future. And certainly with respect to any of the delinquency that's not covered by some of these programs, to make good on the COVID-related delinquencies, we'll try to work with our residents we -- as we have in the past. Again it's a little bit difficult to try to figure out exactly what that means from different areas because there are sets of regulations in a variety of different places, from emergency orders to state rent control and the like. And so it's sort of a case-by-case basis. It's difficult to generalize.

Our next question comes from the line of John Pawlowski with Green Street Advisors.

Adam, I appreciate all the cap rate commentary. I'm trying to square those really low cap rates to the commentary about ramping or being more positive on external growth because, from the cap rates quoted, it feels like you guys are trading at an NAV discount. So can you maybe just help square the external growth appetite and the prevailing private market pricing?

Sure, yes. I mean you hit the nail on the head. It's the reason why we haven't been super active on the external growth side is that these are -- that most of the transactions that have gone down have not been accretive; and to your point and from an NAV standpoint, not accretive as well. We're seeing a few more opportunities out there that will fit. And our stock is recently up, although still I'd say, when you're looking at low 3s, that still -- that puts us in the trading below NAV range. So we're underwriting everything, being more aggressive where we feel like we can make some -- make a difference on growth accretion as well as FFO, but yes, you nailed it. It's that's why we haven't done much, so far.

John, I would add that -- this is Mike, obviously. I would add that we're closer now than we were 30 or 45 days ago. So we're getting close. I mean debt rates have come down quite substantially, as you know. And so there at least is a hope that we will be more -- we're looking at a lot of deals. Adam is looking at a lot of deals. And so we're [pricing] things out and trying to make the numbers work. And again we're going to remain disciplined [to -- and review] the company versus what we're seeing out there in the transaction area. We think that's the fundamental behind the success of the company over long periods of time.

Okay. No, understood. Things are moving quickly. Maybe just Adam or Mike, based off prevailing private market prices today, if you had to double down on a market and you had to exit a market, what are kind of the top and bottom picks?

I'll let Adam deal with that one.

Good question, yes. Thanks, John. So double down. I'm a big fan of Seattle in general, and I would say East side especially given the jobs picture there. Even though supply is slightly elevated, I think the jobs picture there is significant. And it's lots of tailwinds. To exit a market? [We love all of our] markets, but maybe Hemet...

We're definitely interested in exiting Hemet, yes. That's one property...

No. It -- yes. I joke. Ventura has had a pretty good run here as of late. And it continues to do fine, but again if we had to pick a market -- like I said, we are focused on our entire footprint. And so we'll go in where we see opportunities.

There are no other questions in the queue. I'd like to hand the call back to management for closing remarks.

Okay, very good. Thank you, Doug. Appreciate that. And I want to thank everyone for joining us on the call today. Appreciate your time. And we know we've covered a lot of ground. If there are any follow-up questions, don't hesitate to reach out to us. And we thought it was a great dialogue. And we look forward to seeing many of you, hopefully, at a conference and in person in the near future.

Thanks for joining the call.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.