Q4 2019 Earnings Call
Good day and welcome to the Essex Property Trust fourth quarter 2019 earnings Conference call. As a reminder, today's conference call 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 on the company's filings with the S. E C.
It is now my pleasure to introduce your host Mr., Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you Mr. show you may begin.
Thank you everyone for joining our fourth quarter 2019 call, John Burkart, and Angela Kleiman will follow me what comments and Adam Barry is here for Q1 day.
Today I will review, our 2019 results summarize our expectations for 2020 and provide an update on the west coast investment markets.
Beginning with our results.
2019, once a successful year for ethics, as we generated 6.4% core AFFO per share growth representing over 50% better growth in contemplated in our original guidance.
Same property NOI grew 3.9% in 2019, which was at the high end up our original guidance, reflecting stronger job growth than we had assumed.
For example.
Q4, 2019 job growth averaged 2.3% 50 basis points above our initial 2019 estimate once again the tech dominant markets in Seattle, and Northern California are leading the way with recent job growth of 3.3% and 2.6% respectively.
Southern California, where economic growth generally resembles the United States.
Recently added jobs at a rate of 1.5% on a trailing three month basis.
In addition continued apartment construction delays resulted in less competition in 2019.
We estimate that approximately 33000 apartments were completed in 2019 about 7% less than expected. We continue to believe that tight construction labor market conditions will prevent significant acceleration of supply deliveries John will provide more color on funded by.
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Our initial outlook for 2019 did not assume a significant improvement in the cost of debt and equity capital in early 2019, we eagerly bought back or stock at a significant discount to consensus net asset value.
As volatility and the capital markets abated, and our cost to capital improved we altered our business plan and began to actively pursuing investment opportunities.
As a result, we're pleased to report that we exceeded the high end of our acquisition and preferred equity guidance ranges from the focused effort of our investment team.
In 2019, we added ownership interest that eight properties for 856 million as further detailed on page S. 15 of the supplemental. These communities are mostly located in the tech centers, all along the west coast and Submarkets, we know well and expect to be.
Additive to the portfolios growth profile.
We also committed to over 140 million to new preferred equity or subordinated debt investments significantly better than our production in 2018.
In summary, 2019 demonstrated how we attempt to add value throughout the economic cycle.
2019 was also an important milestone for ethics as we celebrated 25 years as a public company with some notable achievements.
A 17% compounded annual rate of return for our shareholders shareholders since the IPO through the end of 2019 in other words $100 invested in our IPO would be worth over $5000 today with dividends reinvested.
Throughs through several economic cycles, our business model has generated an 8.4% compounded growth rate and AFFO per share and a 6.4% rate of growth in our cash dividend.
Which has increased every single year.
We were very pleased to learn that Essex was recently added to the S&P 500 dividend aristocrat index I'd like to thank all of the longstanding partners the Essex team and shareholders, who have contributed to the company's achievements over the last quarter century.
Turning to our outlook for 2020, we continue to see healthy demand for rental housing.
Recent job growth for our West Coast markets continues to exceed the 1.7% forecast for 2020 on page S 16 of the supplemental.
However, we continue to believe the job growth will likely decelerate in 2020, given tight labor market conditions, and a low unemployment rate, which was 2.7% in the Essex markets as of November down 50 basis points from a year ago.
Turning to slide F 16.1 in our supplemental we highlight as central theme of our West Coast focus.
The chart on the right of this slide demonstrates a job growth has remained strong in the west coast and Reaccelerated in 2019 diverging from the rest of the nation.
On the left side of the chart. We note that multifamily permit activity in our Metro's peaked in 2018 and has declined about 14% from that peak again, a divergence from the recent trends outside our markets.
Rising construction costs and a challenging regulatory environment continue to compress development yields and most of our markets, which should lead to fewer supply deliveries in the future.
Our delayed adjusted supply estimates for 2020 have not changed from our original estimates last quarter.
Notable changes year over year indicate about a 30% reduction in Seattle apartment supply in 2020, and about a 45% increase in northern California.
Tight labor market conditions on the West coast continue to push incomes higher per capita personal incomes are estimated to have increased 6%.
Our markets in 2019 significantly higher than the U.S. average of 3.9%.
Personal income growth has outpaced rent growth in most of our market since 2016, which is leading to improved rental affordability.
Consistent with this trend the percentage of customers, who moved out for financial reasons or a rent increase was almost 16% in 2015 in the fourth quarter of 2019. This factor accounted for less than 8% of those moving out.
Despite last year's outsized media coverage of the failed IPO, we work or the disappointing stock performance of other unicorns, the outlook for economic growth and new jobs in our markets remains favorable in 2020.
Having closely followed Silicon valley for the past four decades, we're not surprised to see volatility with respect to VC backed companies the venture capital model assumes many failures.
Which are more than offset by the hyper growth of the most successful investments.
[noise] Bay area venture capital investments dipped in the second half of 2019, but remain at healthy levels well as.
Well above the cycles average pace of investment.
We continue to track over 26000 job openings listed in our markets by the top 10 largest tech firms, a 12% increase compared to a year ago.
The largest tech companies continue to add commercial square footage at a rapid pace, which John will comment on in a moment overall, we are tracking over 38 million square feet of office construction and our core markets, which is almost 70% preleased and underlies the need for more housing.
Turning to the investment markets cap rates remain stable with eight quality properties and locations trading in the high 3% to low 4% range, while bees trade 25 to 35 basis points higher in this environment, we're looking primarily for a modest to be minus quality communities.
In markets with the best long term growth prospects.
Six communities, we acquired from our co investment partner earlier. This month are consistent with this strategy. We're pleased to increase our stake in these high quality communities, while earning a $6.4 million promote from significant value creation for our partners and shareholders.
The majority of our development pipeline will be leasing up in 2020, we have experienced our share of development delays due to a challenging construction labor market. However, we remain pleased with the initial customer response at our development communities and the current leasing pace, we continue to pursue development opportunity.
Steve, but often see a better risk.
Reward relationship within preferred equity and other structured investments that concludes my prepared comments I'll now turn the call over to John .
Thank you Mike.
For the full year, we achieved 3.4% year over year same store revenue growth.
As an increase of 60 basis points over the prior years' growth rate.
Thank you to our 18 for their outstanding work and improving the customer experience, while delivering top results.
Our fourth quarter 2019 results were fantastic with 4% revenue growth over the prior years comparable quarter. This was driven by strong markets and bolstered by a shift in strategy to increase occupancy in preparation for both the seasonally slower demand period and expected elevated supply in the fourth quarter.
2019 in the first quarter of 2020.
This resulted in 30 basis points growth from the increased occupancy.
Additionally, had 40 basis points growth from other income, which included some onetime items such as lease breaks.
Overall, our markets continued to show strength driven by year over year job growth, 2.3% in the fourth quarter of 2019, which exceeded our expectations by 40 basis points.
Income growth continues to outpace rent growth improving affordability in our markets.
Turning to 2020, our guidance of 3.1% revenue growth at the midpoint contemplates rent growth for our portfolio of 3%.
Consistent with long term CAGR is in our markets and what is outlined on the at 16 in our earnings package.
Additionally, we have factored in a slight reduction in occupancy of 10 basis points as well as the negative impact of rent rollbacks related to the recently passed California Assembly Bill Abby 14, 82, which is a 10 basis point headwind for our California communities.
Regarding expenses in 2020, we continue to see pressure and utilities taxes and wages with offsets in controllables, resulting in our midpoint guidance of 3% for a year over year operating expense growth.
In terms of supply the bulk of the new apartment deliveries continues to be in downtown locations. We project that 2020 deliveries will be about 65% lower in our suburban submarkets compared to the downtown urban Submarkets consistent with 2019.
Only 12% of Essex's portfolio is concentrated in downtown urban Submarkets.
We estimate the demand supply ratio in our markets assuming it takes two new jobs to absorb each new home to be 1.7 times, meaning demand is continuing to exceed supply across our west coast markets.
Lastly, we continue to drive our vision of optimizing our portfolio's performance through our strategic tech investments various platform initiatives and asset optimization through data science and analytics.
Recently, we implemented a new lead management system, and our call center and plan to roll it out to the communities this year.
Also in the pipeline is our plan to upgrade 20000 units with smart home technology, and rollout or mobile maintenance platform 2.0 across the company.
Shifting now to an update on our markets in Seattle, our same store revenues in the fourth quarter were led by Seattle, CBD with 5.4% year over year growth.
Well other Seattle sub markets grew between 4.4% and 5%.
Our job Seattle remains the strongest major U.S. market for job growth in the fourth quarter growing 3.3% year over year. This growth was mainly due to an additional 32000 jobs and the top for pain industries, a 57% increase from the prior year.
Regarding made major tech activity in the market in recent years.
Amazon has committed to a sizable footprint of nearly 3 million square feet in the Bell Bellevue area, while recently, putting up 770000 square feet for sublease in Seattle.
Although we're seeing some local geographic movement several other major tech companies, such as Apple, Google and Facebook have recently expanded their footprints in Seattle.
As mentioned on the prior call Apple announced it would expand at Seattle workforce by more than 2000 employees by 2022 significant increase from its current census, a 450 employees.
Other activity in Seattle includes Arab Dnbi, expanding by 60000 square feet and bank of America committing to 116000 square feet of Amazon Sublease.
On the other side of the Lake Washington in Bellevue.
Facebook Preleased, an additional 325000 square feet, but I'll Ali Baba expanded their footprint by 50000 square feet.
Office supply and demand is strong in the market with over 9 million square feet of office space under construction, 79% of which is pre leased.
Multifamily supply in Seattle was down substantially in the fourth quarter and we expected to decline about 30% in 2020 from 2019.
Combination of strong income and job growth as well as declining supply is leading to tight market rental conditions.
Moving to Northern California, you every year same store revenues in the fourth quarter were led by San Francisco, achieving 5.4% growth.
Followed closely by San Mateo at 5.2%, Santa Clara at 4.6% and Alameda at 4%.
Job growth in the Bay area averaged 2.6% year over year for the fourth quarter.
San Francisco, San Jose and Oakland grew at 3%, 2.9% and 1.8% respectively.
The Bay area continues to maintain higher job growth and taught pain industries compared to the bottom pain industries.
Office expansion in the Bay area remains robust in the fourth quarter. This includes biotech expansion activity for about 540000 square feet made up of Amgen's, new lease in downtown San Francisco enzyme virgins, new lease in Emeryville.
In the South Bay, Google expanded by over 800000 square feet, adding a new lease in Sunnyvale. In addition to acquiring a trio of Cisco buildings in San Jose.
Caribbean be grew their south they footprint by signing a 300000 square foot lease in Santa Clara.
There is currently over 15 million square feet of office space under construction in the Bay area.
Over 70% of which is pre leased.
Looking at 2020 multifamily deliveries in the Bay area.
San Francisco deliveries are expected to be slightly higher than in 2019.
Most of which is concentrated in downtown San Francisco and San Mateo.
San Jose is expected to see twice as many deliveries in 2020 than in 2019.
And in Oakland supply deliveries will remain elevated in the broader market throughout 2020 with significant supply continuing to be delivered into downtown Oakland, while Fremont, we'll get an influx half of which will be for sale condos.
Heading for this out further south to southern California, you ever your same store Lake County revenues for the fourth quarter were up 3.5%.
Led by Woodland Hills with 5.5%.
West L.A. with 3.7% and the Tri City Submarket with 3.7%.
The L.A. CBD Submarket continues to decline with revenues down 1.6%.
L.A. job growth in the fourth quarter was 1.5% 10 basis points above the U.S. average.
On supply, we estimate consistently high deliveries throughout 2020 in Lake County.
Deliveries in the L.A. CBD Submarket are expected to remain high at 4% of stock, but down materially year over year.
Our west L.A. and Woodland Hills, Submarkets, we'll see more new supply in 2020.
Moving down to Orange County year over year fourth quarter revenues were up 4.2% and the south Orange Submarket and 3.1% in the North Orange Submarket.
Total 2020 supply in Orange County in San Diego remained consistent with 2019, however deliveries in both counties are expected to decelerate through the year.
Lastly, in San Diego, our year over year fourth quarter revenues were up 2.8% led by the Oceanside Submarket with 4.9% followed by Chula Vista, with 4% and North city with 3.3%.
Job growth for the period was a healthy 2.3% year over year led by professional business services, which made up almost a quarter of the growth.
Apple made progress on their plans to grow the footprint in the Sam in San Diego market by Preleasing 200000 square feet of office space in this rental valley.
Our Q1 renewals have been sent out at about 4.4% and our portfolio is currently at 97.2% physical occupancy with our availability 30 days out at 3.9%.
Thank you and I will now turn the call over to our CFO Angela Kleiman.
Thank you John I will start by providing some color on our 2020 guidance followed by an update on capital markets and the balance sheet.
The key assumptions for 2020 guidance are available on page five stuff our earnings release, and S. 14 of the supplemental.
We are guiding to a midpoint of 3.1 for side for same property revenue and in a way growth this year.
[noise] overall operating fundamentals in our markets remain healthy as we continue to assume study market rent growth near the long term averages and for our West coast markets to continue to outperform the U.S. average.
Compared to 2019, we're expecting a modest acceleration in Seattle, and a slight deceleration in California, largely attributed to demand and supply trends commented earlier.
Moving onto the core AFFO guidance.
We are expecting a growth rate of 4.2% at the midpoint in 2020.
As discussed on our previous call. We have a short term headwind from the repayment of a highly accretive mortgage backed security, which generated a 17% internal rate of return for Essex shareholders.
The loss income from this investment accounts for approximately 18 cents headwind in 2020.
Or 1.3% over a 2020.
That's AFFO growth.
And mostly explain the sequential decline in core SFL between our fourth quarter results.
The first quarter forecasts.
Our 2020 guidance also includes the recent acquisition of a 45% joint venture partner centric in a billion dollar portfolio.
We expect to recognize a 6.4 million promote from this transaction as well so remeasurement gain in excess of 225 million.
Got you incorporate small impairment of approximately 18 million organized into fourth quarter.
This gain and promote will be recognized in the first quarter of 2020 and both are excluded from core FFO.
We remain committed to our co investment platform as it provides for an alternative source of capital and an attractive risk adjusted return for investors.
Over the past three years, we have generated incremental earnings for our shareholders from promote income totaling approximately 66 million.
Lastly on capital markets activities in the fourth quarter, we issued 850 million tenure unsecured bonds.
At an effective 2.8% interest rate prepaid several mortgages with 2020 maturity.
Consequently, we only have 280 million of maturities to refinance this year.
We continue to maintain our discipline to optimize our cost of capital and it will remain thoughtful and opportunistic our balance sheet metrics remain strong with over 800 million of available liquidity.
That concludes my prepared comments and I will now trying to call back to the operator for questions.
At this time will we will be conducting a question answer session. If you'd like to ask your question. Please press star one under telephone keypad, Hey, confirmation, telling when the King. Your line is in the question Q You May Press Star too if you would like to remove your question from the Q4 participants using speaker equipment and maybe necessary to pick up your handset before president Mr., Keith So that we may address questions from as.
Many participants as possible, we ask that you limit yourself to one question on one follow up if you have additional questions. You may recall, Q and time permitting those questions will be addressed one of the fees, while we pull for questions.
First question from Austin Wurschmidt Keybanc. Please proceed with your question.
Hi, good morning, everyone with the move to a high occupancy strategy. What do you guys assuming for blended lease rate spreads for 2020, and then could you also tell us what the spreads look like for the fourth quarter of 19.
Sure. This is John speaking so.
The.
Going forward, what we're looking at in guidance again is 3.1% and that really made up of about 1% or sorry, 3% rent growth as we have on our 16 as well as some other income when you say the blended it would blend to that we pretty much.
Do not push our renewals above the market, we keep them consistent with the markets. So they really run together.
And that keeps it simple and it keeps it focused on the customer experience, which is critically important.
And so what does that blended number versus what it was in 19.
Sure. So in 19 2019, all in you'll obviously our revenue came in at about a four well, 4% for the fourth quarter, 3.4% for the year and that was really about 3.2% scheduled rent, which would be the blended number and the remaining amount.
Relates to other income items.
Got it thanks for that and then just curious what led CPV I'd be wanting to really dissolve that the the venture and what opportunity set do you see across those those six communities.
Hi, its Angela here, the we have I mean, it's an excellent relationship with our JV partners and.
The is it really relates to the timing of the release of the investment. These properties no were form as individual joint ventures, and most of them on form background 2010. So at this 0.1 near that 10 year term and so my sense to have that discussion for the exit.
And so going forward you know, we actually have continued to have oh active conversations about future opportunities at the say come up but as you know US you know we.
Decide to put in an asset or investment and joint venture.
It's really driven by a function of trying to optimize our cost of capital. So it depends on where the stock is trading at the sales are coming in and et cetera.
Did you consider I guess selling outright or was the plan all along really to buy out their interest.
[music].
Well you see that we actually sold one of the assets and the joint and joint venture.
In the fourth quarter, as well and that was myself and so and that was a very attractive sub for cap rate sale.
So we do evaluate whether.
It makes sense to bring it on this wholly owned and really it's what's the best return for shareholders.
Okay. Thank you.
[music].
Our next question is from Alexander Goldfarb Hypersound. Sir. Please proceed with your question.
Hey, good morning out there.
So just following up on on Austin's question on the CPP I'd be a can you just provide a little bit more color on you know funding was there anything transacted or was this sort of an even trade and then to Angela what the benefit is for 2020, obviously you guys working hard to backfill that CMO.
So just curious how much this played a role and and ER and providing Dennis on the F.L. assessed for 2020.
Hey, Alex Oh, I'll talk about the funding and then ill Mike will chime in on the overall strategy a under funding we a use our line of credit to bridge the closing, but our intent is to finance refinanced with long term debt and on the equity portion you know since the portfolio is actually unlevered.
We won't need to raise as much equity to be leveraged neutral. So this will allow us to be opportunistic in our equity issuance or we may sell assets depending on market conditions.
And Alex I'll, just add real quickly [noise] keep in mind that we had a promote.
Which is noted in the press release and we also have a different tax base than what the tax base would be at market and therefore, our yield is a little bit higher and that helps make these transactions attractive to us.
Okay.
Maybe I missed it did you provide what benefit this is on an AFFO.
[music].
Oh, you know what its incorporate into our guidance and so if you look at our Ah we have a line on a accretion from external activities that does include yeah. The CPP transaction among others.
Okay and then second question is Mike your favorite topic, our regulation and taxation. So with all the fun of prop tied in 2.0 prop 13 split roll maybe you can it just address your thoughts on what you guys see the governor and Sacramento as far as increased taxation you know if they do the split right.
Oil and then.
How you think the prop 10 to 2.0 is shaking out at this point.
Yeah, Alex I think it's a good question and it came up very early in the call today. So okay. So.
As I, probably reported recently are actually last.
Late last year, there were 18 bills and were signed by Governor new some dealing with housing.
The biggest one was 14 82, which is a statewide rent control initiative.
Following up on that Theres been some pretty big allocations of funding for housing 1.75 billion last year and 500 million that has been discussed as part of the 22 2021 budget and so I think that be the political environment here.
As.
You know to try to wait and see what happens with these large investments and with 14 82 as opposed to go into the ballot box and trying to create a whole different scenario with crop tend to point out so I think that the politics as a matter or.
The legislature has acted AD in the states is funding.
The housing.
Shortage issue.
To a pretty substantial extent and yeah, let those things run the core so.
That's what we hope happens obviously prop 10 2.0.
They submitted around 950000 signatures in December we're still waiting to see.
If the if the ballot qualifies I'd say that compared to.
The first go round, obviously, we're early early innings and so the.
The proposal has not received a great deal of attention at this point in time, and but if I go back to think about prop 10, there early Poland was that it would pass and that was noted obviously throughout the investment community and it was in fact overwhelmingly.
Feed it into the end and even though this curve proposal is a little bit more palatable.
To the owners I.
I still think that.
That.
We'll be difficult to to pass so and.
By that or I'd been supportive that I would suspect that it will be a.
And ongoing discussion and we will have an entity that will.
Essentially.
Commit to a robust opposition to prop tend to point out and.
Again.
Given the outcome of the Lascaux route I expect that will be successful once again.
Thank you.
Next our next question is from surely Woo Bank of America. Please proceed with your question.
Hey, guys. Good morning out there. So my first question for John .
So I'm actually going to this meet first half a year with more downtown supply and you're really focusing on it off I think that's kind of what they get a sense now in terms of cadence is about 10 basis points.
Occupancy headwind how's that going how do you anticipate that to play out 320 isn't going to be I'm pretty much equal spread or is that going to see more deceleration in the first half versus I count.
Well good question. So let me step back a little bit and explain the occupancy or why we made an adjustment we take a lot of effort put a lot of effort into understanding supply in the marketplace and of course, we know from history that seasonally demand slows down in the fourth quarter in first quarter. So as we ended up.
The third quarter, we've held out as long as possible and then move rapidly made some changes to increase occupancy getting ready for what we saw has a little bit of market disruption and most certainly in northern California, where the supply was going to hit the market. During this lower demand period as we continue through into.
The in the first quarter now we're still at it good occupancy and we expect to most likely carry that occupancy, but the reason why we did it is to put ourselves in a position of strength. So we don't have too. So we if we start to see some isolated pockets of a have a lower.
Repricing, we may hold back in allow a little bit the occupancy to to go down a little bit. So we position ourselves well remembering every time, we lock in a lease at the beginning of the year. It's impacts the entire year of course 12 months. So were really got have our position ourselves position strong all that said I expect our occupancy will be higher.
In Q1, it will go down in Q2 in Q3, and then pick back up in Q4.
Does that answer your question, yes, that's really helpful.
Second question, Andrew. So previously you didn't mention that really every Thompson, which played out in forecasts.
Karen is theres still lot expectation is for more deals in your portfolio to maybe deemed early or are there must be done so far and in terms of pipeline what's in the works to backfill founder.
Surely well that's a good question, we do expect [noise].
Heavier redemption.
And 2020, and I think you may recall that that we had talked about yes.
Our investments tend to have a three year life and sometimes they get extended longer which is terrific and so the redemption timing can be lumpy. So as for I 2020, the redemption outside of the mortgage backed security investment and Ah So under prefer equity.
I am as it's about 25 million and its you know between the first half and the second half its pretty even and maybe a little bit heavier into second half enough for south is probably somewhere around 110 ish.
So that's the cadence as far as the up pipeline.
Hi, Adam will chime in on that yes, certainly this is Adam we're we're pursuing an underwriting several deals in parallel at this point on the private equity side.
It does it these deals are inherently have long lead time, just like any development deal so when they actually come to fruition.
Always be.
An unknown, but we are pursuing many and and have quite a few in the pipeline yeah and surely you may recall, we have a guidance of between 50 to 100 million sources 75 midpoint. So that's a good number two for modeling purposes.
And then the one thing I'll add is really the timing on this funding because they do lag a little bit and so you want to layer that consideration.
Great that's really helpful. Thanks, guys.
Thank you.
Our next question from.
Nicholas Joseph Citi. Please proceed with your question.
Thanks, you probably the decrease in permitted in your markets, but given the current pipeline in the tank construction environment that you talked about what do you expect to see the actual benefit from the decline in terms of deliveries.
Yes, Hey, decades, Mike Schall [noise].
You know I think that when we look at permits you are looking to few years out and there is a natural lag.
There are so.
Connecting the drop in permits over the last couple of years I think we're still looking down the road in terms of when that actually come to keep in mind that California. Unlike many places around the nation has a much longer period as you go through the permitting process and a and delivery process and I think that's.
Complicated to some extent by.
The lack of or the tight labor markets in construction in terms of getting things finalized and moving ahead. So I'd say, we're looking beyond.
2021 to really see a significant impact.
Thanks, and then maybe following up on Charlie's question and I think in your prepared remarks, you talked about continuing to pursue development, but seeing better risk adjusted return with a preferred equity is and the other structured investment.
Obviously can get a better return from those spot there there's a difference in duration and length of investment. So how do you think about the size of both of those and the sticky mess up the cash flows.
Yeah, I guess I'll start Big picture and then added can it can take it from there.
Generally speaking, it's a risk reward equation and we.
We'll do direct development and I would say more at the bottom of the cycle because conditions at the bottom of the cycle are typically better and by that I mean, theres less pressure on construction cost. The cities are more receptive to development because they're trying to keep their construction labor force at work.
And so they are more willing to forgive as you go through the cycle.
More and more impediments and I can use a variety of examples for that public our work projects that are part of your deal more difficulty in getting the phasing or you know temporary certificates of occupancy et cetera, so the headwinds become more substantial and so.
Within the yeah preferred equity I mean, we're looking at the same deals we otherwise could do as a direct develop a direct developer, but we're looking at that risk reward continuum, and we're saying hey, all things being equal.
Let's do acquisitions and preferred equity as opposed to more direct development. So having said that I'll turn it over to Adam because we he has been pretty active at looking at development deals and it's not that we are.
And that actually has found a couple that steady line. So we're looking at both just try to make good decisions and certainly where we are on economic cycle and again construction cost increases and all the other related factors come into play Adam you want to add to that you're looking at briefly I mean, we continue to underwriting.
Track all the land deals throughout our markets.
Unfortunately, though given a dramatic increases that were seeing in construction costs relative to where and why growth as Ben.
We just we've been able to see this real time through our property program generally speaking, we aren't seeing the necessary yield premium too so really pursue the majority of the development deals out there as Mike mentioned, there are some that they didn't that parameter and.
And provide the adequate risk adjusted return, but for the most part deals are tough depends on right now.
Thanks.
Our next question is from Steve Sakwa Evercore ISI. Please proceed with your question.
Thanks, Good morning out there.
Hey, Steve.
Hey, just two questions there kind of both Seattle related or you know you guys spoke pretty positively about job growth out there to the strength that you're saying I think you mentioned supply was gonna be coming down when I look at your 2020 outlook you know you've only got at the midpoint about a 20 basis point acceleration in revenue growth in Seattle and I'm just wondering.
The the commentary would suggest maybe the market's a bit stronger than that so I'm just trying to figure out or you just trying to be a little cautious here is there something that keeps you you know more or less flattish or.
You know how do we sort of interpret that.
Sure. That's a fair question and you at this point in time, you're right Seattle is doing really terrific. It's a rinse youre roughly 5% up year over year at the same time. The unemployment is very low it's a from 1.7% in that zone.
So we do expect the employment growth rate to slow down and and that's partly driving it we were showing in our 16 employment slowing down pretty significantly across the board still staying 50 basis points over the U.S. average for the Essex portfolio, but slowing down because of the low unemployment and.
Yeah, it'll has the lowest unemployment of all the areas. So that's the scenario that we have out there at this point in time, obviously, a employment is beating that expectation and.
We'd love to see that continue.
Okay, and then I guess you kinda the other side on the expenses you know clearly a b has very low expense growth in Seattle I know there were some kinda tax benefits real estate tax benefit. She got can you just sort of remind us of the aggregate benefit in 2019 from that that kind of axis, maybe a headwind on.
The expense side in 2020.
Sure. That's a good question there I'm on the Seattle property tax it was an interesting year in 2019 in that our property tax Bill actually came in lower than 2018, and it was all driven by a assessment dolls and so.
You know what that means is definitely a from a year over year perspective, we have challenges on the comp.
In terms definitely how how we think about 10, Seattle property chess 'cause it it's not Tom it's one of those things those numbers are just not snowball. So in 2019 were 3% lower than the prior year, who the assessments, but the five years before that.
Ah those increases when between 13% to 17%.
So.
In 2020, what we tried to do is kinda thread the needle and and you know looking at Tom.
Like a base run rate of 6% and then you add into you add into it the refunds were looking at how low single digits, 99% for Seattle property tax increase.
Okay. Thanks.
Our next question is from Neil Malkin Capital One Securities. Please proceed with your question.
Hey, Thanks, guys I'm not sure if you answered Austin's question in the beginning of in terms of and the new and renewals that you had in Fourq you, but just curious is what you're kind of seeing in January for new and renewals and what occupancy stands at for the portfolio today.
Yes, sure. So let me go back to make sure I answer that I may have missed that so in the fourth quarter, new rents were about 2.2% renewals were about 3.5% and really the bigger difference was in northern Cal where you know the supply was coming into the market going forward in.
The first quarter I'll answer your question.
Renewals they went out at about 4.4%.
Today market rents are a 2% to 3% up year over year in and that's really a factor of where the slow demand period. So again it. It always is a little bit wonky in December and January we expect.
As to what we expect to achieve the market rates, we have laid out in our 16 and of course, the strongest market as I already mentioned to Seattle.
Right and then what's occupancy.
Oh occupancy is a 97.2.
Okay, Great and then an excellent.
Preferred investments obviously, you've highlighted is is what you guys are you know choosing to do in terms of capital allocation I'm just curious on either the current book or the ones. You're underwriting is there an option are you trying to get options to actually roll your and your preferred into into equity or.
You know essentially take ownership of those deals on when they complete or is the financing market just too too easy to for the developer to sort of get permanent financing.
Yes. So this is Adam we look out in several ways I'd say most stock based on kind of down number fairway, perhaps deal is going to be paid off after certain period of time, whether it be two three years.
We do however, with with every deal we have that conversation, where there are potential hybrids, where there is a potential to convert into equity and and it. It is on a deal by deal basis, and we're seeing probably a little more of that opportunity now given where we are in the cycle.
Alright, thank you.
Our next question is from Rich Anderson as NBC. Please proceed with your question. Thanks Good morning.
So.
And so on the a M a call this morning.
They kind of outlined a sort of a silver lining to supply that you know the rents are 25% above there. They are in place rents and so it's a you know an opportunity for them to deploy some redevelopment so on and so a little bit of and you know you know a good in a bad situation.
Do you see similar dynamic in your markets. Considering you also are sort of a BB plus type of product is is the incoming new supply while problematic.
Provide some opportunities for you to redevelop and sort of find that middle ground between what's being delivered and where are your your market where your rents are today.
Yeah Rich. It's good question that I'll start and lateral to John after that I guess from our perspective, you can't produce a b. So there and therefore all the supply is in the age category. So the closer you are today the more impacted you are.
By the concession environments and the new deliveries so.
In addition to that you have this where's the supply going which tends to be more urban downtown as opposed to suburban. So all of these things are factored into that equation and I think that we are seeing the best opportunities to redevelopment to redevelop in.
Suburban be markets and so I would suspect that that will that will continue John anything I Miss there yeah. No I think you I think you picked it up.
Great and then second question, perhaps [noise].
For anyone but yeah any comment on partner said, a you know I know you guys were in that a years ago and not this time with Aimco jumping in I'm curious if you took a hard look at at Soffe look at it not looked at it at all the anything any kind of color be interesting.
Yeah Rich this is Mike again, it was pretty broadly marketed and so it wasn't as if that was acquired deal was it was marketed around and when I think about our preferred equity business.
Yeah, we think about really two things one is.
Development deals, where we're coming in at the last minute just before start just before the start so we know what the construction costs are so we're trying to take that.
Construction cost risk off the table in those deals and then we also will do preferred equity on stabilized portfolio, which actually was the first go round that we had.
With Parker said when we as you alluded to we had invested in at once before at a much lower value by the way and so this transaction is neither of those because it is looking at the development deals and trying to.
Assess how they might look and so it didnt really fit our basic strategy and we will from time to time deviate a little bit from our strategy. If we really see a lot of value but.
Yes, we just didnt think that was applicable are appropriate at this time.
Okay sounds good thank you.
Our next question from John Kim BMO Capital markets. Please proceed with your question.
Thank you.
I was wondering on the CPP portfolio. If you could provide some color on where the assets are located.
Do they contribute immediately to the same store pool or will it be 24 months now.
And also how do you think the performance of this portfolio will be on a same store base is relative to your existing consolidated assets.
Hey, John so.
As Angela mentioned, we sold maso in Q4, so that was in downtown San Francisco.
And.
So and Andrew why don't you take yeah here and the rest of the portfolio I'm. It's it's all throughout northern California. So.
We have a one in assumed the tail one in Dublin. Good morning, Pleasanton, So in the HM East Bay and San Jose.
And of course Walnut Creek.
So those are the urban locations bets on Northern California, and you know as you know we built these and I have operating them. So no they assets very well and and certainly like in a very much and glad to have roll them into our consolidated portfolio.
They will be in the same store next year, because as you may call, we welcome and and ill will have one year of comparable results before we had him to the same store pool.
Okay and can you just remind us why the coinvestment generally are accounted for under the equity method when you own in many cases, 50% or more.
The joint venture.
[noise] yeah, it's its its an off balance sheet because of the control reasons I'm you know our partner have essentially.
On.
Ah comparable <unk> approval authorities on basic items like budget as well you know a and financing and so it's really a technical reason.
So is there anything different in asset management that you're going to do as as you take these.
Assets under your control.
Yeah. This is John speaking no not at all the operationally asset management wise, we operate all over assets consistent when the consistent way or partnerships, we have great relationships and we don't have a Essex way and then the other way it's I call. It the family it's.
So one way we operated in an integrated approach across the board. So there won't be changes there we do like the location of the assets quite a bit there in the technology markets that are growing and we're excited about that but there's not a or a change like it would happen when they're buying an asset from a third party.
Got it okay. Thank you.
Our next question from Rich Hill Morgan Stanley . Please proceed with your question.
Hey, guys.
Mike maybe I'll start with you just want to think about the age of your portfolio and sort of the age of your assets within your portfolio and how that influences your capital allocation decisions to maybe by some assets and sell authors.
Sure Rich.
Yes, our portfolio with you as you note is a little bit older than other portfolios and I would attribute most of that to the fact that we produce less than 1% of our stock of our housing stock per year, and therefore as you can imagine over 20 years, you produce less than 20% of your stock and therefore, 80% of your portfolio.
Leo is more than 20 years old. So just the fact of life and and we think that this is a very very good thing.
We don't produce a lot of housing in general and.
So I think it's just that is the nature of our markets and we are a reflection of our markets in terms of opportunity you know again I would say you can't build a b and therefore, you see less competition and so I'd say generally speaking at the early part of the cycle.
So maybe the A's outperformed the BS and as you get later on in the cycle These outperform and though.
All of those.
Broader themes are out there and then I'd also say that.
As the a product becomes more luxury oriented it opens the door toward very thoughtful redevelopment programs, where we can add value and add a yield that is higher than a cap rate.
And benefit both from the growth embedded in the redevelopment program.
And the.
Increasing the value of the portfolio any cap it out so it's kind of all those things.
Got it that that that's helpful. Mike.
John quick question for you look we definitely agree that there is not enough supply of apartments relative to demand sort of picking back up for what Mike said in so look I think a lot of questions. On this call has been about supply, which is obviously a near term consideration, but we've always thought demand and job growth is a big long term driver over them.
Long term. So I was wondering if you could just maybe take a step back and help us think about what are you looking for in your west coast markets, where demand could accelerate to the upside and and maybe what what makes you leave what would leave you a little bit more cautious.
Sure you know what we see right now was as I mentioned, we have great demand in a in the Seattle area and that combination with a great demand in the decline in supply is a tightening up the rental market quite a bit that terrific you know as it relates to cautious it gets back to just the.
Temporary impact that disruptive impact of the supply entering the market and that again is largely located around the downtown locations. There's some level of that is certainly in L.A., although l. is getting a little bit better little bit less supply than last year still l. downtown L.A. is problematic.
Oh plant to some extent, but of course Oakland is you have to understand Oakland it fits into the broader bay area and so whereas L.A. downtown L.A. sits there in its own market Oakland is really into related to San Francisco because people take Bart across so you have to look at the demand in a broader area there, but it's.
It's the supply that causes some concern and it's temporary as as as you noted.
Does that answer.
Yeah, Yeah. It does it sounds like what you're seeing what you're saying is that.
The demand side of the equation remains very very strong and although you know.
Although tech is diversifying across the United States Tech remains very strong in the up their economies you operate in or are quite diverse.
That's true in it and I would say with attack. It is it does it is going across the U.S., but this headquarters are still here in the highest paying jobs are still here. So it's yeah, they're doing the natural thing as far as taking more of the back office and moving that out and then taking other components of the business, but that the creative design the top notch.
Aspect to the tech really still located west coast, you find that in each of the different companies that are that are out here. The major companies and so it's that and the incomes that are tied to that which really drives income growth and that is certainly beneficial.
Yeah, great guys. Thank you.
Congrats on a good quarter.
Thank you thanks.
Our next question is from John Guinee.
Stifel. Please proceed with your question.
Great just building on the current discussion Oh, the great affordability migration is alive and well.
And all you, although you have a really good property tax driven competitive advantage in your markets and.
And with an ability to really grow outsized f. out any chance you would ever look at the.
Higher growth markets, whether it's a Denver Phoenix, Austin, Portland places like that.
Hey, John It's Mike.
We've been in Portland, before and exited Portland.
And we do look at it from time to time, it's it's definitely on our list.
Portland.
The reason why we exited is because they had an urban growth boundaries that they essentially except expanding and so we can we convinced ourselves that was not supply constrained.
So you know I guess it depends on.
What housing and how these markets adjust so.
Our experience, it's not just the apartment supply, but relatively inexpensive single family housing meant that essentially as soon as rents get to a certain level people go you know what I don't need to pay this read anymore I'll, just go and buy a house and so.
We look at that dynamic of what the what well be charged for rent and what the comparable house and how difficult. It is for our renter base to be.
Diluted by Homeownership and so.
If we could find markets that satisfy and that look appealing from both those perspective is good job growth and the overall amount of supply.
Is somewhat limited and the transition from a renter to homeowner is somewhat limited we think that that is that a good market practically speaking and we would go through this process with our board every year in terms of current markets and and other possible markets. So Portland is definitely on that list and there are so.
Some other markets that are on the list as well generally speaking there that more supply constrained markets.
Great. Thanks.
Yeah sure.
Our next question is from article Zelman and Associates. Please proceed with your question.
Hey, guys Ah Thanks for taking my question.
I looked at your.
Same store revenue guidance I, just focusing on northern California.
That range <unk> point.
Thank you.
Give me some color on what has happened in the market or 2.6.
Javed and then what has to happen for 3.6, we achieved what are the scenarios.
[noise] well it really revolves around supply as a new homes, and then demand and that interaction. The yeah. We obviously believe we're going to hit the midpoint that is the the probable target, but the impact the disruptive impact of supply coming into the market in Q.
No one could negatively impact things again at that point you are locking in.
Rents lower rents, possibly for a longer period of time for the year.
On the other side, if supply gets delayed and it moves into the higher demand season, Q2, Q3, that's beneficial so.
It's a range we expect to hit the midpoint, we knew this enough supply demand it did dynamics going into this but if they move around a little bit honest that will that'll adjust that does that make sense.
No. Thank you it doesn't mean just as a quick follow up I noticed you guys are going to be planning lumping that acquired can you discuss why.
Cost to capital.
Just the type of product you're looking to buy is it isn't going to be more of.
Selling older stuff that others see as value add and buying recently.
Recently built stuff well what is kind of the niche that you're targeting.
Okay. So so nothing on the disposal added this is Adam on the dispose side, we're going to target the assets that have been slower growing within the portfolio in order to maximize our overall portfolio growth.
On the acquisition side and on the disposition side, our our target is between one and 300 million. As you noted we expect to be not acquires this year and again, we're looking at.
Just shy increasing increasing shareholder.
Return over also we're going to be looking at our higher growth markets.
As Mike alluded to earlier in the call, we're going to be looking in that probably a minus to be category. The brand new staff as we've seen.
The last few years, given where that's what the supply is coming.
That that product has not grown nearly as well as abuse.
[laughter].
Got it and its are there plans to renovate something when you buy side or is it something you like to look for something that's already you know that doesn't need any incremental comp.
Yeah. This is Mike yes, we do just about everything so yeah. We've been needs renovation plan, we will build that into the pro forma and if it's in good quality shape.
We will look at that as well I mean, we're we're really sort of agnostic as to.
Where the property is from again that let's say the b minus to a level. It's all about growth is Adam as Adam suggested and if that growth comes from redevelopment, we're happy with that if it comes from us understanding the market and growth rate a little bit better than everyone else so be it.
Again, we're totally.
Totally focused on what does the return of what we're buying versus you know compared to the portfolio as a whole.
And that's how we make those decisions.
Got it. Thank you that's all for me.
Our next question is from John Polaski.
Green Street Advisors. Please proceed with your question.
Thanks, just one question for me John You mentioned there was a 40 bips left to other income this quarter largely due to lease break fees. It's a lot larger than last several years than in the fourth quarter. So just curious what's driving the outsized lease break fees right now.
Yes at least brakes was was one component was the biggest component I called I called that out there was other items as well.
But yeah, what was driving the lease breaks really relates to the supply that was coming into the market in Q4.
And again that goes back to our decision as we saw that this year supply was going to start hitting the market and we filled up or increased occupancy. We did anticipate this type of thing to happen. What you go into the low demand period. The a concession start to increase set at the new supply and you get to about eight weeks free in some cases and pay.
People will break their lease and transfer and so that's what was driving it.
Well actually I got I can add that the move out to purchase homes was.
Has recovered a lot and was 12.1% in Q4 little bit higher than has been and the recent past.
Okay.
All right I take care guys.
Our next question from Rob Stevenson Janney. Please proceed with your question.
Good afternoon liked as the continued legislative environment and ballot initiatives in California may condo projects any more attractive in certain submarkets and any chance, we see some of the under construction apartment projects go condo before leasing.
Yes.
That is a good question you know one of the Conundrums that we've experienced over the last several years as we bought.
Many.
Ill condo buildings in the last cycle and we had hoped to.
Converted back to condos and sell them at a lower cap rate than we could otherwise cells apartments, we have not sit down that's the case at all in fact, if anything it's called the other way Weve produced.
More rental housing much more rental housing than we have.
For sale housing and that's been an ongoing dynamics. So we haven't seen that spread that we had hoped for.
In pricing.
Versus a at apartment values and which of course is what what triggers that and you know with the recent [noise].
Recent past increases in.
The price of the single family home being in the minus one minus three I think in San Jose to about 1%.
In the best of our locations.
It hasn't helped that condo versus apartment valuation.
Okay, and then I think I heard you guys say that the negative impact of 14 82 is 10 basis points in 2020, given your supply issue commentary you guys really havent, many units, where you'd be raising rents by more than 5% plus inflation. This year, if you cut.
Yes, so where the this is John where that negative in impact tons comes a hits the revenue it really relates to short term rentals in the premium associated with that and so you'll often times at the end of lease we will always gives our customers the options they wanted and on the show.
But if they want to shorter term option there was a premium related to that and ER.
14, 80 to restrict that premium and so thats, where the a 10 basis point headwind comes from.
Okay, and just 14 any to.
Restrict fees for like parking and other stuff and is it based on gross or net effective rents in other words most of the apartment Reits are operating on an effective rent basis, because 14 82 lead you to offer a higher face rent and then use concessions to get to essentially a market rate level or does the legislation see through that game.
That's a great question, then like you know lot of legislation things aren't always spelled out as much as we would all like.
So that's not necessarily contemplated in the a in the legislation my sense is that will get a addressed in the a in the courts, but it's really focused on rental revenue and not other revenue, but as far as the details of that I think it'll get resolved somewhere in the future.
Okay, and so there is no clarification, right now whether or not it applies to face rents are not effective.
We interpret it as being applied to face rents.
Okay. So off of unit was ramping if market around with a thousand dollars for 12 months you guys could theoretically raise that rent a 1200 now for two months free.
And being the same place economically and have ability to have more greater rent growth and 5% plus inflation.
Hi, just discounting glass.
Yeah I mean.
First let's go back to step so so the there's 14 82 really is it impacts.
Renewals right. It when the unit goes vacant it's a it's market rent so at the end of the a.
Lease period.
We typically in the residents typically respond to a direct renewal this not generally concessions in there.
And it we're not anticipating going that direction.
Okay, just curious given your sub 50% turnover and it keeps heading south every year, whether or not you get into a situation, where you actually you're going to need at some point greater turnover.
Yes, I mean, I frankly, I love. The fact that we have lower turnover I think it's reflective of quality of service out at the assets.
As well as being fair, we meet the market, we're not trying to push rents beyond the market.
Were fair in in a in how we price things and.
Again, I think that the site teams are doing a terrific job. So I think the lower turnover is reflective of that I'm not sure it's going to go much lower than that.
You had to there's a natural need for people to move.
Okay. Thanks, guys.
Thank you.
We have reached the end of the question answer session and I will now turn the call back over to Mr., Michael Schall for closing comments.
Thank you operator.
Want to thank everyone for joining the call today and look forward to see in many of you at the upcoming Citibank conference have a good day. Thank you.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.