Q3 2022 Essex Property Trust Inc Earnings Call
[music].
Good day and welcome to the Essex Property Trust third quarter 2022 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.
We're 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.
Other information about these risks can be found on the company's filings with the S E T.
It is now my pleasure to introduce your host Mr. Michael Schall.
It didn't and Chief Executive officer for excess excess property trust. Thank you. Mr. Schall, you may begin.
Thank you for joining us today and welcome to our third quarter earnings Conference call.
Angela Kleiman, and Barb Pak will follow me with prepared remarks, and Adam Berry is here for Q&A.
I will begin by congratulating Angela for her appointment to the Essex Board and for being chosen as the next CEO of the company. Following my planned retirement in March 2023.
I have known Angelo for almost two decades, and we have worked closely together since he joined the company 13 years ago.
Angela embraces and exemplifies ethics his strategy and core values and there is a dedicated thoughtful leader as well as an excellent negotiator.
Our recent leadership announcement was a culmination of a multiyear succession plan administered by the Essex Board and I appreciate each participants commitment to the plan that resulted in its success.
It has been an honor to lead this awesome company made possible by my Great leadership team and the coordinated effort of every ethics associate.
My thanks to all of you.
Today, I will touch on our third quarter results introduce our initial market level rent forecast for 2023 and provide an update on the on the apartment investment markets.
Our third quarter results represent our fifth consecutive quarter of improving core <unk> per share.
On a year over year basis, we reported core <unk> per share and NOI growth of 18, 3% and 15, 4%, respectively with core <unk> exceeding the midpoint of our guidance by <unk> <unk> per share.
The positive results are reflective of the team's execution and the continued recovery throughout our markets largely driven by the ongoing rebound in northern California, and Seattle with Southern California remains consistent and strong pro forma.
Year to date the economy on the West Coast has shown resiliency with job growth as of September 2022 of four 3% in southern California, and significantly higher in the tech markets of Northern California and Seattle.
The positive job growth is partly attributable to the recovery of workers lost amid the significant shutdowns early in the pandemic, especially leisure hospitality and service jobs that were added throughout the summer.
As a result, it is not surprising that the unemployment rate at each Essex market with the exception of Los Angeles is under 4%, including San Francisco, and San Jose and the new <unk> in the mid 2% range.
The unemployment rate in Los Angeles is higher at four 5%.
Likely related to the ongoing eviction moratorium in the city of Los Angeles, which is expected to run to end in February 2023.
Job openings at the large tech companies have declined from record levels. During the pandemic. Although there remains significant with approximately 20000 jobs available roughly consistent with the number of job openings. They reported between 2016 and early 2020.
Thus, while we recognize that tech job growth is slowing the large tech companies are well capitalized and continue to expand and hire in our markets.
As in previous years, we have included our initial forecast for 2023 market level rent growth on page S 17 of the supplemental.
Our forecast begins with the consensus estimates of third party economists for the national economy with respect to GDP and job growth indicated at the top left of page 17.
Based on these estimates our data analytics team estimates job growth in each Essex Metro.
On the supply side, we use our ground up fundamental research to estimate apartment deliveries, which has proven to be highly accurate over many years.
Everyone's visibility into next year is limited by uncertainty related to past and future.
Ed actions and their impact on the overall U S economy, and therefore, the forecasted rent growth may vary if the key assumptions prove inaccurate.
In summary.
Housing supply across the Essex markets is expected to grow at 6% of existing housing stock with the greatest increase occurring in Seattle with a one 1% increase job growth is expected to be new next year growing at 4% overall in the Essex markets with the best job growth.
Expect it to be and in San.
San Francisco at just under one just over 1%.
As a result of these demand and supply assumptions, we expect net effective new lease rents to increased 2% in 2023, with our California markets expected to marginally outperformed Seattle.
On a year over year basis, we expect apartment supply to decline about 10% in 2023 with northern California, having the largest expected reduction down 45%.
We also expect 2023 single family deliveries to be similar to 2022, even with permits growing modestly given much higher mortgage rates.
With respect to for sale housing declining housing production and reduced affordability or tailwind for apartments in the Essex markets, representing a small positive factor contributing to our rent outlook next year.
Given economist's expectations for a modest recession in 2023, I'd like to summarize our historical experience about operating our portfolio in previous economic downturns.
Generally in each significant past recession, our weakest market has been Seattle, which is due to the confluence of negative job growth and higher levels of housing supply deliveries.
Northern California follows a similar pattern to Seattle with respect to job losses during recessions, although was significantly less supply that results in outperformance relative to Seattle.
Finally, southern California is our best performer during recessions, given its diverse economy and minimal supply.
That being said each recession is unique and there are several factors that could lead to a different outcome.
Most of the previous recessions, followed a long economic expansion, where rents grew substantially and as those higher rents at pressures affordability and fosters higher level of apartment supply.
On the West coast rent plummeted in the early part of the pandemic and our recovery was much delayed compared to the rest of the country, where southern California's recovery beginning in mid 2021 in northern California, and Seattle in early 2022.
As a result, the west coast is still in the early stages of its recovery from the 2020 recession and housing supply has not had sufficient time to fully recover.
In addition, with many offices closed during the pandemic. It was common to higher remotely with the expectation that workers would need to relocate closer to offices upon reopening which is now occurring.
The relocation of employees back to the West coast pursuant to return to office programs represents demand for apartments that are generally not included in job growth. Finally, we expect less outward migration in the next few years, primarily because because those are typically leave California, such as the newly retired probably.
Left early in the pandemic when businesses were shut down.
In a moment Angela will comment further on migration.
Turning to the apartment transaction market. We have recently seen a few deals close evaluations that were negotiated before the most recent increase in interest rates and conditions have changed since then.
Significantly impact transactions as expected the immediate impact of higher interest rates will result in diverging buyer and seller expectations for property values, resulting in a larger bid ask spread Jenna.
Generally it takes more than than higher interest rates to create financial distress, especially with recent strong rent growth given inflationary pressures. However, pockets of distress may develop from credit or liquidity events or access of fed tightening although no major issues are apparent at this point.
Broker price talk with respect to apartment transactions indicate that cap rates for high quality and well located apartments are in the mid 4% range in the Essex markets.
Finally, I wanted to note that our balance sheet is in great condition. Thanks to the unwavering urgency of Barb and the finance team over the past several years when the markets turn positive we expect excellent opportunities to invest accretively and we will be in a position to be opportunistic.
With that I'll turn the call over to Angela Kleiman.
Thank you Mike I will begin by expressing my sincere gratitude to Mike for his Mentorship and guidance over the past 13 years I am honored to have the opportunity to lead this organization and to build upon the company's long history of thoughtful capital allocation and operational excellence.
My comments today will focus on our third quarter performance, followed by some regional highlights and then wrap up with the key operational initiatives that we are excited about.
Starting with the third quarter journey during much of this period, we capitalized on the strength of the underlying fundamentals in our markets by pushing rents and achieved 10, 3% year over year growth in new lease rates in the third quarter.
Although this is a deceleration compared to the 20% growth in the second quarter keep in mind that new lease rates in the first half of last year declined by about 6% in the second half new lease rates surged to positive 17%.
The tough year over year comps is the key driver of the deceleration and the third quarter results are in line with our expectations.
In general we have seen a normal seasonal rent pattern accordingly, as we approach the end of the third quarter, we shifted to an occupancy focused strategy.
Turning to the delinquency.
In recent months, we have begun to recapture more units from nonpaying tenants with the ending of eviction moratorium. It is no surprise that the number of move outs related to non paying tenants have increased looking forward. We planned for a higher volume of move outs, which may create a temporary headwind in occupancy.
The rest of the year and into 2023.
For this reason, even though we have shifted to favor occupancy, we anticipate our occupancy to be slightly lower than historical levels.
The good news is that regulations are being pulled back which is allowing us to finally make progress until FMC.
Moving on to regional highlights starting with Pacific Northwest after a strong start to the year rents in this region have peaked and you in late July .
The seasonality through the third quarter, which includes the typical decline in market rents subsequent to the peak.
It's consistent with what we have experienced featuring twenty-six gene in 2019. However.
Since mid September we've been facing softer demand along with higher level of supply deliveries in the second half of the year.
So we are monitoring this market closely.
As for Northern California. This region has led our growth in net effective new lease rates since the start of the year.
Strong job growth and return to office, our two key contributing factors.
[noise] Bay area net in migration has continued to accelerate this year in the third quarter over 35% of move ins were primarily from outside of our markets, which is an increase from 15% in the first quarter, notably we are seeing positive migration trends from markets as diverse as Dallas and Boston.
System with our previous commentary on commitment of Tech Giants to continues to expand in northern California.
We are excited to see Google break ground last week on its massive mixed use development in San Jose.
This development is expected to bring 25000 high paying jobs and effectively doubling the amount of office space in downtown San Jose This will be a long term benefits of ethics as we are almost 6000 units in this region.
I'm, two southern California healthy.
Healthy job growth is continuing to drive incremental demand for rental housing and such this region continues to perform well. We are also seeing positive in migration to southern California, There's 30% of our third quarter move ins coming from outside the region compared to 70, 17% in the first quarter.
Turning to key operations initiatives.
We have completed the rollout of first phase of our property collections operating model, which focused on leasing administration and customer service.
By way of background. This model Optimizes, our geographic density and transforms our business from operating each property individually to a collection of around nine to 12 property.
Shifting business strategy enables us to leverage our team and technology to improve the customer experience and achieve significant efficiencies.
I'm pleased to announce that phase one is fully rolled out across the entire portfolio ahead of plan and the progress is beginning to show up in our financial results year to date administrative expenses were up only by one 4%. Despite a significantly higher wage increases along with other inflationary pressures on expenses.
The next step is to apply the collections operating model to the maintenance function.
We have demonstrated previously this model has created more career advancement opportunities for our employees through specialization, while improving efficiency and customer service.
Maintenance collections highlight is currently underway and rollout is planned to start by mid next year.
Lastly on the technology front.
The implementation of funnel software suite is progressing well as you may recall funnel is a R. E T venture company with whom we have chosen to co develop applications to enhance health platform.
The funnel product will handle the end to end customer experience from initial prospect inquiry through the phone rather than lifecycle, which will result in better experience for our customers.
From an employee perspective, this technology will streamline automate the manual tasks associated with roughly 60000 transactions each year. Our initial pilot showed a promising 35% reduction in cask time associated with these activities continued refinements are underway and we are.
<unk> to work towards a full deployment by the end of 2023.
With that I will turn the call over to Pat.
Thanks, Angela today I'll discuss our third quarter results, followed by an update on investments in the balance sheet.
I'm pleased to report third quarter core <unk> per share of $3.69 of <unk> to the mid point of our guidance range half of the outperformance was due to lower operating expenses, which is timing related and the other half was from higher co investment income due to better NOI growth at the joint venture properties and higher prefer.
Equity income for.
For the full year, we are raising the midpoint of core <unk> by two cents per share to $14.47, representing approximately 16% growth compared to last year.
As it relates to delinquency, we are seeing continued improvement in our gross delinquency, which is helping to offset less emergency rental assistance fund.
The same property portfolio gross delinquency improved sequentially from four 5% in the second quarter to approximately 3.5% in the third quarter October improved further to around 2% we suspect the gross delinquency trends will continue to.
To improve as they work to recapture delinquent unit.
However, the improvement is unlikely to be linear.
One additional positive development that recently occurred is the city of L. A approved removing eviction protections starting on February 1st of next year. This will allow us to recapture delinquent units and an area that accounts for approximately 40% of our outstanding bad debt and will allow us to finally get back to work.
Oracle level of delinquency.
However, it will take time to achieve this goal and we would expect delinquency will remain elevated through the first half of 2023 with the expectation that we will get closer to our historical average of 35 basis points of scheduled rent by the end of next year.
Turning to our stock repurchase and investments consistent with last quarter investing in our own portfolio and select a preferred equity investment offers the best risk adjusted returns in today's market.
And the third quarter, we repurchased $97 million of common stock at a significant discount to our internal NAV.
Which we plan to match fund on a leverage neutral basis with proceeds from a disposition expected to close in the fourth quarter.
As it relates to other transactions, we closed $65 million of new preferred equity and subordinated loan investments during the quarter and committed to one additional investment in October . These new commitments are expected to be match funded with redemptions of two structure finance investments that are slated to close in the fourth quarter.
Finally, I want to provide some additional color on the strength of the balance sheet, our net debt to EBITDA ratio remains healthy at a five at five eight times and we expect this to further improve its EBIT continues to grow.
It should be noted that we operate in around the same leverage levels before the pandemic and our balance sheet metrics are strong.
In addition, we are well positioned from a capital needs perspective in October we closed the delayed draw term loan that will be fully drawn in April 2023, with proceeds intended to repay $300 million in bonds that mature next year, we have swapped this debt to an all in fixed rate of four 2%.
As a result of this transaction we have all our non funding needs addressed until May of 2024. The company has no significant unfunded development needs and confirm the dividend operations and capital expenditure needs from free cash flow.
Additionally, our variable rate exposure, excluding our line of credit is minimal at less than 4% of our consolidated that with.
With over $1 1 billion in liquidity no funding needs for the next 18 months and access to a variety of capital sources. The balance sheet remains well positioned I will now turn the call back to the operator for questions.
Thank you ladies and gentlemen at this time, we will be conducting a question and answer session.
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Please limit yourself to one question and one follow up so we may get to everybody's questions.
Our first question comes from the line of Nick Joseph with Citi. Please proceed with your question.
Thank you and congratulations both Mike and Angela.
Maybe just starting on the building blocks for next year, obviously, you provided the market rent growth of 2%.
Earn an expected from 2020 to be seen and then where's the loss to lease today, and where would you expect it to be at the end of the year.
Hey, Nick it's Angela here, so on the earn in for 2023.
I think if it's okay with you I wanted to start a step back and make sure we're using a consistent definition.
For us the way, we look at our NIM is.
We look to the September loss to lease, it's not too hot not too cold.
And take 50% of that so in this case September to off lease was close to 7% taking half of it would be about three 5% and that will be our earning and we assume no market rent growth.
Now what we've heard is there's a eight eight.
Question about.
'twenty 'twenty three revenue growth and and how does the earn in applied to that and so what we've done in the past is explained that by saying you take you earn in.
And then we look at our 'twenty 'twenty 317 market rent growth and take 50% of that.
So that would be that market rent growth is 2% and so half of that will be 1% you add that to the three and 5% earn in that gives you a proxy of about four 5% for revenue growth for 2023.
And so as far as the loss to lease.
Where we are is worry about two 5% last week in October for the portfolio.
And and you know of course, it varies by region, but that's coming from a loss.
Loss to lease in September .
And end of six 7%, so definitely a deceleration, but it is expected and loss to lease at this level for October is actually.
Better than our historical patterns.
Typically around this time of the year worried about 1% loss to lease and heading towards zero by yearend. So a 2.8, we're feeling pretty darn good about the portfolio.
Thanks that was very helpful. And then maybe just on the transaction market given kind of your expected rent growth and worked at costs are today.
Four five cap rate.
Sense for most buyers are how are they thinking about getting to their unlevered IRR is.
Given maybe the negative leverage.
Situation initially right now.
Yeah, Hey, Nick this is Adam.
As Mike mentioned in his opening comments.
Transaction volume is definitely down from from where it was a quarter ago, but there are still deals being priced or there are still deals going non contingent and.
In talking to buyers, who are still active in the market.
They're willing to take a certain level of.
Negative leverage for 18 to 24 months is the number that I'm hearing now and so with with various assumptions about rent growth repositioning.
And those types of strategies, that's that's what we're seeing in the market.
Our next question comes from the line of Steve Sochua with Evercore. Please proceed with your question.
Yeah. Thanks.
You know look I guess the biggest thing that are you know everyone's focused on is the 2% and you know Angela you walked through the math and I know this is not the not trying to get this into a debate about 'twenty three but the math that you just walked through wood I think basically imply your revenue growth is several hundred basis points below several.
All of your peers and I guess I'm just trying to understand is that really a function of market mix is that a function of the conservatism that 2%.
I don't know what the history of that number is and if you start low and kind of work that number high.
Over time, but you know it just strikes me as you know your your implicit growth for next year is kind of well below the peers.
Hey, Steve.
Let me try to handle that one so F 17, beginning a few years ago decided to start with the consensus of third party economists as to the U S. And then drill down from there into what that means for our markets and we obviously have chairman Powell out there talking about breaking things.
And pain to come in a mild recession, which is what this is based on and so rather than using our own how we feel we think it's important that we create a scenario thats based on the consensus of the people that are really studying these things and certainly not ignoring what theyre, saying and so.
That's where this macro.
<unk> come from do we feel like that's a little bit dire, yes, we do but again.
Several years ago, we made the decision to start facing.
F 17 on the on the macro Economists' view of the World, which in fact is pretty dire and it seems to us that we shouldn't ignore.
The fed's comments about pain to be add et cetera. So that's where that scenario comes from do we feel like.
Things are a little bit better than that well, yes, we do and if we were basing this on how we feel.
We would come up with something that is more optimistic on this but.
Again, we shouldn't ignore the fed and that seems like it's what's happening out there and we think thats fundamentally misguided I guess that makes sense.
Yeah look I'm I I agree that there are storm clouds. It would seem like you would need to see negative job growth occurring in order to really diminish the pricing power that's out there and so when I look at your job growth forecast or the the market job growth forecast of 40 basis points against supply growth.
60 basis points those are largely in lockstep with each other there's not big dislocations on the supply front in your market. So it would feel like occupancy is going to be relatively stable and so I would have thought that rent growth you know it wouldn't be off to the races, but that it might be better than 2%. If you told me job growth was very near.
<unk> I would agree with you.
Well with that and that's exactly what the third party economists are saying so up there on the upper left hand corner is the consensus of the.
Again third party macro economists say job growth is going to be minus 2% next year and so that forms the basis of what we think so we outperform in terms of job growth.
The U S economy, and in fact that minus two for the U S is translating into Kuwait.
Quite 4% job growth for us so not a lot, but again, it's a pretty dire scenario.
<unk>.
So that's where that comes from.
Again, we don't feel like it's this bad I mean based on what we see in front of us today.
We're having some seasonality here in October we expect that loss to lease typically goes negative by the end of the year. It probably will this year.
Keep in mind.
The demand side of the equation is driven by by jobs and obviously we.
We pay attention to the seasonally adjusted jobs, but the reality is if you look at total non farm employment it gets pretty soft in the fourth quarter and so these things can happen. So basically we don't feel we feel like this is a pretty draconian scenario, but we're trying to.
Maintain some consistency with respect to.
What we are trying to.
<unk> put out there with respect to F 2017, and just following through on the historical pattern and.
Looking at what the economists out there are saying we think this is this scenario could it be different it absolutely can be different and we hope it's different but again I don't want to ignore the elephant in the room. It seems pretty important to actually consider what the macro economists are saying and what it means for for us and I would I would add.
After that.
Everyone across the nation is going to feel the same.
Same pain if this occurs.
Not just the west coast, it's a national thing it starts with the U S job growth and then we look at historical relationships to try to determine what it means for the west coast and Thats, where these numbers are coming from.
No I appreciate that thanks, and then I guess, maybe just in terms of.
Return hurdles and and how you're thinking about underwriting can you just give us a sense for.
How you guys have altered either acquisition hurdles development hurdles in light of.
Given where stock prices have gone where bond yields have gone I mean, how much have you raised your you know cap rates irr's are in today's environment.
Hey, Steve This is Adam again.
So consistent with what.
What we just talked about the four five range is kind of where we see the market, we're probably not buyers at that.
At that range, we have better use for our capital.
And and development yields will need to we will need to move off of that base, if not maybe maybe slightly higher so when we when we look at development deals depending on where they are in the entitlement process and we're looking at a 20% to 25%.
<unk> over to adjust for for the risks related to development.
Our next question comes from the line of Adam Kramer with Morgan Stanley . Please proceed with your question.
Hey, I just wanted to ask maybe about a little bit deeper into some of the markets.
And then looking kind of at the October new lease growth.
The two 8% figure I'm wondering if you can maybe give some color just on performance across kind of a different market.
It'd be helpful.
Sure happy to so on the the the new lease rates for October it two ways, it's actually a pretty wide range. So with starting I will just go from north to South Pacific Northwest.
It's a it's a negative about 90 basis points and that's consistent with my earlier commentary about the softness in that market.
And then.
Northern California, the strongest at about four and a half and southern California closer to 2%.
So that's kind of point out continues to be the steady Eddie and in Northern California is rebounding as we have.
We anticipate it.
Occupancy figure area, it looks consistent kind of October versus third quarter.
Maybe just comment a little bit about kind of a yawn, Arkansas.
Our concessions being used I'd imagine maybe weaker northwest Martin maybe they are big news, but would love to just kind of hear your architecture is being used.
Is that going to use as a tool to kind of maintain occupancy here.
Sure.
Concession use it just for us.
We focus on where there is a competitive supply so of course during a well if we're doing our own lease up we used concessions.
As part of our pricing tool, but absent of that.
A function of how many lease up do you have neither property and and how do we remain competitive and meet the market.
So.
In terms of.
E concessions usage, just the change between October and the third quarter. It has ticked up and it's primarily driven by our Seattle.
So Seattle.
In the third quarter, and I've mentioned that we had a very normal third quarter.
It was less than a week and it is now about two weeks and that's the biggest change.
With all the other markets, it's incremental couple of days more which is consistent with what we expected and so portfolio over why overall concessions has gone up from.
I'd say half a week to about a weak portfolio why and what's the key driver being a Seattle.
Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.
Hey.
Good morning, good morning out there and Angela Congrats and I guess now you get the joy of answering directly to George after after each earnings season, So I'm sure you'll enjoy that part.
So question two questions for you and going back.
To Steve's question traditionally you guys are conservative team I don't want to say.
Yeah, I won't characterize it any more than that but traditionally you guys are in under promise over deliver Mike I hear you on the.
Economic forecast.
Forecasting at 17%. This is independent consensus this isn't your world, but when we think about just bottom line earnings growth because obviously the stats get worked with the Covid rebound. It sounds like you guys were saying that revenue was four 5%.
All your loss to lease right now is 7%.
But you're only saying next year, maybe 4% four 5% for revenue.
Prop 13 helps on the taxes next year.
So your Opex should be you know, probably a little bit better than the national average because you don't have the.
The opex the property tax pressure, but as we think about bottomline growth.
Growth.
For 2023, assuming that it's not a blood bath recession should be sort of more of a normal type earnings growth or I'm, just trying to figure out how much the marked the year over year stats are impacting our clouding. The <unk> growth that is implied by what what you guys have presented.
Yeah, Hey, Alex there's obviously lots of moving pieces here and you were asking.
Good question kind of what does that mean for the bottom line. Let me just clarify a few things and you know and then I'll flip it back to Mike to talk about 2000.
17, and maybe Bob on basketball.
The 7% that you're referring to is September loss to lease.
And what we normally do is take half of that with R&M. So that's how we got to the three and half.
And so that's yeah, that's pretty consistent math for proxy purposes.
And as far as the the expense comments I do want to address that for a minute I do think that we.
We should perform a little better than inflation on average and especially on the administrative side of it you know that's shipping.
Quite a bit below inflation inflation.
And with them, but since we have not yet rollout maintenance collections that.
That will be higher than in the admin growth and so we expect controllable to come in comparable to this year at about 4% for Nexium.
But that's uncontrollable.
And so that's some of the building blocks from the P&L perspective, and then Mike.
Yes, Alex I, just wanted to add a couple of things.
So.
First thing is that.
Angela She takes for next year, but kind of proxy formulas that three and a half plus half the growth of next year, which is the 2% which is a pretty dire scenario. So I'd say there is some potential upside if that dire scenario. It doesn't doesn't take place. So that would be one thing and then I just want to mention that we feel pretty good about where the comp.
<unk> is positioned right now.
<unk> right now is at.
At the high end of the Bicoastal peers. When you go back and compare it to Q4 2019, so we feel good about that.
We've accomplished that with really southern California.
A full recovery in full recovery mode.
Not northern California, and Seattle, and we attribute that to the fact that.
Both of them fell further and have a longer.
Period of time, that's required for.
Poor recovery in Northern California for example rent levels right now.
Roughly equivalent to where they were at pre Covid. So theres been no rent growth in northern California, and historically the tech markets are the driver of growth and I suspect that they will be the driver of growth going forward. We're just not there yet so we feel we feel good about this when you think about some of the other things you'll incomes median incomes.
Household incomes in San Francisco, San Jose are now over 100.
$1 a year, that's the median which is pretty amazing and screens very affordable as it relates to rental value.
And that's that's what drives people to the West coast here, everyone talks about well the costs are higher on the west coast, but the reality is they are drawn by the incomes that are much higher as well.
And so we think that there is going to continue to be a recovery.
<unk> recovered jobs lost in the recession in Northern California, and Seattle, We think that they will once again become the drivers of the company going forward and very little of that is priced into the stock, which makes us think that there's very good upside here.
Okay. The second question is on your debt for equity program.
Yeah, obviously, one of your peers had had a default and then taking the property back here in New York.
The office company.
Converted to DTE positions.
You guys did a number of investments do you see the risk profile of B E.
Or your view is that.
As you monitor the deals they're all financially performing the way you expect them, meaning nothing you havent seen anything outside of.
What you've been monitoring along the way both in performance as well as in the in the <unk>.
And the developers the ability to get financing.
Yes, Alex.
So at this point, we're not seeing any potential for a material default, we constantly assess our preferred equity book. So the short answer is no. We're not seeing anything at this point a little more background behind it.
Over 75% of our profit Mezz book was underwritten in 2020 year before so we really we didn't go down to the depths of the mid three recaps chasing deals. We did very few deals during that time and so with this recent expansion in cap rates.
It really it really doesn't impact where we are in the stack and then you couple that with.
With pretty significant NOI growth and we feel like we're in a pretty good position.
Okay.
Our next question comes from the line of Joshua <unk> with Bank of America. Please proceed with your question.
Yeah, Hey, everyone.
I wanted to explore one of the comments I think Angela said in her opening remarks on.
Higher move outs, I think what youre expecting going forward those higher move outs from non payers, who I guess, you'll be able to address.
Without restriction going away.
Just trying to get a sense of like will that lower occupancy kind of impact same store revenue.
Sure sure Yeah. There are two things happening on the move outs that the higher turnover is driven by two factors. One is of course the Seattle.
Softness that I've talked about earlier.
And it's attributed.
Mostly to a elevated level of supply in Seattle in the second half of course, you know when there's more supply there's more concession.
Concessions in that draws people out of stabilized properties, that's not unusual during a period or corporate hirings are slowing once again, that's what's happening in Seattle as far as California, the higher move out it is attributed to the non paying tenants moving out which we see.
It's a good thing.
And so.
With the.
The L. A march one the carrying next year, we do see another opportunity there.
And so we're able to make good progress on the delinquency front there. So that's that's that's the.
Hopefully that's what you're looking for.
Yeah, No that's helpful and then you.
Another comment you mentioned was just shifting more to focus on occupancy.
Yes.
I guess, what's driving that is it just like you want to hang onto occupancy assuming like.
It sounds like you guys are taking the big picture macro view that there might be like a recession.
Oh, I see what you're saying, yes, so so the.
Normally.
When we.
C market strength, and which is usually during period of strong.
Demand we pushed rents.
And.
As we head toward the end of the third quarter and into our seasonal low in the fourth quarter.
Historically switch that strategy to push occupancy and so what we're doing here is consistent with what we've always done in the past and what we're seeing is this is what I'm trying to convey there is that this is a normalized market that is stable and we're essentially shifting the strategy.
To maximize revenue during.
During this period of time.
And the reason so normally what you would see us in the fourth quarter, our occupancy may run say in the mid to high 96%, but because of this eviction headwind. It may run a little bit lower so maybe in the low 96%, but I wanted to signal to you know to the community.
That's not because there's any problem here or if this is actually a good thing.
Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Hey, good morning, and congrats Angela Mike.
Angela I wanted to ask your methodology on the earn it and I realize this is.
Somewhat of a new figure at least to us on the outside.
And.
You used to have taken a September last beliefs and approximated by using half abroad for lease.
I would've thought the earn in was basically the rent contribution this year versus next year on rents that you've signed today.
I was just wondering how this.
Earn and compares maybe to prior years and then also how accurate using September lots of lease to buy the go to market is that to the actual contribution.
Yeah, So if I look at the.
Kimberly loss to lease and and you know use us 50% of that as a proxy.
And I look at that number relative to prior periods pre COVID-19.
September numbers Ashley.
About.
Twice as high as the normalized period normalized normally around September the loss to lease is around 3%.
And so this is one of the reasons why we feel good about where our portfolio of assets and you know as we head into next year.
Yes.
Absent of course, a recession, we certainly should do quite well.
So historically your earnings about one 5% per year.
Yeah that sounds about right now the one thing I do want to clarify is that.
With.
Everybody calculates a little bit differently and so for US we are not including concessions. So if we include concessions that earning number obviously will be much higher.
Trying to just keep it apples to apples so yeah.
To minimize confusion so it's the same baseline.
Okay.
I know this has been asked a few different times, but on your 2% rent forecast I'm, just trying to get a sense of.
What kind of range that you would see that that and how difficult it was to forecast job growth.
For next year versus prior years, when you come out with this initial forecast.
Yeah, Hi, John It's Mike.
So again, we're trying to start with third party economists ask of the macro scenario and then what happens in the across the country will be a function of that and.
Again, typically we outperform the national economy with respect to.
Job growth and so the consensus of the.
Big economists as for U S job growth to be minus 2% next year.
And we think we'll do better than that.
Plus <unk> four but.
9500, new jobs under the four scenarios about 4800 households against 50000 plus new.
New supply in the marketplace. So again do we think that'll happen.
Now and given what Andrew just said.
Seems like that's pretty dire, but again, we should not ignore what the economists are saying and we should not ignore the fed talking about wrecking things in pain points. So we don't know our visibility into next year is no better than yours, and whereas we feel pretty good today.
As I said earlier.
We can't ignore these numbers so again I'd rather have this discussion. So you guys know coming from then to just create a scenario out of out of thin air because that doesn't sound relevant when we do our budgeting process, we start with <unk>.
Economic rent growth I don't know, how you do a budget without that because you can't leave it to the property teams to try to decide what rents are going to do you have to have some macro view of the world and based on that you populate your budgets based on supply and demand at the local level I don't know how else to do it.
I'm not saying our budgets are based on this scenario.
Because again it does seem somewhat dire.
Dire. However, we are mindful of the macro economy, we're mindful of what the fed is saying and.
We're going to adjust accordingly does that makes sense.
It does I know its difficult times to some decrease.
Got it thank you.
Thanks.
Our next question comes from the line of Nick <unk> with Scotiabank. Please proceed with your question.
Oh thanks.
First question is just in terms of your portfolio I was wondering if youre seeing any differences right now in the operating trends in recognizing you have a broad portfolio that's different price points suburban urban because we think about return to office being most challenged on the west coast and San Francisco.
Proper in Seattle proper in downtown L. A proper.
Very downtown San Diego too.
How are you seeing a different performance of your apartment assets in those urban cores.
Then the rest of the portfolio.
Yes, it's Mike I'll start and then flip it to Angela here in a minute.
The answer is yes of course, we see all kinds of differences out there and I'm going to give you the broader perspective of what our portfolio is and why it is the way it is which is.
We hope to have property throughout the fastest growing metros.
And again we.
Look at supply demand to try to get to those numbers, that's how we deploy capital.
We generally want to be in the b or renter by necessity category, because when new supply hits or when you have the supply demand imbalance, which could happen next year.
The properties that are hit the hardest are those that are near the new supply because of the new city of women.
Someone down the street has eight weeks free in Europe brand new apartment competing with that competed directly with that you will be impacted to a much greater extent. So our portfolio is mostly suburban in nature.
Again, we're not trying to be in San Francisco and San Jose were trying to be in the whole Northern California Metroplex within let's say.
One hour commute distance from the major job nodes.
Portfolio composition, and we think there are there is inherent.
Safety and the beach, because you can't produce b quality property and in a world where the A's.
Are more concentrated in the downtown and the newer product is more susceptible to that.
The impact of concessions that they increased substantially we think those are the areas you're going to get hit the hardest and the b quality property will do quite well, so Angela I'll flip it to you.
I think maybe I'll just give you a quick example of what Mike is talking about.
These sessions in downtown L. A is about one five weeks.
And concessions throughout the rest of the L. A area averages.
About a week and so that gives you the magnitude.
Of the downtown versus the market.
Okay great. Thanks, My other my other question is just in terms of you know move out.
Activity that you're seeing on like a real time basis in the portfolio I mean, how much of that would you attribute to.
People, who have tech jobs.
Are you seeing any signs yet of of of <unk>.
Tech freezing layoffs hit in your portfolio.
Nick.
I'll start with that to our portfolio.
Polio is not positioned to be near the tech companies per se or to cater to the tech employees. We are trying to cater to the broad range of employment within our market. So we do have a couple of buildings that are predominantly tech related employees, but it's the exception and.
Actually not even close to the average so we are a reflection of the broader economy and therefore, the tech component in northern California, and Seattle will be more but there's a lot of there is a pretty diverse job base. There in general and so again that goes into the philosophy of the company. So I don't.
I think we're particularly exposed to attack.
We're more exposed to supply demand imbalances and.
We hope won't happen, but again.
The dire financial scenario 17 sort of contemplate that scenario.
Our next question comes from the line of.
John Guinee Lutheran <unk> with Goldman Sachs. Please proceed with your question.
Mike first of all congrats on the retirement and answered all congratulations on the new role.
What are you guys seeing on the preferred you obviously raised your commitments for the year.
How do you how do you see appetite for investments next year, obviously with higher interest rates and how has <unk> changed.
I know this came up briefly on the call, but do you see any distress distress related opportunities generally in the broader market as you think ahead.
So a couple of questions in there I'll try to go backward.
As far as distressed opportunities word, we're not seeing them as of yet.
There is talk of the potential for rate caps expiring and and a need for that kind of rescue capital, where we're not seeing it yet.
Haven't.
Haven't really heard from anyone else, who who has seen that there is there's definitely talk but.
Haven't seen any any of those opportunities come to fruition yet.
As far as let's see I think your other question was.
Just what we're seeing right now on a prep side.
We have increased returns so for deals that we are currently pursuing we've increased returns between 100 and 150 basis points.
I'd say, where the market is today.
There are opportunities given the.
Given the difficulty of that today, but underwriting is a little more opaque. So so I think for.
For the fourth quarter. There is probably we have one or two deals in our pipeline right now.
I don't probably see more than that coming into the fourth quarter, I think things will slow down a little and people may take a pause.
And then going into next year, I think I think it will start back up in.
We will see more opportunities.
Okay and this one is going to be very quick follow up so I completely understand and appreciate the use of third party economics and kind of the view of the world that is out there right now, but if we don't go into a full blown recession next year is it fair to say that there is more potential for rent growth in 2023, given the market never fully recovered.
For some of your key markets or.
Is that a fair assessment.
Around 6% of stock that looks like it's probably the lowest.
Where in the U S is what I'm guessing are on the low end, let's say and.
Supply is the enemy and our view and trying to avoid supply is a key part of why we're in these markets. So.
If we get a little bit of demand growth I think we will do just fine and <unk>. If the recession is just a short recession and we're in and then back out of it.
That scenario would be better than what is on page 17. So.
It appears that the F 17 is probably close to the worst case scenario, but of course, none of us really know.
I appreciate your question.
Our next question comes from the line of Robin Lu with Green Street. Please proceed with your question.
Congratulations Mike and Angela and thank for taking my question. So I wanted to style.
Good investments.
Subordinate in line business.
No.
Yeah.
Any capital provided us that you'd normally see in bidding tents.
Drop offs.
<unk> ski preferred deals.
Going forward.
Great question. The answer is yes, predominantly the debt funds they are they have disappeared.
I know.
We would.
Go into some of these deals and especially the debt funds. They would provide what we call stretch senior so it would be zero to call it 75%.
They have.
There are no longer in competition, so we're seeing more opportunities coming to us because of that.
Do you mind, just expanding whether barbie debt funds are actually domestic clients.
All things are in play.
Yeah. This is Mike I think most are aware of where domestic players.
I don't I'm not sure that we know exactly where theyre coming from.
We know that we were refinanced out of several deals with high yield funds and I didn't.
Candidly don't know exactly who they were but it seemed like they were just <unk> domestic high yield funds, so and there were a lot of them out there.
So we were these redemptions have come to an end consistent with what Adam said and it looks like.
The market is.
Much less competitive now and going forward, which we think is a good thing.
Our next question comes from the line of Neil Malkin with capital One Securities. Please proceed with your question.
Thanks, everyone, Mike I'll Echo everyone.
Sentiment congrats enjoy are not.
And not having to prepare for earnings.
And Angela looking forward to.
Continuing to work with you.
I guess just along those lines.
I think that California's struggles are aren't lost on people and youre still kind of working through that and there's still a lot of uncertainty.
I guess Angela.
Do you think that the Angela Kleiman era will see asics.
Venture out from California, maybe like a Phoenix, Denver, Salt Lake, maybe even in Texas.
Uh huh.
There are a lot of the businesses in populations are going.
I understand that it's easier to build supply but.
Yeah.
Sunbelt markets are supposed to have I mean have been outperforming you guys for like the last three years and look like they're going to again in 'twenty three and they have a lot of supply.
Just if you could maybe comment on how the Angela Kleiman era.
Could could look regarding portfolio composition.
Thank you.
This this is kind of a broader.
A strategy question and so let me start with.
Why we are here and and and and that's.
T. J you even said it the sunbelt has outperformed for three years well to US three years isn't exactly long term and what drove these three years as a pandemic.
And so you know.
The way we look at the World is we don't expect to have regular pandemics that will completely change behavior and legislation.
But in terms of this general discussion about other markets.
This one is looking.
Looking at other markets is not a bank.
Angela Kleiman era, yes.
Specific pointing to that.
It's a discipline that we've always had mike's been doing this for a very long time and and.
I will continue that work and make sure that we are in the right place and where we can generate the highest long term CAGR for our shareholders and.
Supply is definitely something that we cannot ignore because that is a key reason.
Of our outperformance combined with being in the center of innovation that drives demand and income growth and job growth I mean, they're all interrelated and so we'll continue that discipline and if we do end up venturing outside of California. We will also do it in a very thoughtful way.
And consider our cost of capital consider future growth and of course the.
<unk>.
The basic supply demand dynamics.
Yeah.
Okay.
I.
I appreciate that.
And then I guess the other one is on I don't know if we've talked a lot about.
The.
The delinquency in California.
The February 23 is that for sure going to burn off because I know that throughout the.
Pandemic there've been a lot of fits and starts in the lines in the sand that had been quickly erased.
Is that like a firm.
A firm date, because it just seems like obviously every company is different but you know people who have had pretty pretty varied opinions on how long it will take to sort of get back to pre COVID-19.
Bad debt.
I Dunno, how do you guys is that like a certainty.
How do you think about that.
And potentially does that go into any of your the market rent forecast by chance.
Hi, Neal it's Barb, yes. The February 1st 23 date is set with L. A the city Council has approved that so that is not changing at this point.
So if a tenant is not has not paid current as of February one we can start eviction proceedings we.
We do think delinquency it could remain elevated in the first half of next year as we work through.
L a and the rest of our portfolio and getting tenants out we are making progress.
But it's going to take time, we think the second half of the year things trend closer to our long term average as we.
The non.
Non paying tenants out and replace them with paying tenants and as Angela said, there could be some temporary impact to occupancy, but we don't expect it to have a huge impact to the market and to our results. We think the delinquency trend is favorable the one offset to 2023 that you have to keep in mind is we don't.
Spec to receive emergency rental assistance next year, which we received quite a bit the share. So that's why we think delinquency won't be.
A significant positive or syndicate significant negative in 2023, and it should be pretty much a push we think at this point.
Our next question comes from the line of Brad Heffern with RBC. Please proceed with your question.
Yes.
Hey, everyone.
Just coming back to an earlier question are you seeing any sort of elevated levels of move outs due to lost jobs not not necessarily talk specifically, but.
Just in general.
No we really haven't.
We're seeing the move out it is.
Really.
Attributed to just normal.
Market activity is and then you layer on to layer on to that the other dynamics that I mentioned earlier.
Okay got it and then I heard concession stats for the Pacific Northwest and for Southern California can.
Can you give where things stand in northern California.
Sure Northern California is sitting about a week.
And that is a slight.
Slide <unk> two.
To date uptake.
From last quarter. So, it's just not a meaningful change.
Our next warning keep them.
Oh go ahead I'm sorry.
That's okay I was just going to add that keep in mind, our northern California portfolio.
Mostly suburban.
And San Francisco consists only about two 5% of our portfolio.
Yes.
Okay.
Okay.
Our next question comes from the line of Austin <unk> with Keybanc. Please proceed with your question.
Great. Thank you Michael Angela I know you guys are talking about that 2% market rent growth feeling a bit dire, but I guess, how do we get comfortable with the fact that the loss to lease was 7% in September of this year versus a historical level of 3% yet you still expect the loss to lease to go negative in December which would imply kind of a.
Fortunate slowdown here.
How do we get comfortable with that and then why do we expect it to get better as we enter into early next year.
Yeah, I'll start and maybe Angela will have a have a comment.
The seasonal pattern every year and.
It's not the same every year there are variations it's really.
Defined by.
The drop off in demand I E jobs from October to December and supply continues on being delivered during that period of time and so that causes the seasonal slowdown.
And so it's it's not perfect, it's lumpy and all that other stuff and so we're just commenting on the historical patterns. So by the end of the year.
<unk> loss to lease is zero or negative a gain to lease and then we January hits and we start getting all the new budgets, all the new hiring et cetera as it occurs in that first quarter end.
That makes the markets recover so that's how it works it's been like that for many years or anything specific to this year that looks different no other than that so.
So far better than historical patterns, I don't see anything different.
Okay.
Then just secondly, certainly congrats congrats to you both and I'm just curious you know Angela.
When you're moving into the CEO role.
The plans or are you planning to elevate somebody.
Internally to take your place to oversee operations and how should we think about sort of the timing of that announcement.
Well the transition is about six months and so Mike is still the CEO until March 31, and I'm Gonna I plan to enjoy every single day of that.
As far as the the team is concerned.
I am not we are not going to make any changes to the operating team we have a terrific team and great Benjamin.
And.
If you look at our company history for Mike first nine years as CEO , we did not have a CLO. So this is not we're not doing anything unprecedented.
Our last question comes from the line of Richard Anderson with S. M. D. C. Please proceed with your question.
Rich you there.
Apologies I had asked you to issue here.
Congratulations to both of you, Mike and Angela Angela maybe the first order of business can you simplify the page numbering you know F 18 point to there's an infinite number of numbers. Just so you know if you can make it a little simpler and all of us.
But thats.
Just a little side note.
When I think about this 2% number you know that we're all talking about if you were to go back and say in a normal time and you were to look at.
F 17.
And and you look at the supply number that youre referencing a 0.6 and the job forecast a point for and it's a normal time.
What would rent what would be the number so what's the in backing into that what would be the what would be the fed impact that's come to the 2% number but if it if it were more of a normal type of a world would would that before would that be five would that be eight could you could you comment on that.
Hey, rich I, just want to make sure I understand the question so.
We have this <unk> four and <unk> six and that results in a 2%.
Rent growth, primarily because we're mostly mostly in the b area, where most of the stock and on the West Coast is a b by definition and Theres just a huge housing shortage. It's the backdrop behind all of this and so we think that we can get some rent growth obviously moving into for sale housing is.
People are locked into the rental rental pool in the.
In the <unk> space and as a result of that we think we can get a little bit so I think thats.
So no matter, what we think we can get about somewhere around 2% and then we'd never.
<unk> recessions, we always have job growth and and how.
Household growth using sort of a two to one ratio.
Almost always well above the supply so it's early.
Recession scenario that that occurs.
There isn't a recession next year, then we would expect and with respect to job to be much better and that pretty quickly cover supply and again.
And again in other markets Youre going to have a lot more supply if theyre going to have the same demand issues. So on a rough basis, we still think we'd do better so I'm just.
Not really.
The 2%.
Impacted by Fed action as you described I'm just asking what it was.
What's the what's the factor in that 2% and what would it be if in the absence of this environment based on the building blocks, but if you don't if you don't have a good.
Good answer.
Well I'll go back to what Angela said, then you start with the earn in which is somewhere around three five.
Using the methodologies that she gets too.
And then you would take roughly half of the economic rent forecast that would be based on the better scenario. So if.
The supply demand is better next year and that 2% becomes 4%. We would expect the building blocks to be three five plus two five and a half okay. Okay.
Okay got it Alright second question is.
We did some work on where all the Reits stack up relative to the entirety of their markets not just not just competitive to your existing portfolio, but the entirety of the market and you guys registered the best in my opinion.
Yeah.
Running.
From a rent perspective, just below the market average.
I think that's a good place to be if people trade down to a cheaper alternative.
If you were operating at the very top of the market you could lose some people not have others coming in the front door.
I assume you agree with that and second do do you see any of that happening where people are coming from a more expensive unit and coming to your more class B varietal.
And that creates an extra leg of demand for you guys as we go into this rough patch.
Yes, I think rich you have to throw Vegas, great question by the way I think you have to throw affordability into the mix. So.
Incomes are especially in the tech markets they are extraordinarily high.
The screening on rent to income is very low as a result of that it would be during the pandemic as I said earlier.
Rents in northern California, about where they were pre COVID-19, but the median household income has moved materially.
And so it screens very affordable that's not the case in southern California, and so I would expect to see it I don't have any direct.
Indications are reporting on this but I would expect to see some doubling up <unk> moving to more affordable units given the very large rent growth, 35% from pre COVID-19 roughly at that level, even with some income growth are still probably is affordability pressure in southern Cal.
<unk> will definitely start to see some of those other things that happened people move farther away they double up they trade down et cetera, So I think thats, what youre getting at and I totally agree with the premise.
That concludes our question and answer session I'd like to hand, it back to management for closing remarks.
Okay. This is Mike once again want to thank you for joining our call Greek Angela by both really appreciate all the congratulatory sentiment out there much appreciated.
We look forward to seeing many of you at NAREIT in a few weeks.
Okay. Thank you.
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.