If you don't know me, it's Joshua Dennerlein. I cover the residential REITs at BofA. I'm pleased to be here with the Essex management team, CEO Angela Kleiman, CFO Barb Pak, and Rylan Burns, who has a new title, which we'll, I'm sure we'll go through a little bit later. But with that, I'll pick it up, or I'll pass it over to Angela, who can give a brief introduction on Essex.
well, great. It's great to be here, and thanks for having us, Josh. You guys always do such a nice job on this conference, and it's good to see everybody here. Essex, for those of you who are not familiar with us, is an S&P 500 company, about $22 billion in total market cap, and we focus on West Coast, so California and Washington, apartments, and up and down the coast, close to major job centers. And we are a Dividend Aristocrat, and which means we've grown our dividends consecutively for over 25 years. In fact, we just announced our 29th year of consecutive dividend increase, so very proud of that history.
One of the reasons we've been able to do that is we've been able to grow our rent growth, our compound CAGRs of rent growth outperformed that of the U.S., and primarily because where our markets are, we have the benefit of lower supply, and being the key center of innovation with higher job growth and demand characteristics. And of course, combine that with higher income growth, that all adds to our ability to outperform. We have an operations update, but I'll turn it back to Josh in case you wanna kick it off with any questions.
well, maybe actually that operating update, I think it would be beneficial to kind of go through, go through it, the nuances and within the, within the numbers you updated, and just kind of how we should think about maybe the rest of the year.
Terrific. Thank you. So I'll flip it to Barb to talk about guidance and our expectations in a second, but we have a presentation that's published, and on page 12 is our operating update. So a couple of key highlights on our operations update. In the top box, you'll see that preliminary July and August same-store property revenue growth is at 2.4%. And so you see a natural deceleration from beginning of the year, which is what we had anticipated and forecasted for guidance. But the one other factor that's not shown on this page is that with our delinquency as percentage of rent at about 2%, that is a key driver to this deceleration and why we're at 2.4%.
Because without this delinquency, we would be in the 4% range for rent growth. And just to put a little finer point on that, last year, July, August, delinquency as percentage of scheduled rent was only 60 basis points. So fast-forward to this year, it's at 2%, and the big driver is emergency rental assistance. So the reimbursements is no longer available to us. So if you're looking at apples to apples, gross delinquency has been improving since last year. However, because of the, the availability of the government, reimbursements is no longer there, which is why delinquency is ticking up. So it's not that things are getting worse, but this is playing out as we expected.
On the bottom box, you'll see our leasing rates, and so with August preliminary blended rates at 2.3%, you'll see that new lease rates have been gradually improving. So from Q2, it's 1%, now at 1.6% preliminary. So it's a slow improvement, but nonetheless, it's what we have anticipated. Renewal rates have been decelerating, which is also what we expected. So they're kind of moving in opposite directions, you know, going from 3.4 in the second quarter for renewal rates now to 2.9, and that's because we have forecasted market rents to be at 2.5%. And so, of course, as we renew all, we're gonna move toward that market rent. So once again, things are playing out as we expected.
And the one last note on the new lease rates is that we do believe that the new lease rates is being tempered by the delinquency overhang, which is leading to evictions. You know, we're trying to recapture the non-paying tenants, which is creating effectively additional supply. So in those kind of environments, what we're trying to do is preserve occupancy, which means we are not going to be as aggressive on pushing rents. And so this whole dynamic is playing out as we've expected. Barb, you wanna talk about our guidance?
Yes, so quarter to date, the results are in line with our guidance and our expectations. And when we did revise our guidance for the full year on same-store revenues, it was really what we had achieved year to date. We didn't change the back half of the year for a higher rent growth per se. So the guidance and what we're seeing right now is very much in line with how we forecasted on our second quarter call.
Angela, I just wanna follow up on a comment you said about how in the markets where you're facing the delinquencies, you're focused on preserving occupancy. I remember at the 2Q call, you mentioned you were switching back to pushing rate-
Mm-hmm.
versus, like, holding occupancy. Just kind of curious, is it like a micro-like situation that you're still holding occupancy, and how did that switch to pushing rate go?
Yeah, that's a great question. This year is somewhat unusual for Essex. So normally, we push occupancy during the seasonal low, so that'd be first quarter and the fourth quarter. And during second and third quarter, we're pushing rate really hard while just holding occupancy flat. And we did some of that, and we talked about that on our second quarter call. And what happened subsequent to the second quarter call is that it's a good news, bad news. In that, the good news is we're able to make good progress on vacating tenants that are not paying, but in so doing, it created more vacancy. So you'll see that we are very nimble, and we're gonna adjust between that pushing rents and pushing occupancy back and forth. And normally, it's not this much back and forth, but once again, this is an unusual year.
And I do wanna make one more note on this delinquency conversation, because typically, it takes, say, 2-3 months to go through an eviction process. And because the courts are so backed up, because you can't find more eviction, you know, law clerks or judges or eviction attorneys, and the entire market, not just Essex, we're working through these evictions, so it's creating a logjam, and so it's taking 9-12 months to evict a tenant, which is prolonging the whole process. And so we do see light at the end of the tunnel, but it is taking longer because of the volume. And so it's not a legislative issue, it's purely a personnel availability issue.
How should we think about that return to normal delinquency? Like, how is this like a continued overhang for 2024, or do we kind of get back to normal by the end of this year?
well, it's a great question, and one we don't have a crystal ball on. I would say to get back to normal by the end of this year is not likely, and it's not part of our guidance. We've assumed we're kind of steady eddy from here at 2% for the full year. I would say we do expect this to be a tailwind into 2024, just given where we're at, and we will continue to make progress. It's just, exact timing on when we get back to our long-term historical average is a little unknown. What I would say, though, is that we don't believe there's a structural change in the market to allow tenants to be delinquent and for us to be at 2% forever.
I do think this court system, which Angela mentioned, is an issue, but we ultimately will get back there. It's just gonna take longer than expected.
Then, your strategy obviously focuses on the West Coast. What, what gets you excited about those West Coast markets today, and what's really needed to get those markets to re-accelerate and outperform?
I'm gonna have Rylan cover this, who's now our head of investments.
Thanks, Josh. Yeah, when I look out the next couple of years, I am particularly positive on Northern California. And the reasons for that are pretty simple. The supply outlook is relatively muted next year, and based on new construction starts, should improve thereafter. This is a market where rents have not grown since pre-COVID, and incomes have increased around 20% on average. So affordability, as it relates to apartment costs, are as attractive as we've seen in over a decade. The cost to buy a home now, with mortgage rates where they are, is around 2.5 times more expensive to buy a home. So in terms of affordability and looking forward on the supply side, we feel there is a very attractive fundamental setup in Northern California. Tech has retrenched in the past year.
Tech jobs were down year-over-year, and we have seen a stabilization in that submarket of the jobs, and they're stabilized and starting to pick up. So I think with all of the excitement we're hearing around AI, with venture capital still flowing into the space, I think that next leg of economic growth, which higher beta tech companies should benefit from, that whole industry, I think we can get back to a period where we've seen significant outperformance, and catch up in Northern California being one market. But we feel pretty good about our fundamentals across all of our markets. Southern California continues to do well. The supply outlook looks relatively muted there, as well next year.
And then Seattle, supply can be a little bit more volatile in the Pacific Northwest, but the underlying fundamentals, in particular, affordability, remain attractive. So I'm not anticipating significant changes in terms of our allocation, which are, if you're not familiar, 40% Southern California, 40% Northern California, 20% Pacific Northwest. We don't anticipate major changes in the near term and are feeling pretty good about our relative and absolute fundamental outlook over the next several years.
Rylan, what's... You mentioned the incomes in Northern California have jumped 20%, but the rents, they haven't moved at all. Like, what, what's driving that? Like, why, why hasn't half of the rents kind of kept up with income?
We had a state-mandated government shutdown in California, where people could not go to the office for a year and a half. I think most people in this room are familiar that we've seen some outmigration during that time period. Followed shortly thereafter, pardon me, during that time, these tech companies hired considerably. It was effectively 100% remote because it was not in our markets. They could not be in our offices. Followed by what we've seen last year with the rising interest rates and a tech retrenchment. Northern California, where tech is the major driver of employment, has had three years in a row of challenging fundamentals. As I mentioned, I feel like it's stabilized. We're starting to see job openings slightly increase. The percentage of job openings that are remote went from 100%-
to 25% last year, they're now in the single digits. We've also seen anecdotally, the work from home, the reversal of work from home mandates in assets that are right next to, you know, for example, South Lake Union. We also have several assets that are near Meta's headquarters, in Northern California, and the rent growth year to date in these properties is quite attractive, like low double digits from the start of the year. We know that as they start to bring more people back to the office, which it seems like they're finally serious about, we believe that's gonna be a tailwind for our assets as well.
Where are we in the process on return to office across the West Coast?
Still very early stages. I believe many of you are familiar with the Kastle data and the office utilization rates. So it's still very early stages. But we track this in several ways. We're on messaging boards trying to understand what the companies are actually telling their employees, and it feels like they're starting to actually take this serious. And we've been head faked several times over the past few years, and we do not anticipate, you know, hockey stick level growth, where you're gonna see a bunch of people rush back to our markets now that they are pushing people back. But I do believe it is a continued tailwind for several years as new college graduates, new hires, are being asked to be in the office.
So is that like, I guess from our seat, like, what's the main thing we should be looking for? Is it just more return to office, or is there some other metric we should be focused on to, like, figure out when, like, markets start re-accelerating?
I mean, job growth, as we've always said, is a major indicator of housing demand. A lot of the jobs that have occurred in our markets here to date have been in the leisure and hospitality space. Healthcare has been a big driver. Once you start to see those tech companies start to hire again, once you start to see more, we believe AI companies emerge and hire talent, again, they're all done headquartered in the Bay Area. I think that would be a catalyst for not just those people that come in, but they have a positive multiplier effect on their ability to drive economic growth and bring more people into those markets. So we've seen this cycle play out several times over the past 30 years since the company's been public, and our view is that it's gonna happen again.
Then just maybe thinking about your market mix, it's 40% Northern California, 40% SoCal, 20% Seattle. You know, how are you thinking about that allocation going forward? Just given, like, the comments, it sounds like Northern California, you think it's got maybe some of the best prospects a little bit further down the road.
Yeah, as I mentioned, I don't anticipate it changing much. One thing we are seeing on the transaction side is that those cap rates across all these markets are very similar. So, it could change on the margin, especially if we were to see some differentiation where we can add value by trading into, you know, reallocating our portfolio. But by and large, for the next few years, I wouldn't anticipate a significant change.
I just wanted to touch on Seattle, the supply. It feels like it's maybe the one market that has a lot of supply for your West Coast markets. Just kind of curious, how competitive is that supply versus the properties you own, like, as you look at it?
Yeah, Seattle has always been a terrific market for us, and it does mirror the U.S. a little bit more in terms of the supply profile, so it creates more volatility. Having said that, because it has strong demand drivers, it's a market that we've always liked, but we keep it at 20% for that reason. It can be lumpy. So supply, we anticipate in Seattle to be heavier in the second half of the year and mostly concentrated in the CBD. Fortunately for us, our assets are mostly on the east side of Bellevue and those corridors. So there'll be some impact, but not as intense as being in the CBD areas.
Is there any markets that you look at, and I'm not necessarily talking about, like, geographically much more diverse than, like, the West Coast, but even within, like, the West Coast, are there markets that you find attractive and might check, like, a lot of the boxes that you look for in a new market?
Mm-hmm. well, this is interesting because, you know, during the pandemic, definitely the secondary and tertiary markets were very appealing. Having said that, with the reversal of return to office, we're seeing our market coming back to how it's been functioning normally. And so we do track about 37 submarkets throughout our own portfolio, and for us, we will lean in from time to time wherever we see dislocation or any opportunities.
Any questions from the field? Yep, Chris.
Yes, as I understand it, about a month ago, there were enough signatures to get the Costa-Hawkins out.
Mm-hmm. Mm-hmm.
It's obviously not the first time in that rodeo. How are you guys thinking about that, among the lack thereof-
Mm-hmm.
behind that name?
Sure. No, it's a great question. So the question is on the repeal of Costa-Hawkins. So the leader of that group is a guy by the name of Michael Weinstein, and so he come back with different names. Having said that, what he's been able to do in the last two campaigns is get the repeal Costa-Hawkins on the ballot, and it's really an anti-growth initiative, and he uses, you know, his AIDS Foundation funding for that. So what we would expect is that it's been-- it was overwhelmingly defeated last two times, every county except for one. Voted in favor of Michael Weinstein, and the governor has come out and said publicly that he was not supportive, so we don't expect that he would change his position.
There is another initiative, and that's getting traction, that's going to be on the ballot, which relates to your ability to use your funding source for these other kind of projects. And because, you know, what's happening here is, using money that's earmarked for a particular charity to do something else completely different, it doesn't seem to sit right with the general population. So that's one path, and then the other path is we have always maintained our organization to address, you know, this issue. And so they're working hard on the political and legislative side, and we will continue to do that, and we expect that we will win again.
Any other questions? Maybe just thinking about, like, the operating platform, the years you put in operating initiatives. Is there anything technology-wise or just initiative-wise that you're really focused in on and you're looking to kind of roll out across the platform?
Sure thing. So I think many of you who know us well have seen the terrific results from our asset collections program, which we rolled out across the company. Essentially, it's operating our properties because 70% of our properties are within three miles of each other, so we operate 10-12 properties as one business unit. So there's a lot of efficiencies when it comes to pricing and sales and administration to group those. And so that's behind us, and we've generated about 150 basis points of operating margin improvement, and that shows up when you look at... I think we have one of our slides in there on our controllable cost per unit and controllable expense increase year-over-year.
That, and you know, we're certainly one of the better ones relative to our peers. In terms of the next phase, is to focus on the maintenance side, and so essentially replicating the asset collections model to the maintenance team. The goal with that is not so much personnel change, but it's more focused on better vendor management, better turn efficiencies, and then some of these other ways for us to improve our business. The other initiative is on the revenue management side. We have rolled out our own proprietary management, which will allow us to have better visibility on amenity pricing and be much more and react, you know, even faster to the market dynamics. So we'll have better visibility on the top line as well.
Did that roll out, or it's in the process of rolling out?
That rolled out, so we're just starting to get implemented.
Okay. And what are kind of the early, kind of, like, results that you're seeing as you fit?
Probably too early to tell, just because right now, our revenue management platform is, you know, has a lot of noise between delinquency and occupancy and some of these other challenges. I think next year we'll get a better indication.
So next spring leasing?
Mm-hmm.
Then, maybe turning to the capital allocation front, just thinking about how do you think about prioritizing, like, deploying capital in this environment?
Yeah, I think for us right now, it's difficult to deploy capital accretively. I think you all know us very well. We are very disciplined in our capital allocation decisions, and nothing has changed about that on this front. Our cost of capital is very high relative to where transactions are occurring in the market. We can't make it work, and so we haven't been aggressive at buying assets. I think for us, where can we deploy capital? You've seen us sell assets, buy back stock. That could still work today, depending on the right opportunity. And then we still like preferred equity. I think we're getting a very attractive return today on new preferred equity investments, although the volume is down quite a bit, and what fits into our box is, it doesn't necessarily... There's not a lot of that right now.
So we would love to be able to put more capital to work in various areas. It's just, can we make the math pencil and really push results to the bottom line? And that's been more challenging over the last few years.
Given maybe where your stock trades or the private market cap rates, thoughts on buybacks than in the past?
Yeah, we need a source of capital to do that. We've always been disciplined and done it on a leverage-neutral basis. And even today, though, where cash rates are, you can earn a pretty decent yield on cash. So we would have to decide if we were to sell an asset, whether it's better to buy back the stock or just even park it in cash. So it's something we're weighing and looking at. We aren't actively marketing any assets. We always are out there looking. You know, we have a lot of contacts to see if there's anyone interested in buying any of our assets, but we're not actively marketing any assets today.
And then, bBroadly, what are you hearing from your JV partners? What is kind of their mindset as a private source of capital?
Yeah, I think there are, like many people, anticipating some opportunities to emerge, you know, given the move in rates, and so they are still working with us collaboratively. We're underwriting deals. Their return expectations have increased in the past year or two, understandably, with the rise in rates. But, we're not materially far off from where the transaction market is today to where I think you'd see several partner, you know, institutional, non-REIT public investors looking to put capital to work in our market. So just, again, try to be patient, wait for the right opportunity, and making sure that it makes sense for Essex. We're not gonna do a deal just to do a deal.
We wanna make sure that we have a plan to grow and to grow creatively, you know, leveraging our partners' goodwill.
How do they feel about the revaluations on Essex stock, attractive to them?
I mean, that's probably the number one pushback I would get, you know, 9 months ago. You know, deals like: "well, why would we go buy at a 5? We can buy your stock at a 6." And I said, "I agree. Please, please go buy the stock.
And then just if we're... Like, what's trading today? Like, is there any indication on kind of pricing? Is there a kind of a sweet spot on the cap rate where people get more excited?
We're still seeing transactions close in the 5 and below range, and I think that surprises several people from the outside, given where rates are today. So the volume is down considerably. What you are seeing are 1031 buyers, unlevered buyers who are buying on a basis play that are still transacting. I do think those cap rates are slightly backwards looking, given the move in rates we've seen this summer. So there is a relatively wide bid-ask spread, especially for the levered buyers who are looking for typically positive leverage within a year. But, you know, there are opportunities. As Barb mentioned, we were able to sell two assets, one at a 4.25, one at a 4.5 within the past year.
We continue to look for those opportunities where we can lock in our source of funds and go back in the past year, we were able to buy back stock at a very attractive cap rate. But, yeah, that's where we're still seeing transactions. But again, with the caveat that volumes are down considerably, and going into the fourth quarter, I don't anticipate that changing materially until early next year.
Go back to your memory. See plenty of charts around president. Do you have any recollection what expected was active or all like that?
Yeah, I think, you know, that's a great question, and it's almost like beauty is in the eye of the beholder because it depends on the investor. So for a foreign investor, they're pegging their return relative to other fixed income opportunities. And so if they can get a little spread above the 10-year, they're happy campers. In the US, it's really more of the looking at the real estate asset class relative to a S&P 500 index. And depending on, you know, the investor, somewhere around 100-200 basis points above the expected S&P 500 return. And that's how the world was. But keep in mind, in the 1990s, REITs were still relatively a new asset class.
And so I think that perspective and the sophistication of, you know, the companies that have survived since then have also changed, you know, that mindset as well.
Any other questions from the field?
Yeah, you know, development underwriting is getting much more challenging in our markets. We have not-- We pulled back from development several years ago because it didn't make a lot of sense to us, and with the rise in construct- construction costs for the past several years, as well as, debt yield, debt costs today, we're seeing a material falloff in new developments, therefore, fewer opportunities on new development financing. We're still seeing some opportunities for recaps or sponsors that are looking to take proceeds out of a stabilized property that we're evaluating. So the market remains open. Rates are in the, call it, 10%-13% range, higher for, new developments. But it's not like it was in terms of previous years when you had a, a pretty still open development market.
It's a little bit tougher to put capital to work in that space.
Um...
That is an interesting question. So coming out of the 2008 recession, in our markets, you know, the expectation was, oh, there's going to be a lot of opportunities and massive dislocation. well, I can tell you that in the West Coast, in 2009, we didn't buy anything, primarily because so little gets built in our market to start with. And of course, we have Fannie and Freddie as a backstop when it comes to financing. Fast-forward to today, I think interestingly, there may be more opportunities because development deals that, you know, pencil at 3.5 cap rate, that are 2-3 years ago, that are now in the midst of lease-up and refinancing, they might need some help. Having said that, massive dislocation, once again, in our markets, it's really hard to see that's happening.
Having said that, you know, we have a terrific balance sheet. Barb's done a great job in essentially anticipating all our debts and refinanced everything that's available, that's possible. So we have $1.5 billion ready for Rylan to do something with when an opportunity comes up. Mm-hmm.
Any other questions from the field?... Angela, last time, last time I guess we met in person was, must've been in March, and I think the following Monday you were officially taking on the CEO role. Just kind of curious, just, anything internally that you've kind of done just maybe a little bit differently?
Mm-hmm.
Outside seems the same, but just kinda internally, are you running things differently and promoting Rylan again?
She's doing a great job.
well, interestingly, I took over on April Fool's Day, so that tells you, you know, my mindset there. Fortunately for us, we have a terrific business, good people on the team, and, and of course, you know, Mike was at the helm for a long time, and he ran a tight ship. So there wasn't any issues for me to really address. So the focus has really been incrementally on the margin. How do we, how do we move the company forward? And, and how do we grow? And, you know, how do we expand our talent pool? And, and, and, you know, those kind of things, which have been... Our conversations are ongoing. And so one of the minor changes that, that I made was on the management side, and in promoting Rylan to run our investments.
We believe that this is a great time to do so because we're heading into the seasonal low for our business, and with a muted transaction volume, this is a great year to essentially look at our investment platform, figure out how best to enhance that platform and add resources to it. But what I love about Rylan and his background is Rylan is very strategic, and so he, you know, so in looking for a business partner that can understand data analytics and capital allocation, and all these other different nuances, and how to arbitrage between the costs and different costs of capital and different type of investments, and how to optimize that, I think he's a terrific business partner for that, and so that's the one, big change that we made on the management side.
Thanks. Maybe just talking about, like, kind of thinking about as we head into 2024, could you remind us what your loss to lease is today, and just, like, your earn-in and-
Loss to Lease, we have that.
So our loss to lease is 1.6%-6% through August. And we haven't disclosed our earn-in yet. I think it's a little too early to discuss that at this point. But, you know, we use our loss to lease as a proxy for where our earn-in will be in 2024, and we'll know more in September. But we have peaked in terms of rents, and so we would expect that loss to lease to come down a little bit from here.
Yeah. And just one thing on the Loss to Lease comment. As I noted earlier, relative to our New Lease Rates, our Loss to Lease is also tempered because of our occupancy push. And so normally, you would see a higher Loss to Lease, but this year, once again, we're in a transitional year as we work through our actions. So that's going to temper the Loss to Lease number, and you'll see that, but it's what we expect.
Is that because market rents are depressed or just-
No, it's because we're trying to maintain occupancy. So if you look on our, you know, our current print for August occupancy in 96.5%, but with 2% delinquency, it's not really 96.5% occupancy. It's like 94.5%. And so in our effort to shore up occupancy and close that back door, you know, our loss to lease, which is the new leases that we're signing, is going to be also tempered because we're willing to negotiate a little bit more or give a little more concessions to draw people from out of, you know, outside of our properties or even in the renewals. And so that tempers that new lease rate number.
Okay. So if, if there's, what is it? Percentage points of people who aren't paying their... Okay, that makes sense. And then we're just about out of time. We've been asking all the management teams, three rapid-FIRE questions, two are a two-parter, so it's really five. The first one being: Do you believe the Fed is done hiking, yes or no? And do you expect the Fed to cut rates in 2024, yes or no?
So yes, on number 1. I don't know. No, on number 2.
Good choice.
Good choice.
Do you believe real estate transactions will meaningfully pick up by, A, the fourth quarter of 2023, B, the first half of 2024, or, C, the second half of 2024?
C.
Are you using AI today to help you run your business, yes or no? And do you plan to ramp up spending on AI initiatives over the next year, yes or no?
Yes and yes.
Fantastic. Thank you.
Thanks so much.
Thank you.
... Those of you who don't know me, I'm Joshua Dennerlein, and I cover the residential REITs at BofA. I'm pleased to have with us the Equity Residential team, CEO Mark Parrell, and Marty McKenna from the Investor Relations team. With that, I'm gonna pass it over to Mark for a few opening remarks, and we can definitely jump into Q&A. I'd love to keep it interactive, so if you guys have any questions, I'll—you know, feel free to jump in, and I'll definitely ask the field. With that, Mark?
Yeah. Good afternoon, everyone. Thanks for joining us. Thanks to Josh and the BofA team, and Jeff for including us in the conference. Really excited to be here. So I thought I'd just talk a little bit about operating trends with you, a little bit about the setup for 2024, a moment on capital allocation, and then open it up to questions and whatever Josh and the rest of the group wants to talk about. Pardon me. So we put out our operating release last week. We're on track. We talked about a new lease, we talked about our blended lease rate, we talked about, so where do we sit in occupancy? So it really, the year is ending as we would expect. So this time of year, we start running the business a little more for occupancy.
When you get this late in a year, in a normal apartment operating year, it's really hard to impact your numbers generally, because any leases you write, particularly good or bad, will impact 2024 a lot more than 2023. So right now, you're trying to build some occupancy into the seasonally slower part of the year, so that when you get into 2024, you'll really be able to run the business, at least in the later part of the winter, early spring, for rate. So that's where we sit. Lease rates for us peaked the second week of August and have been declining. That's what lease rates do in the apartment business, so everything is kind of as we would expect on the operating side. In terms of regional trends and the like, the East Coast is stronger. It's higher, more highly occupied.
Rental rates grew more through the year. On the West Coast side, the story in Los Angeles continues to be the abatement of delinquency. So we have a lot of folks that did fall out of lease compliance during the term of the pandemic, who are working through the eviction process. So, Los Angeles has lease turns and just a lot going on in that market. I think the team's doing a great job, and I think that'll be a source of incremental positive strength for us next year. San Francisco and Seattle. I was out in Seattle two weeks ago. The team's doing a great job. I would say in sum to those of you who haven't been in those markets, it's better than you read it about in the East Coast papers.
I just can't emphasize enough the importance of going to see places like San Francisco and Seattle for yourself. I mean, the groundscape is improving, crime levels are improving. It is not perfect, far from it, but what you read is not what we see. And again, I was in Seattle two weeks ago. I was in San Francisco in May. The teams there, our occupancy is generally around 95% in those markets, with the center city weaker than the suburbs. But again, we have decent occupancy. We just really can't move rents. So that's a little bit of color on operations. Happy to take questions in a moment. Shifting over to 2024 in the setup, we aren't giving guidance.
We don't do that until the January call for the fourth quarter, but we do do this time of year to start talking about building blocks, like, how does the year look? What are we thinking? What is your management team thinking about next year? So I thought I'd go through those with you quickly... I'll use some terminology. Everyone in this sector uses a little different variation of terminology, so I'm gonna start with what we call embedded growth. So embedded growth, which is often called earn-in for others, embedded growth for us is when you take at the end of this calendar year, our rate and our occupancy, and you just say, "Nothing changes." No lease rates go up, occupancy doesn't go up or down, just stays the same. What would the contribution to same-store revenue be? At the beginning of this year, that...
I call that kind of your running head start. The beginning of this year, it was 4 percentage points for us, a little bit above that. That's a very high number. That number for us is usually 50 basis points to 1 percentage point. The way we're talking about it with you all at this point is assuming the year ends as we would expect, the earn-in or embedded growth would be somewhere between those two poles, but further away from 4. 4 was a lot of the pandemic recovery, was really a lot of strength in that, so that number would be a little lower, but in that range, because we still feel like we're ending the year pretty well. So then your second variable is delinquency, which is usually for us, around 50 basis points.
By the end of the year, as we've disclosed on the call, we would expect it to be about 1.3%. So you got 80 basis points of pop opportunity there, but you're not gonna capture it all. Because it's not like in January, we're gonna flick a switch, and it's gonna be back to 50 basis points. But there is some opportunity there, and we'll talk about that as we get on the call more clearly, but there's something there for us, and I'm guessing for a lot of our competitors as well. Occupancy. Occupancy is really interesting. Right now, we're 96.2% occupied, more strength in the East than in the West. And so what's interesting about that is when you're 97% occupied in a market like New York, the opportunity is not significant. You're almost at frictional vacancy.
It's hard to be higher. But I just told you a moment ago, you're 95% occupied in Seattle and San Francisco. Those are markets with opportunity, and in the Center City, it's lower. So those are markets where we could nudge up the occupancy a little if we continue to see demand, and most of all, if we start to see some hiring by the tech giants. We really, the impact of the layoffs and the rest have really been for us not to be able to raise rents, but we didn't lose a lot of occupancy. We just can't raise rents in Seattle and San Francisco. So again, in some places like South Lake Union, where I was a couple of weeks ago, you see the return to office. South Lake Union is very vibrant. There's Amazon employees. Our sub-market there is 97% occupied.
But again, what our people on the ground are telling us is they are seeing people that lived in exurban and suburban Seattle move back. So these were prior employees that moved out during the pandemic, and they're moving back, and they're filling our buildings up. What we're not seeing is that graduate from business school, that graduate from engineering school, taking a new job. That second ingredient is, in our opinion, necessary in order to really drive rent growth, and we aren't seeing that yet in Seattle. And there's a similar story in San Francisco, though the South Bay with San Jose is better positioned than the city and the Peninsula. All right? So we've talked about delinquency, occupancy. We've talked a little bit about the last and hardest thing to handicap is your intra-period growth. What happens to rents during the year?
In a normal year, we often see around 3% growth in rents. This year, we handicapped a number around 2.5%, and we're right on the mark. Our thinking was right on the mark. I don't know where to put next year, and that's the mystery of the future, and we'll all talk more about it, but we can all have our opinions. But I think EQR is set up very well. Compared to our competitors, less supply, we're gonna feel less of that burden. I think the demand feels good, the ability to recover, both in Los Angeles, which is where most of the delinquency is, and hopefully in the two big tech markets, some amount of job growth, I think positions the company to outperform next year. You can see the convergence between the Sun Belt and the Coastals.
I think you're gonna see the Coastal apartment REITs, led by us, sort of pass that number, and, you know, perform better. The last comment I'll make about supply: Supply is a very significant input, all right? The hurricane of supply is offshore, okay? It is not yet onshore. The amount of supply in the Sun Belt markets in 2024 and 2025 is very significant. Because it compounds for years, it'll affect rents for several years. We like some of those markets, like Dallas. We wanna be in those markets more, but the results for the next couple of years are gonna be very challenging, and the challenge has just begun, and that's where I think the Street underestimates. I think there's a lot of conversation that the impact is here. The impact is just beginning.
The impact will compound and get worse, likely for two or three years in our experience, just because of the amount of supply being delivered in some of those markets. Quickly, capital allocation, then we'll turn it over to questions here. So, we haven't been very active. We want to be. We'd like to continue to allocate some capital to markets like Denver and Excuse me, Denver, Dallas, Austin, and Atlanta, that are markets that have a lot of supply, and hopefully, they'd have a lot for sale, but there just isn't a lot for sale right now. We'd like to have more balance in the portfolio to be both in markets that have, you know, less and more regulatory risk, that have less and more supply risk. We're just trying to balance those risks out between urban, suburban, and between these markets as well.
So we're looking and looking, but there isn't a lot for sale. I think pricing expectations continue to be unreasonable from our perspective. So you'll see us do a few things here or there. We may start one development deal, we may start none. It just depends how things come together. Hard to make development pencil. Right now, it's just the cost of building has not gone down, and of course, the cost of capital and what you think cap rates should be on an acquisition have, and so it's tough to make those numbers make any sense... All right, so that's what I got for you. I know, Josh, if you've got any questions you wanna go through?
No, yeah, of course. Thanks for those opening remarks. I guess maybe just thinking about the operating update in the market-by-market commentary, just kind of curious, where has things been better and worse than kind of your expectations?
well, again, it's not gonna be like September numbers, and I wanna make one little cautionary note again. You all are getting numbers now from us and from our competitors almost on a monthly basis, and there is enough variation there that you shouldn't read too much into it. Like, at least on our numbers, new lease can be a little better or a little worse by 0.2 in a month, and it doesn't mean there's an inflection point. There were commentaries made about our numbers and that of others, and I can't speak for my competitors, but again, when you have these short time periods, when we last reported to you in July, so you saw some July numbers, now you're effectively getting August numbers. You know, it's just... Is the number on track? There's all these gives and takes.
So I'd say the East Coast continues to feel better. New York has been stellar. Washington, D.C. has been a big surprise. It has a fair bit of supply, but it's absorbed that supply very, in a very orderly fashion and done really well. The expansion markets, again, which are those four markets, Denver and the two Texas markets and Atlanta, you know, they have a lot of supply. I mean, we still have occupancy, but we feel the price pressure, but we don't have a lot of units. It's about 5% of our company are in those markets. On the West Coast, again, we just don't have the ability to really move rents in San Francisco and Seattle. L.A., and certainly Orange County and San Diego feel better, but we're working through our delinquency issues there. No impact from the strikes.
We've talked to our people on the ground, asked, you know, "Do you see people giving keys back? Do you see people doubling up? Do you see people saying, 'I'm stressed out, I'm probably gonna have to give back my keys?'" We don't see that in L.A. with the actors' strike, and the writers' strike, and all those, so that's not something that, to date, has happened. So that's kind of where we sit.
Maybe zeroing in on Seattle and Northern California, like, you, you mentioned you don't have the ability to push rent. well, like, what do you think drives that? Like, you mentioned return to office is starting to pop up in-
Mm-hmm
... certain submarkets. Like, is that just the key, and we got to continue focusing in on that, or is there something else, like job growth or?
You know, I made this suggestion about going out to these West Coast markets. I know for many of you, that's quite a commute, but what I'd say is, to answer your question, RTO matters. Certainly, it matters because of activation. But New York isn't fully back, but our occupancy is great and our demand is great. So I think it's more for our demographic, think 25-40-year-olds in high-paying jobs, generally not with families. I think those folks are looking for exciting, interesting cultural entertainment, amenities, things to do. Do they feel safe in their community? Can they go out for a run at night and feel okay with that? Can they find a restaurant? Can they meet with their friends? So, you know, these East Coast markets are attractive, Josh, in that way and are less concerning.
And I think out West, you know, Seattle and San Francisco are getting better. They aren't where they should be yet, but they're working towards it. I think political leadership is focused on, you know, having a, you know, a safe, safe place for people to live. So I would disconnect a little from RTO and talk more to: Do you have just net job growth, and is it an attractive place to live? Because, again, we don't have full RTO in New York, we don't have full RTO in Boston, and we're doing great, and in D.C., even less so with the government, and we're doing well in all those markets. So to me, it's much more about, is the streetscape activated? Is it fun to be where you live? Is it safe to be where you live, and is there net job growth in that area?
Do you think there's markets like Seattle and Northern California in particular, like, do you think they can make it attractive and safe for 2024 to kind of get, like, an acceleration in that?
Yeah. You know, I heard that San Francisco hired a PR consultant. I thought that was a good move. You know, they need to talk up what's going on. There's a lot of cool things in those markets, too. Yeah, I think they can make improvements. There's an election for city council in November in Seattle. I think that's helpful. I think for politicians to have check-in points with voters puts pressure on them to continue to make changes. San Francisco has a mayoral election. I think Mayor Breed has done a lot lately to try and improve the city, but the candidates against her are mostly running on a more law and order type format, so I think that's good, too.
So this is a little bit about government, a little bit about industry, a little bit about just the pandemic's aftereffects being... lasting a little bit longer, and that being coupled with a secular decline in the tech sector that has really hurt those markets. But, boy, you see the share price of the tech companies are doing pretty well, and usually after stock prices, you get jobs. So my hope is that's what happens in 2024, a little more job growth and just a continued improvement in, you know, quality of life.
Then when I think about apartments, like, demographics can be a real big driver-
Mm-hmm
... kind of where things are going, and I think if I, I'm quoting correctly, I think, like, the average age of a renter in your portfolio is 32. And then I look at, like, the next few years, the 32, like, kind of bracket, like, is towards the end of millennials, and then it kind of, you get the, the next generation. It looks like it shrinks for a couple of years. Like, how do you think your portfolio is positioned to weather that, and is that a concern at all as demographics kind of flow through?
Yeah, good question. Yeah, I mean, demographics hugely important to the apartment industry. I think our number has actually been trending up a little in terms of the age. I think we're gonna capture two groups disproportionately. One, I think these older millennials are staying with us longer.... I think their ten is going to be longer because it's hard to buy a home because rates are so high. Home prices haven't adjusted, not a lot of homes for sale. So I think they'll be renters longer, and I think we'll benefit from that. I also think that, you know, there's going to continue to be a good number of people that will be graduating from college. I've got a couple of kids in that bracket. Gen Z is not a small group. It is a large demographic.
This millennial group is particularly large, but it's not like a tiny group here. This is a large group of renters that, you know, we don't know their preferences yet. We'll have to see, but we have every reason to believe they'll be interested in dynamic, diverse urban environments and interesting suburbs near big cities, and that's where we play. So I'm not worried about that. We really spent a lot of time looking at that, and at the end, it felt like between longer stays of the older millennials and between Gen Z being a pretty large group, that we would be okay in terms of, of the demographics.
I think at least pre-pandemic, there was maybe talk of like the baby boomers kind of rotating into the cities and go-
Mm-hmm.
Are you seeing that? Did that kind of just fade or?
It's not significant for us. Yeah, I, I can't quite explain why. Part of it might be we have a portfolio that's more one bedrooms and studios. We do have twos as well, but I, I don't have an explanation for that except to say that I think a lot of those people are pretty well off, and they may be buying, or they may be renting extremely high luxury stuff, and we have a lot of high-end properties, but I actually don't want to own A plus plus assets. That's just a very narrow part of the pyramid. So I, I have not seen a big boom of, call it... See, they, now that I'm over 55, they say that over 55 old group. I don't like that. I'm just going to say older, more mature group. So, no, we have not seen a big tailwind from that.
Okay. And then maybe just thinking about, like, COVID's impact on cities and just like, you're the most urban out of all the apartment REITs I cover. Just how do you think about that strategy going forward? If, you know, did you want to kind of start maybe rotating a little bit to the suburbs, Sun Belt? Like, how, how are you thinking about that play and, and pushing into that theme?
Sure. So this is something we started talking to you about in 2018 and 2019 when we started to buy in Denver. I mean, just having a little broader footprint, it helps mitigate supply risk a little bit. There certainly is regulatory risk in some of these markets and mitigates that. So to just have a little bit more balance, and balance doesn't mean being in 35 states. We were once in 30-odd states. It means being in 10 or 12 of these great cities that attract our demographic, these higher-end renters that will rent for a long time, that either for lifestyle reasons or cost reasons, won't buy very quickly. And in markets where, again, like, you're not stuck with one industry, you're not stuck with one supply dynamic.
So that's our goal, and we—like I said, we laid that out and started working on it in 2018 and 2019, and the pandemic has just reinforced our thinking on that.
Do you think there'll be more opportunities to grow, just, like, given all the supply risk in the Sun Belt? You mentioned Dallas. Like, do you think, like, you'll see more opportunities over the next two years, or?
Yeah, we've been on the record saying we expected to see more even by now. So we hear brokers doing a lot of opinions. We hear a lot of conversation, but I think it's going to happen for a reason I'll talk about in a second, but maybe more slowly than we had hoped. So we thought there'd be a lot of these development deals where folks had capital structures where the debt was 3% 18 months ago, and now it's 8% debt, where their development capital, both the lender and the equity, is itchy. They were sitting in this deal longer than they expected, and where, you know, frankly, the developers made enough money, and they'd cash out. Instead, what we see and hear and feel a little bit is developers that aren't interested in capitulating yet.
They've made a lot of money over the last few years in the apartment business. If they think their building's worth $100 million or would have been before the Fed started to raise its rates, they now see that it might be worth $75 million or $80 million. Brokers telling them that, and they're like: "You know what? I think the Fed's going to capitulate, rates will go down, cap rates will go down, and I'll get the advantage of that, and I'm going to wait it out a little." And so our sense, Josh, is that there'll be a point at which... And oh! I should also add, their NOI hasn't gone down. And only in the Sun Belt markets has that started to occur in South Florida and in Phoenix, where NOIs are negative. So you're making money, you're leasing up your building.
Maybe it isn't perfectly on pro forma, your costs are a little bit higher, but you made a lot of money in the business. You're confident you can do it again. So I think people are waiting it out a little, and I think they're going to end up being motivated because of how expensive their capital is to sell. I don't think we're getting anything for free, just to be clear, but we're looking for 10%-20% discounts to replacement cost and stuff we can buy that's, you know, better than our cost of capital.
Because one of the things that you should ask, I would suggest, when someone says, "I'm buying an asset in a highly supplied market," is if I tell you it's a 5.5 cap rate in year one, it's got a lot of supply, the cap rate in year two is likely to be lower. So you just gotta. That's okay. I mean, we're buying, we're 10-year buyers at least, right? But you just got to be thoughtful about what's about to happen in those markets. All right? You're not gonna. I mean, why would your apartment building be the only one in the market with rents growing unless the prior owner was really out of pace with market rents?
So to that point, you know, one of the things, reflecting on some I heard in the housing panel earlier, was just that the supply being offshore in Sun Belt, and that, I think we suggested that the pace of delivery is actually slower than that just because it's taking longer. So on that delay-
... but also I think versus 12 months ago, economic growth, U.S. generally, not well as well, has also been strong migration. So I'm kind of wondering when you're thinking about, you know, growing in your markets, understanding that there's attendant risks, but also some other things that are definitely better if supply comes off a bit lower. How do you kind of think about maybe averaging your way to achieve some of your growth objectives while realizing you're not necessarily gonna bottom-tick every asset? How, how do you do that?
Yeah, the bottom-ticking every asset thing is definitely not the approach. That doesn't feel right to us at all. We're no, no one's that good. So just as we look at the markets, as we think about... and just go through the end of that just one more time. I just wanna hear the end of that question again. I'm sorry.
Yeah. So I'm thinking as like, as maybe the economy holds up a little bit better, supply comes to market, maybe a little bit slower-
Right.
But longer.
Thank you.
Kind of the intersection of all of those things.
Yeah, and that's a really good question. So if it was one year and supply was 6% of stock, and now 6 was gonna be 3 and 3, I'd say absolutely a buyer on that. What we're seeing in a lot of those markets is supply is 5-8% in 2024 and 5-8% in 2025.
Five-
Yeah, it's just too high to begin with, and the concessions will build on each other. So you're gonna be out there leasing with 2-3-month concessions, and that'll damage all the properties existing in you. And then there's gonna be another new property right across the street, and then in 2026, to your point, some of the 2025 supply will move. So our experience is that looking at the fourth quarter of 2024, what we think will deliver, will open and start leasing, that 25% of that, so if we think there's 10,000 units in that quarter, and there's nowhere that high, but that 2,500 of them will move into 2025. Does that make sense? Even right now, there's gonna be delays still. We totally agree with that, but it's the compounding.
So getting 9 and 9 and making that 6, 6, and 6 is not an improvement in the outcome for the apartment owners in that area are not much of one. Now, if you get lucky and the economy starts to accelerate, I agree with that. That's a real bonus. That would be good all around. It'd be particularly good if you're 97% occupied in New York, like we are. So if you're sitting where we are in our East Coast markets, and you're telling me there's job growth, unless your thesis is that job growth is limited to certain places, I think we're gonna benefit disproportionately from that because we have less vacancy, and we're gonna have less because the supply is so much less.
there any big Western markets that all of a sudden started evaluating in some way here? So I think I would handle it actually, Jason.
The answer to that is no.
Any other questions from the field?
Half of it.
That's good.
Yeah. So question was about expense growth for 2023 and just thoughts on 2024. So our guidance midpoint is 4.25%. We've been very good compared to the industry in managing expenses. A little of that is the benefit from Prop 13, we're 40% California. 40% of our expenses are property taxes, so we do benefit from that, but we also are very good at managing our payroll line item and our repair and maintenance line item and all that. So I think we'll put that number up. I mean, I feel good about our number on expenses. This year, the pressures come from insurance. So though we don't have windstorm risk, we don't have properties in places like Florida, our insurance costs were up 20%. I would expect a similarly strong number or high number next year, unfortunately.
I think we won't have as high a number on... There's a line we call other operating costs, which is usually pretty low, but it does include legal costs from processing evictions. I think next year will be much, much lower. That's a line item that has millions of dollars running through it. Property taxes for us this year are about 2.5%. I think they'll be a little higher next year, but again, a lot of work gets done between now and the end of the year because you talk to your experts. It's not so much you talk to the assessor, you talk to the people who are talking to the assessor, who feel the budget issues in the market and can give you a little feedback, what's gonna happen to rates and assessments.
So we got a little work to do there. I think we'll do better on payroll. This year is gonna be a 5% payroll year for us. That's higher than we usually put up. There's some special reasons for that. I think next year will be lower, and hopefully the same on repairs and maintenance and utilities. So I'd say it'll be above what it was the last five years for us. We had years where same-store expense growth was, you know, 1.5%. It's gonna be higher than that, I would think, but I think the number we put up this year is probably the high end of the range for next year. Is that good? All right.
Any other questions from the field?
What are you thinking about regulatory risk in the years ahead? In California, it's got, I think, Costa-Hawkins is back.
Mm-hmm.
But then I think like in New York, there's a case working its way up that would get rid of any kind of forms of rent control or rent stabilization. I guess it depends on how you read it. Just-
Right.
Just kind of curious.
Yeah. I mean, regulatory risk is significant in some of our markets. There is government risk in all markets. I mean, we talk about some of the markets in states like Texas have different risks. They may become less appealing to our demographic, depending on social and economic policies. Some of those cities, places like Dallas, have pretty significant pension issues of their own, by the way. So it isn't limited to the big northern cities in California, where maybe there hasn't been as much spending discipline as some of us would like. So you got to be mindful that regulatory risk exists in many forms. There will be a ballot measure in November of 2024 in California, the third one, proposing to allow local rent control. The industry is super well-organized and will fight that. I was in D.C. yesterday for the-...
Meeting of the industry association, so we're really well organized. We've done it twice. We've won it by 20 percentage points. I don't know if we'll do that well, but again, it is a bad idea. It does not solve the problem of affordable housing or homelessness. It makes it worse. Every reasonable, legitimate economist agrees. So the industry, though, has to say yes to the right things, and yes is the more supply. We need a lot more building in these markets. I mean, the Sun Belt markets are about to prove what happens when there's a lot of new construction.
But we need new construction of Class A, workforce housing, everything, and I think some of these zoning reforms, I think Governor DeSantis' new rules down in Florida, I think what the state of California did on the other political spectrum on a bill called SB 9 , which was a bill about deregulating zoning near transportation nodes. Those were all really good ideas. I think Governor Hochul's proposals were very thoughtful. They weren't put in the law, but I know the legislature is gonna consider them along with some other things. So I think, you know, those are all really important things to do. So, you know, we're thinking a lot about California. I certainly think that New York is always something that merits conversation.
There's been a lot of talk of what they call Good Cause Eviction, which is just rent control by a different name, and the industry will continue to suggest, again, reinstalling 421-a, which built a lot of units in this market. Public-private partnerships like that can be pretty effective in doing other things like that, but, you know, those are the main things we're mentioning. But it's mostly about education, and a lot of the folks we talk to understand the point. A lot of these public policymakers, they don't argue with us on the merits. They're more just terribly frustrated. They're more really anxious about, excuse me, homelessness or housing in their market. So, like, we get it. We're just trying to come up with an effective solution for them. As for the court case, we'll see what the court says.
Maybe just staying with New York on your comment on the 421-a program, is that something like that being considered by the legislature?
So again, I'm sort of going what was in the paper a little bit. You never know exactly what happens. Albany is a little bit more of a closed system than California, for example. It's much more of a back room process, but there was a big trade that was proposed to reinstall 421-a with... Which again, to remind people, 80% market rate, 20% affordable, and I think it was 80% or 50% of area median income, and in exchange, you got a big property tax break that burned off over time. So that was the 421-a program. A lot of units were built under that program. That program's now expired. There's some transitional stuff. So they wanted that program back. The other side wanted rent control in exchange for it, so that didn't work.
So they're gonna have to go back to the well and figure out if there's some compromise they can all live with.
Then any questions from the field? Just maybe thinking about the platform at EQR, any kind of initiatives that your team is working on, anything that you're focused on in the next 12 months?
Sure. So what we've talked about for the last few years have been more about expense limiting. So we call it podding, other people use other terms, but just running properties jointly. So we often have assets near each other. So maybe you have one large asset and one smaller asset, and the smaller asset may have no staff assigned to it anymore, but the larger asset staff will come service that asset, take care of maintenance issues, lock the property at the beginning and end of the day. A lot of our leasing now is done, really all of it, remotely, meaning tours are done using an app on site, and so, we do follow up in person on that.
We think that that's an important touch point, but that's allowed us to really lower the amount of staff on site, and again, it's kinda common now in the industry that that's been the case. Some of these revenue enhancements, we've got a lot of storage space in our buildings. We've got a lot of conference rooms we can rent out during the day when our residents are often at work. So all of those initiatives, short-term housing stuff, Wi-Fi, there's all sorts of opportunities that we're focused on. So think of us as a little more focused on revenue now versus the expense control, 'cause we feel like utilization of staff is pretty high in our company.
For the revenue side, like, should we expect things to kind of be rolled out in 2024, or is there a little bit longer dated?
Little bit this year on the revenue. I think the number we promised was something around $10 million over the course of this year and next, and, you know, we revise that number up and we tell you, you know, where we go. We benchmark it and let you know. So I'd say, you know, it's a couple of year process.
So insurance has been a hot topic. Just curious, could you remind us when your renewal is, and then just kind of any early indication of where it might go, and if there's anything you can do to control that?
Sure. So our property insurance renewal is in March of each year, and again, it was up 20%. We didn't materially impact our deductibles or anything else, so it's kind of a clean number. Important question to ask people and when they tell you their insurance number is, did they change their risk profile? 'Cause if they took more risk, then the premium should have gone up less, and they may have mitigated some premium dollar increase by taking more risk on. But in any event, that's where we sit. Right now, we're exploring other alternatives. Our biggest risk, given that we're not in windstorm, hurricane areas, is earthquake, which is not climate related, but is a material risk for us, and getting earthquake insurance is gonna get harder just 'cause the whole industry is stressed.
Thinking about alternatives is useful, like are there other places we can tap, you know, cat bonds and things like that. That's a useful thing for us to think on, that we're thinking on.
But would you take on more risk, or do a... Sorry, do you have a captive as well?
We do, we do. We take on more risk if the premium was out of line with the cost, with the risk being assumed. You only transfer risk when it makes sense and it's fair, or when you can't afford the risk. So with EQR's balance sheet, we can afford the risk. You know, we can take a certain amount of deductible risk, but a significant earthquake in California may create significant damage in the portfolio. You'd want to have some insurance for that.
And then we're about out of time. We've been asking three rapid-fire questions. They're very difficult. No one knows them until-
No one knows them? Wow!
Unless you were in another panel, like, you know, some people around here. The first one is, do you believe the Fed is done hiking, yes or no? And do you expect the Fed to cut rates in 2024, yes or no?
I think rates are gonna go up again, and I don't think they're cutting rates in 2024.
Do you believe real estate transactions will meaningfully pick up by, A, the fourth quarter of 2023, the first half of 2024, or C, the second half of 2024?
Let's go with the first half of 2024.
Are you using AI today to help run your business, yes or no? And do you plan to ramp up spending on AI initiatives over the next year?
Yes, and I'd expect our multiple to immediately increase by two turns. So we've used AI, and a lot of others have, to help answer resident inquiries and do other things. We're using it for more advanced stuff now, experimenting like everyone is.
Awesome. Thank you, guys.
All right. Thanks, guys.
... My name is Camille Bonnel. I am the Office and Industrial U.S. REIT Analyst here at Bank of America, and I'm joined by my colleague, Dan Byun. Today's roundtable session is now with Kilroy, and we have a great representation from management. John, in the middle, Chairman and CEO. We're also joined by Justin Smart, President; E liott Trencher, Chief Financial Officer and Chief Investment Officer; Rob Paratte, EVP of Business Development; and Bill Hutchinson, IR. It won't be the last time we see you, but John, we appreciate you participating, for a final time at our conference. And I don't think this will be a final goodbye since I believe you plan to stay on as chairman. So any thoughts you'd like to kick off the meeting with?
well, I, you know, I've been doing this a long time, and I'm looking around, I see a few other people with gray hair, and some of them didn't have gray hair when I first met them. I'm going to be doing my fifty-fourth NAREIT conference in November, and if somebody had told me that I was going to do that way back when, I would have said, "You're out of your mind." I do think there is some kind of conspiracy because there must be some unwritten rule that if you're in the REIT industry, you got to stay at hotels or go to these hotels that are not exactly terrific, but this one's okay. Thank you for having, having us here, and let's get going.
All right. I guess on that note, any update you can provide on the succession planning and key qualities that you're looking for in the next CEO?
... well, I'm not going to get into that in detail because that's a board issue, and we're actively underway now with our search, and we have some initial rounds of folks who we're talking with, both internally and externally. And our intent is to try to get this done by the end of the year. We want to make sure we get the right person in the spot. And that's about all I can tell you at this point.
Okay. And we'd like to make this an interactive discussion, so if anyone has a question behind me, feel free to ask. But given where today is, you know, sentiment is very negative on the sector, but I think there's a view that we might be nearing a bottom, or at least the deceleration is slowing. I'd like to get your thoughts on how you characterize where we are in the office sector, and let's start there.
well, there obviously, there are a number of influences that many of us have been aware of and talked about at length over the course of the last couple of years that are influencing the office sector. And I'm not going to list it in order of priority, but let me give you a few things that's very much on our mind. One is, we've been, I think, the leaders in providing modern workplace environments to our tenants and prospective tenants over the course of the last several years. And I think we identified earlier than most that there had been a seismic change in the way people are using office space and the kind of space they want.
There's roughly 70% of the office space in this country that's either obsolete or growing obsolete, and that's not the asset you want to own as a stock investor in an office company, or as a direct investor of an office building, or as a lender to an office company, and it's not where you want to be if you're a tenant. So there has been a seismic change in the way people are thinking about product. We've seen sustainability become a big issue over the years. We've been the leader in that for 10 years. We've seen wellness become a bigger and bigger issue with tenants. We've been the leader in that. I think we own more well buildings than anybody in the United States, other than the United States government.
So I think we've made the right calculations and investments in the type of assets. The other thing that's been very much on people's mind is return to office or RTO. We're seeing that in full bloom right now. People, office is very relevant, but it's the kind of office space that people want, not the obsolete stuff. We're seeing a real flight to quality that's been going on for some period of time. The pandemic, of course, accelerated that. I think we're very well positioned in both our core portfolio and our development pipeline to provide state-of-the-art product. The other thing that's happened, of course, is we're in a... We've had a pandemic, and that, of course, caused people to not come to work. And as I mentioned, RTO is back in full force.
What's really important is that more and more companies have thrown down the edict that you will be back in the office. It could be two days a week, could be five days a week, but you'll be back in the office. If you notice, Zoom came out with an edict that you're coming back to the office because they need to have the collaboration and the teamwork and so forth to develop innovative products as well. I thought that was a really great proxy. So we're seeing that, and we're seeing utilization rates increase very substantially. It's different in each market. We're seeing the type of product and amenities that people want. We're doing well in our products with regard to that, and there's been a seismic shift there as well. So those are big influences.
And then, of course, we have this little thing, are we in a recession, are we not in a recession? And obviously, there's been an interruptus with regard to interest rates and availability of debt and so forth. And I think that you're going to see a couple of these factors play out probably along the following lines. Obsolete buildings are not going to attract lenders because lenders don't want to lend to obsolete buildings. There are a number of buildings, be they obsolete or not obsolete, that have feasted on low-cost debt. And think about the dilemma you have as an owner. You say, you've just done a lease, or you're doing a lease with a tenant, and it requires $10 million, $20 million, $50 million of improvements and so forth, tenant improvement work, etcetera.
And you have a loan coming due in a couple of years, and you know that's an irreplaceable loan because, the interest rate that you have is not achievable again. So now the question is, do you go ahead and do that deal and invest that money, or do you say, "I got to wait until I work out something with my lender?" So I think there's going to be a number of buildings and owners in the country that are going to have a difficult time, leasing their buildings, and funding that. So those things tend to play well, I think, for us. But notwithstanding that, we're in the office business, as well as life science and some resi and retail, and those negative influences can impact everybody.
From our standpoint, balance sheet-wise, I think we have the best-in-class balance sheet. We have $2 billion worth of liquidity. We've just done some interesting things that Eliott can talk about. And we've got a great tenant profile. 50% of our tenants are high-grade rated, and you know, we're very confident in that. We have a great schedule on lease terminations and loan terminations and so forth. So as a company, I don't think we've ever been in better shape in a recession than we are today. Can you expand a little bit more on those utilization rates that you're seeing within the portfolio? Because when we look at public card data, San Fran continues to lag, and it seems like it's driven by the tech industry.
But when you hear about the footfall activity going on in Manhattan, it just seems like they're polar opposites. So what are you seeing within Tower?
Sure, Camille. Good afternoon, everyone. I think one of the misleading things, I'll, I'll pick on Kastle data, since everybody refers to Kastle. One of the big misleading factors in that data is that they're only tracking card key, and a lot of buildings in the country do not have card key access. You're missing a lot of suburban activity. You're also missing a lot of activity, particularly on the West Coast, where security is not as stringent as it is here in Manhattan.
The other thing I'd say is that in general, using Kastle as well as our own data that we provide or that we access on our buildings and our tenants, is that occupancy has gone up quite dramatically, and it really took hold probably in, I would say, May 1st of this year, when Amazon was the first to really put meat into the concept that you're coming back to work, and it's not, you know, when it's convenient for you. Subsequent to Amazon doing that, many other companies, including Zoom, as John mentioned, have followed. So you do see much more foot traffic in a city like San Francisco. For example, I've been impressed when I've come to Manhattan the last year or so with the number of people that are back. San Francisco is getting there, and so is Seattle.
Keep in mind, those two cities were the longest with the, you know, longest, most prolonged pandemic shutdowns, so they are catching up, but they're doing actually quite well. Our parking revenue is up. We often have our parking garages full by mid-morning, which we haven't seen for a while. The last thing I'd say about occupancy that all of us need to keep in mind, or I guess, particularly when you talk about Kilroy, is that, you know, we build high-performance buildings. We own high-performance buildings. That's what these growth tenants want. They're hiring knowledge workers, and they're hiring people that are professionals. And so even before the pandemic, you had a maximum physical occupancy somewhere in the 60%-70% range.
If you look at it today with some of the companies we've talked to, they're saying whether it's 2 or 3 days a week, or 4 days a week, or whatever the number of days a week people are in the office, 50% of that time is in the office, but other parts of that time are in customer offices or off-sites and other sorts of, you know, venues that you were doing prior to 2019. I think it's a misnomer to really look at data that we're gonna get to 100% occupancy. Maybe call centers were like that, but, you know, professional services were not.
And we heard from one of the panels this morning, there seems like there's improving CBD trends, in particular around Seattle, which is a bit of an outlier, when you look across the West Coast markets. So what are you specifically seeing in that market? Is it driven by Amazon or to you?
Again, Amazon is the largest employer in that market in the Pacific Northwest. So yes, they do drive a lot, but, there are other tenants in the market. It has a... Seattle does have a life science component to it, and there's also an AI component that has been growing in Seattle as in San Francisco. So, I think the best thing that happened to the Pacific Northwest over the last 10 years is the broad diversity that's come to the market. Not only Amazon, but Apple, Facebook, Google, Salesforce, you name it. They have a terrific talent base there for tech, but they also have a good, you know, strong FIRE category segment to the market.
John, you've been in the circus of that, sort of the political situation out in L.A. and San Francisco, and how that's been a challenge to getting people back to work. How's that going? How are you seeing it today? Anything change?
You know, Mark, I thought somebody might ask that question. So I want to give you San Francisco, 'cause that's the one that's people seem to focus on the most, and, you know, it's different in each city. I would characterize the issues of homelessness, crime, drug dealing, all these things that we've seen impact negatively so many American cities, probably elsewhere in the world. You know, it, it's a scourge. You can't have society function and business function with that kind of activity going on prolifically. You'll never get rid of all of it. So what's happened in San Francisco? I mentioned over the course of the last couple of years that a bunch of us have gotten together to form a broad coalition, and it's not just real estate, it's across all industries, it's across all kinds of homeowners, all demographics.
People are fed up with it, and they're fed up with it in San Francisco, and they're fed up with it elsewhere. So what do we do? We changed some of the school board members through our group, then we got rid of the district attorney, Chesa Boudin, and we got in Jenkins. And Jenkins, she's a tough prosecutor. She's hard on crime. Then we got her reelected. So the crackdown on drug dealing and use in San Francisco is underway big time. I'm gonna give you a couple little statistics or comments here. You have a task force that consists of the DEA, I believe the FBI, the state of California and its various agencies, including the CHP and so, et cetera. You have the sheriff's department, you have San Francisco PD, all cracking down on crime.
They've arrested over 300 violent drug dealers this year. They're prosecuting them. Persecuting is probably a good idea, too. But they're prosecuting them, and then what we're doing is we're going after the judges that we're going to expose the judges. I don't know where all of you vote, but there's always this thing: What judges do you vote for? well, you can get their records. So now what we're doing is a coalition called Neighbors is exposing the judges that are soft on crime. They just, you know, they refuse to hand out sentences. And all those things are part of an effort, an effort that's very important to accomplish, to clean up this illegal activity. It's been prolific.
The snatch-and-grab stuff you hear about all over California, you hear about it in other cities as well, it just can't go on. There is an effort right now to change next year, in the 2024 election, a number of the Board of supervisors. Our group was able to get two moderates, two additional moderates in the 2022 election. I think we'll get two, maybe three, in the 2024 election. If we do that, we'll have a majority on the Board of Supervisors. For those who don't know, San Francisco is a city-county government. California, we have city councils, and we have county Board of Supervisors, so they're one and the same when I talk about the supervisors in San Francisco. I'm not going to talk about some of the other candidates because it's probably inappropriate to do so, and occasionally I don't violate that.
But I will tell you, this is serious, and there is big money, big interest, broad cross-section in this coalition. The increase in police funding, it's at an all-time high. They're the highest paid police officers, I think, in California, certainly in the Bay Area. We're hiring 220 new police officers. We probably need a couple of hundred more, but there's a big increase in police funding. The crime trends are really starting to tick down and, and be favorable. That doesn't mean they're acceptable, but they're more favorable. And on business taxes, the city of San Francisco recently approved an annual budget, which pauses a bunch of scheduled tax increases, and that included new tax incentives for downtown businesses, and I think that trend is likely to continue.
Said in Kilroy speak, we had an unacceptable group of people for a long time with very bad policy and not causing people to adhere to the law. You cannot have a decent society and, and have that happen, and that's being rolled back now. It's not going to be easy. It's going to be a continuous fight, but there are a lot of people in it. And now, as people are coming back and occupying their buildings, I think you'll see a lot of the big office users put added pressure on the city and the, and its various agencies to clean things up. So I'm more optimistic about the city of San Francisco than I've been in the last two years. That does not mean it's fixed. It's the beginning of being fixed.
But like I've said before, a train that's going the wrong way has to stop before it has a chance to go back the correct way, and I think that's where we're at. L.A. has its own set of issues, but similar things are happening. Seattle has had a bunch of issues. You know, they replaced the mayor and a bunch of people that were not constructive on the city council. They brought in a new district attorney. This was a couple of years ago. They're making real strides there. It's a little bit weird to be sitting in a business conference like this at this stage of my career, and wondering what the heck happened to common decency, the enforcement of laws, and how did we ever tolerate this stuff?
I would just encourage every one of you, as you see this in your communities, stand up and fight because you can make a difference, and it's happening. That's the big top-down summary. You're welcome.
And so you touched on how Kilroy has curated a portfolio that remains relevant in this new way of working. Can you just expand on how you define quality and what you're hearing from tenants on their space requirements?
well, let's talk about what the modern workplace environment is. It's highly efficient buildings. They're generally higher floor to height. They have bigger floor plates. They have, you know, higher density of restrooms, better mechanicals. They're sustainable, they're well. They have a lot of people areas inside and out. They're surrounded by tremendous number of amenities, either within the project in which they sit or within the community in which they sit. They have all the bells and whistles that people want, and if you don't have those things, you've got a real problem. You've got something that's heading to or is already obsolete. So basically, if a tenant is on a tour, they've got 50 opportunities or 20 opportunities for spaces that are big enough for them, they're not going to go to 50 or 30 places.
They're going to go to 5 or 3, and we're always going to be one of the 3 or 5, and that's our goal. And then our space is market-ready, speed to market. So what happens in these downturns, and this one's different because of the pandemic and so forth, and the obsolescence issues that are confronting our industry. But what always happens is things look so dark, and then bang! All of a sudden, you see some deals being done and then some more are done. So I go back to 2000, the big tech bust, right? So what happened? People said in '01 that there was 20+ years of supply in Silicon Valley, and within 2 years, there was, like, 2 or 3% vacancy. I think that was 2000.
So basically, space gets absorbed very quickly when it's a growth market in our particular markets. There is a contraction for sure that's gone on, and part of that is because of the economy, and part of it's because some of the tech companies have decided not to pursue various products they were thinking about developing. And part of it's simply because they didn't know what space they were gonna need because everybody was working from home. Now, that's changing, and I think you'll see... I'm not gonna predict whether it's all this year, but let's just say within the next year or so, I think you're gonna see a far different situation in our markets than you see today.
On that topic of AI and technology growth, have you guys tried to quantify the opportunity within your portfolio and markets?
well, we're in the markets where AI is located. I mean, I can't name the tenant 'cause I'm not supposed to use their name. This is just being recorded, right? So, you know, we did a major AI facility. It's a global AI facility in Seattle for a big tech user, and that's growing up there. Most of San Francisco, you can talk if you will, Rob, to what's happening in AI and how we're seeing that.
Sure. So everyone is talking about AI, and there's a reason for it because if you look at San Francisco right now, we have about 3.9 million sq ft of demand in the office sector. About 35% of that is technology, and somewhere around 20%-25% of that is related to AI. Camille, we have AI tenants in our buildings now and have had, and some of them are, you know... All, all of them actually are very good credit. I think a couple of things to think about with San Francisco and AI, the bulk of national funding, VC funding for AI, is going to the city of San Francisco, not the Bay Area, although the Bay Area is a leader nationally. The bulk of the funding is going to San Francisco.
Since 2018, there's been $120 billion of VC funding directed to AI in the Bay Area, so it is the center of where everything is going on. Average deal size for AI tenants started out pretty small. It's now averaging around 14,000 sq ft. There was recently about a 150,000 sq ft AI deal done in the market, and one of our tenants in one of our buildings sublet space to an AI company as well. So it's definitely in the market and, and creating demand. But the thing that's been, you know, really helpful to San Francisco during this downturn is that the FIRE category tenants, banks, finance, insurance companies, have also been moving to quality space and absorbing space, taking advantage of opportunities when they see it.
Can we also touch on the life science and supply outlook you're seeing in your markets?
Sure. So probably about two years ago, demand in South San Francisco. I'll talk about specifically South San Francisco, because that is the dominant life science market on the West Coast. We had about 3.5 million sq ft of demand, 3-3.5 million sq ft of demand. Today, that's about 1.5 million. The delta between that 1.5 million of demand today and what was is still out there. It's on hold. A lot of boards for companies, whether they were venture-backed or late stage, basically said to their companies, "Despite the fact that you're hiring people, let's put the brakes on taking down space." And we have had some conversations with people that lead us to believe that some of that may get relaxed.
We still continue on the West Coast to outpace other markets from a funding point of view, on a VC funding point of view, in South San Francisco, and that's a positive. There's some sublease space on the market, to be frank. It's about 800,000 sq ft. Some of it's okay space, not great. Some of it's quite good, and the quite good space will, will move quickly because one of the things about sublease space that helps company when it's hard to have clarity, is that it provides flexibility until you can really make a decision. So, we have 3 buildings under construction. Skin is on the buildings. They are in terrific shape right now. We're right on San Francisco Bay.
One of the three, we've multi-tenanted, and we'll be delivering spec labs to the market, and that's really broadened the net, so to speak, of companies and activity that we've been talking to.
I do have a few more questions on your operations, but I do want to give Eliott a chance to speak, just around the balance sheet management. Can you talk about the philosophy at Kilroy and decision behind addressing 2024 maturities so far in advance?
Yeah, sure. So, as many of you probably know, we raised $375 million earlier this year via secured debt on our One Paseo project in San Diego. And the thought behind it was we really liked the optionality that it provided us to both, on an offensive perspective and a defensive perspective. And without knowing exactly how the economy will play out over the next year or two, if things are challenging, then defensively, we have enough cash on our balance sheet today to fund our 2024 bond maturity, which is in December, development for this year and most of next year. So we can really hunker down. If things get tough, we've got cash. And we have a line. We have a $1.1 billion line that would remain totally untapped.
So it gives us a lot of flexibility in a defensive scenario. If things are better, then we now have $375 million more of cash to go on offense. So that flexibility is very valuable to us. We were able to get a 5.9% interest rate with an 11-year tenor which in the scheme of things is, we think, a pretty good piece of paper to hold over that period of time. It keeps our debt maturity pretty staggered. And the cost of doing that early was pretty modest, given where interest rates are today. So we can invest that cash at a pretty attractive rate, minimize any sort of near-term earnings dilution, and keep that longer-term optionality.
Are you starting to see more of those investment opportunities come to market?
So for us, we really haven't seen a ton yet. There are a few things kind of around the margin that we're looking at, but nothing of size or scale. Most of what we've seen trade has been much lower quality product. It's not the kind of product that we want to own over the long run. And so we keep our finger on the pulse of what's going on. You can look at our track record and see how we have been acquisitive at certain times in various cycles. So we're ready to do it if the opportunities are there, but we're not quite seeing them just yet.
What we are seeing is there are a number of folks that have come to us about recapping. In some cases, that's buildings, some cases that's... I'm sorry, but I happen to be sitting on a very uneven part of the floor here, and I have a table thing in front of me, so I'm trying to get comfortable. There are a number of developers that have worked for a number of years to entitle projects where they have a capital partner that is no longer interested or they're unable to achieve the kind of financing they'd like to achieve. So I think there's going to be some opportunities in a variety of different areas.
But if you think about it, if we in the brokerage community is right, and 70% of the product in the country is obsolete, don't want to buy that, only want to buy good stuff. And most of the good stuff is owned by pretty good institutional owners. Some, in some cases, it's owned by maybe some private folks, where they have an ownership consortium that may not be working well together, or they may not be able to get debt replacement and so forth. So there's going to be some opportunities there. But as Eliott mentioned, we haven't seen anything in scale that we like. We're seeing a couple of little things that are adjacent to some properties we have that we think we could acquire attractively and, you know, create some value. But we're not there yet to play offense.
But I would remind everybody, in 2008, in San Diego at NAREIT, every investor, and I think every management team, was talking about, will there be a real estate industry? Will there be financing? I'm looking at some of my friends down at the end of the table. They're nodding their head. They remember. What we said in 2009 in Arizona, NAREIT, the fall NAREIT, is you will see us in San Francisco, Seattle, Portland, any number of cities, looking around so that when we feel it's the time, to strike, we'll be there, and we will have done our homework. And in 2010, in May, we, we were selected to buy 303 Second Street, and the locals couldn't believe it. Who are these guys? And the locals were all focused on their problems.
The most important thing in a time like this, and this, I'll use a kind of an analogy that many of you heard, have heard. There's a reason why the windshield's a lot bigger than the rearview mirror. The rearview mirror is the past. The windshield's what's out there and opportunistically where you can play the game. If you are so confronted with problems that you can't think about opportunities, or if you're so constrained in your balance sheet that you can't fund opportunities, then you're not going to come out of this thing nearly as well. We've come out every cycle better, and we've never been positioned more attractively than we are in this one. So I'm sort of optimistic for the next couple of years. I think there's going to be some great opportunities, but I don't think it's buying big portfolios.
We have time for probably one or two more questions before the rapid fire. I think in the room, in case anyone has questions.
Yeah, maybe just one on my end. I'm curious to get your thoughts from where you're going to now, how much do you think rents are down? What do you see as bottomed out, or is there a bit more pain to go?
I guess I would counter your question with we, at least in our portfolio, have not seen negative.
... you know, effective net effective rents drop significantly. I mean, here and there, you might be off 5% from where you were, but frankly, from the pandemic and throughout the pandemic, net effective rents in the best quality buildings actually increased and surpassed the increase in tenant improvement costs, and that's particularly true in the field of life science. If you have product that is not well located, everything that John was hitting on, if you're not well located, you don't have amenities, you don't have light and air, clear heights, elevators that are able to handle the density, you're just not even gonna make the tour list. So in San Francisco, for example, if you need 50,000 sq ft, you have over 150 choices. No one is gonna take the time or have the time to tour that many spaces.
So you've got to get down to that list of five, and the list of five, when you really look at the vacancy rate in San Francisco, the higher quality buildings, premium tier that we operate in, is half of what the overall market vacancy rate is. So again, stating it another way, if you've got inferior product, your net effective rents, you know, maybe you're covering your operating expenses. But with superior product, what I call high performance premium product, I'd say net effective rents in San Francisco are stable, and in some of our other markets, they've actually increased.
Before we get to the rapid fire, just one point we wanted to make, which we've brought up in some of our individual meetings, is, when we look, we talked about our balance sheet and some of the offensive and defensive optionality. In addition to having pretty low leverage and being investment grade rated, our, we generate free cash flow, pretty meaningful free cash flow. We also have a low 60% FAD payout ratio. So when we look at ourselves and compare ourselves to some of our peers, our payout ratio is about 15 percentage points lower. This is after increasing our dividend 55% since 2016. So we have a pretty secure and stable dividend, that we think is another attractive thing about the company.
And then, for those listening on the webcast, we did also publish some slides that are on our website for anyone that wants to look at them.
That's perfect. I was going to put in a question on the dividend-
Okay.
But I'm glad you covered it. So we can go into our rapid fire. Oh, sorry. There's one more.
Yeah, going on offense. What sort of valuation implies in certain areas where you either... Generally speaking, oh, you know.
You know, I don't want to get too specific on that because it's gonna be different in every market. I think the way we look at it is, you know, we operate in our company by three kind of really simplistic, sort of objects, if you will. One is a circle. It's got to be where you want to be or where, where business want to be. Has the amenities and so forth. One is a square, which represents physicality. Are the buildings the kind of buildings that people really want to be in? And then there's the triangle, and the triangle simply means, is it time, and can you make money? If it doesn't give a yes, a resounding yes, in each of those three shapes or those conditions, we're not interested in buying it or developing it.
I think that the big problem with answering that question is there are things that are trading at cap rates that are fairly high at, you know, if it would have traded at 1,000, it's trading at 800, but the rents are probably over market, and the buildings aren't that great, and when a tenant moves out, you got $200 or $300, $400 worth of stuff to do.
So you look at it and you say, "Unless I've got a really terrific asset that's as good as new, why do I want that asset if it's not terrific, and I've got this big CapEx thing downstream?" So it may look attractive on a price-per-pound basis, it may look attractive on a Cap Rate basis, but at the end of the day, when you reposition it and take the risk, do you get the kind of yield you want to have, and is it the kind of asset you want to own for the long term? That's why I have such a dilemma with that. It's very asset- and location-specific.
Okay, thank you. Just on our rapid fire questions, the first one is on the Fed. Do you believe the Fed is done hiking, yes or no?
No.
Do you expect the Fed to cut in 2024, yes or no?
No.
Second, do you believe real estate transactions will meaningfully pick up by, A, the fourth quarter of 2023, B, first half of 2024, or C, second half of 2024?
I'm kind of thinking you're going to be somewhere between the mid and the end of next year, but remember, we've got an election coming up, and crazy things can happen in election years, too.
To generate more activity?
well, they could influence the financial markets, is what I'm saying. It depends, if there's a particular candidate that, and I don't necessarily know who they're gonna be, I wish I could divine that, but I can't. You know, that could influence substantially the markets. But I think you're gonna see there is a-- there will be a new normal. I'm not sure exactly what it will be, but I will say this: In my career, I've never seen anything with 3% or even 4% interest rates until 2010. Never in my life, and I'm 74. I've been doing this for 54 years. So the interest rates where they are today is pretty much kinda like most of my career. I made money in-- when interest rates, when the prime, what was it?
Up to 17% or 18%. well, it actually went up to 20% at one point.
Ten-year treasuries.
Pardon me?
10-year Treasury, yeah.
I think that's what really differentiates Kilroy. We're really well positioned.
Finally, last question, or two-part question: Are you using AI today to help run your business, yes or no?
No.
Do you plan to ramp up spending on AI initiatives?
I'm sure we will. It's early. I heard the other day that there's somebody thinking about replacing air traffic control with AI. I'm gonna ride my bicycle.
All right. Thank you.
Thank you, Camille. Thanks, everybody, for attending.