Welcome to Citi's 2024 Global Property CEO Conference. I'm Nick Joseph here with Eric Wolfe with Citi Research, and we're pleased to have with us Essex and CEO Angela Kleiman. The session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqa.com and enter code GPC24 to submit any questions. Angela, we'll turn it over to you to introduce the company and team, provide any opening remarks, tell the audience the top reasons an investor should buy your stock today, and then we'll get into Q&A.
Great. Thanks, Nick and Eric. Thanks for including us in this conference. You and the team always do such a terrific job here, and it's great to see everyone here for the Essex company presentation. I'm Angela Kleiman, the Chief Executive Officer, and to my right is Barb Pak, our Chief Financial Officer, and on our left is Rylan Burns, our Chief Investment Officer. I'll just start with a brief overview of the company and provide a quick operations update, and then turn it over to Q&A. Essex is an S&P 500 company and the only public multifamily REIT dedicated to the West Coast. We invest, develop, own, and operate approximately 62,000 apartment units in the coastal markets of California and Washington. We have generated one of the highest total returns of all public REITs since our IPO, and we have increased our dividends for 30 consecutive years.
The key driver of our long-term outperformance is favorable supply-demand combined with our capital allocation and operating strategy. On the fundamental side, starting with supply, our California markets historically produce a low level of supply, well below the U.S. average, and that's primarily because of the lengthy and costly entitlement process. In addition, we have high costs of home ownership, so that creates a natural barrier and an economic incentive to rent versus own. In fact, in our markets, the percentage of ownership versus rent is, you know, we have 55% of population that rent versus own, and that's the reverse in other markets, for example. On the demand side, over the long term, our markets actually have generated above-average job growth, even though we don't need meaningful job growth to meet the demand, to meet the housing supply.
As we all know, job growth is the key driver of housing demand. So those would be some of the key reasons to own Essex. Then lastly, our efficient operating model and disciplined capital allocations approach drives cash flow to the bottom line and enhances total return to our shareholders. Moving on to just a brief operating update, which is detailed on page 15 of our presentation, our markets are performing on plan with same-store revenue growth of 4.3% to start off the year, and this is a terrific start. I do want to caveat that 4.3% has a 1% benefit from delinquency, so a year-over-year comp benefit. In March, it's going to reverse, so when you see a print for Q1 of around 3%, don't panic. It's exactly where it should be.
We are well-positioned heading into peak leasing season with strong occupancy and continued improvement and concessions. An eviction-related turnover is going to, we anticipate, that will lead to temporary lumpiness similar to last year, but at a much better trend compared to last year because of the progress we've made, and that has continued in this area. Lastly, on our operating platform, we implemented our technology initiatives and property collections operating model since 2020 and have generated sector-leading operating margins, and that is shown on page 9 of our presentation. It's also on our website. We are going to continue to refine our operating platform and enhance other income opportunities and drive revenue to the bottom line and further improve efficiencies. With that, I'll turn it over to Q&A.
Great. That was helpful. You have another slide on here that shows the amount of NOI that ends up translating to FFO growth, and I thought it was interesting because, you know, when I think about Essex's history, you have had a strong history of compounded FFO growth. So what would you think is going to be the sort of key to keeping that up in terms of, you know, peers are all sort of in a relatively close range in terms of same-store NOI growth? So how do you deliver better-than-average FFO growth going forward?
A couple of, I think, a couple of factors that's contributing to this outsized growth in terms of FFO. First is our fundamentals are very strong, and so the way we see our markets is especially in Northern California, we have all the building blocks for outperformance, starting with much lower supply. We're at a historically low supply, and when we track permits, we don't see that changing. From an affordability perspective, it's at the best we've seen since we started tracking this metric. So affordability is kind of in that low so this is rent-to-income ratio is in that low 20% range. Long-term average is 25%. Peak is 30-some %. So we have a lot of runway. If nothing else, since COVID, income growth has been growing at a healthy 5% clip, and rent growth is still, in Northern California, kind of at par to pre-COVID levels.
So that's, you know, that speaks to the fundamentals. As far as our operating efficiency, that's really the third leg, right? And with our we've operate 9-12 properties as one business unit, so we generate a lot of efficiencies, and we have more to come on that. We only completed phase one where we talked about and we provided about 200 basis points of margin improvement. The second phase, which includes additional technology improvements and the maintenance collections operating model, that's going to provide even more operating efficiencies.
Maybe you talked about your update on operations, 4.3% same-store revenue growth, but call it about a percent of that is due to bad debt. I think you said bad debt's like 1.7%, so presumably it would have been like 2.7% at this time last year. One thing I was trying to understand, though, is, it looks like in your guidance you're expecting, like, low 3% sort of same-store revenue growth in the first quarter, so I guess I would think you'd need to come down, you know, to, like, 1.5% in March to kind of get to that number, which would seem to be a little bit more than just bad debt.
So, I guess I was trying to understand whether I was thinking about that correctly, if it's just bad debt or there's other things that would take you down to that level, but it seems like a big drop, so I'm. I don't know if it's just conservatism, but trying to understand, you know, what's embedded in that first quarter number.
Yeah, no, that's a good question. It is primarily bad debt. So last year in March, our bad debt was 1%. That's not what we've budgeted for the first quarter. We've assumed about 1.75%, and so we think we have a tail or a headwind in March on the bad debt line. So showing monthly numbers does lead to some lumpiness because the bad debt doesn't come in pro rata and ratably, and that's what you're seeing. We had a benefit in January/February. We're going to have a headwind in March, so it will net out to 3%, we think, for the quarter.
Got it. So, it's okay. So you have a benefit, and then you have a headwind, so it's like more like 200 basis points or whatever it is that gets you down. Okay. Understood. And then in terms of market rent growth, it sounds like you're seeing sort of normal seasonality thus far. Is that fair? I mean, I think, you know, talking to some of your peers yesterday, they were pretty encouraged about what they were seeing in Northern California and in Seattle, much more so than what they thought they were guiding for.
Obviously, they're going to give the caveat that it's early days, but maybe just help us understand sort of, you know, what you've seen so far in terms of the strength of demand, how that compared to your initial expectations, and sort of what the leading indicators are telling you about what the strength of the peak leasing season might look like?
Yeah, that's a good question. We have a little chart on page 15 as well that shows how we're tracking relative to pre-COVID, you know, the three years where things were pretty normalized, and we're a little bit on top of that right now, which is terrific, right? You know, ultimately, when we provide guidance, we guide it to 1.25% for market rent growth, and that's not because we see any cracks in the fundamentals or have concerns about our market. It's really driven by third-party economists' consensus, and we want to align to that because it's at the end of the day, we're part of the overall economy, and if the powers that be are forecasting a soft landing, we don't want to get ahead of that.
And so, you know, in fairness to your question, if the economy outperforms, then we should outperform, and so far, the economy doesn't look like it's going to be a soft landing, which is why we're performing the way we're performing currently.
So based on your guidance, that 1.25, at some point, you're saying that line, the lines that you have here in terms of the market economic rent curve, is going to start deviating and going beneath what you normally see from a seasonal perspective. Get to that one.
Well, it's pretty close. So what I mean is that line will then the peak won't be as high, or if it peaks, the acceleration will be more extreme to end up getting to that 1.25 average for the year. And so the issue here is it's two months into the year. We're still not sure how the economy's going to play out. I think we see some terrific indicators, but there's unknowns. You know, got some war out there, election. I don't know what that means. I'm not smart enough to understand politics. But so far, from what we see, is things are pointing to that the fundamentals are good, and we're feeling good about our business at this point.
Maybe just one last question on it. You know, if it were to follow a normal just track that line, just perfectly track that line, you know, be an average type of year, you know, what would that mean for market rent growth? Instead of being 1.25, would it be more like 2? Just trying.
Sort of 3-ish.
3. Okay. All right. So on renewals, you know, it's been tough to, I think, for people to track because there's a sort of concession burn-off. It sounds like the concessions are going to be mainly burned off on the renewal side by sort of March, April. I'm just trying to understand. Do you think that we'll start seeing the renewals kind of come down to like a 2.5%-3% range once that happens or sort of stay closer to what you're reporting in February?
Yeah. We actually have concession burn-off by the end of January, so what that means is that renewal rate of, you know, 4.8% in January, about half of it is concessions. So you could say that the true increase is really, say, around 2.5%-ish, 2.4%, and February is coming in at 3.8%. And so but we're talking, you know, we're looking at spot to spot, right? So for the rest of the year, we really don't have concessions until we hit the fourth quarter, and so it won't be a tail or a headwind for the rest of the year until, say, October. And ultimately, because renewals lag market rents, if we are assuming that market rent is going to average 1.25%, then that renewal rate is going to come down over time to match that 1.25%, you know, assuming the economy is what the consensus, you know, has forecasted.
Got it. And so that 3.8%, I think, is the February number. That doesn't include really any impact of concessions.
No.
Okay. I think you said on the call that as part of your renewal strategy, and you just brought it up a second ago, which is that renewals eventually should just go down to your market rent growth level because eventually that's where it's going to go if you're not raising your renewals above market. You know, it does seem like some of your peers maybe, you know, push above market as a strategy. I think, you know, EQR in the past has said maybe they go to like 3% above. Just curious whether that's, you know, like why you only stay going to market, whether you're, you know, willing to build a Gain to Lease. If not, why not?
Yeah. Well, I'll start by saying EQR, that team, they're smart operators, and every market is a little different, and so whatever their dynamics are may drive their behavior and their focus, and which may lead them to be more focused on, say, renewal rates. For us, our goal is total revenues, and to build up that total revenues, you have a couple of key components. The big one, of course, is your renewal rates, and then your net effective. You're pushing on your new renewal. You're creating more vacancy. You're going to end up with lower new lease rates. So those are some of the dynamics, and in between, you could use concessions to play to try and optimize those numbers. And so for us, our overall strategy is to be market-appropriate.
What that means is we tend to send out renewal rates maybe a little bit higher, and when if and when necessary, we'll negotiate because in an environment of, you know, a few percentages of growth, we don't want to push turnover. Ultimately, when you push renewal above market, we don't believe that's a long-term play because at some point, they're going to move out, and then you're going to create that friction. Our view is that, you know, turnover costs on average, say, you want to be able to raise your rents by at least 6%. 6% is your break-even in order if you want to push, you know, take that turnover cost. So our view is you try to run a slightly higher occupancy, and you are market-appropriate under renewals, which then allows you to push on new rents better.
You're in a better position to do that, and we've had a, you know, 30-year history how that optimized our total revenues and then ultimately flowed down through the bottom line.
And then maybe on bad debt, you know, it looks like you're expecting sort of 1.5 for the year, maybe then sort of low 1s to kind of get to your guidance starting out a little bit higher today, kind of like a 1.7. You know, is the right way to think about the potential upside there? You know, if you're ending at low 1s, your guidance is 1.5. There's another call at 30-40 basis points of upside for next year in terms of bad debt, assuming that you're, you know, you stay at the same levels that you're ending at.
Yeah. I think it's a little early to talk about 2025, but I would say that we're moving in the right direction on bad debt. We continue to get back units, and the court systems, which has been the impediment to getting back our units, is starting to improve. We're still not back to the 2-3 months that we need to get back to our long-term average. But for example, in Los Angeles, a year ago, we sat here, and we still didn't have the right to evict, but today we do, and a year ago, it took 12 months to evict somebody. Today, we're down to 8-9 months, so it's an improvement.
Outside of L.A., we're at about six months, and so that shrinkage of time for people to be evicted is allowing us to get back our units faster and allowing for the improvement that we are seeing and expecting to see throughout the rest of this year. And then we think the courts will continue to the improvement in the court systems will continue throughout the year, which will allow for the tailwind to continue into 2025.
Got it. And then for those tenants that aren't paying, I guess, what's the sort of average months that they've been delinquent? So you said there's, you know, 8-9 months it takes to get them out sort of on average. You know, have they been delinquent for 4 or 5 months? I'm just trying to understand. You know, usually, these things aren't like linear in terms of bad debt improvement. Usually, there's like a step function, you know, down, so trying to understand if that could happen in the near term.
Yeah. I mean, it varies in terms of the average amount that or average length of stay that they've been delinquent. I think what we have seen is the number of new tenants coming in and then going delinquent has declined because they know the game is up. So when you could move in and know that you had a year free, you would see some bad behavior, but we're starting to see that abate, and that's also improving the bad debt as well. So net and net, we feel very good that we're finally on the last legs of this topic after four years, given what we're seeing in the court systems and then tenant behavior as well.
I guess if you step back from that, what we've seen over the last four years and kind of the concern around at least some of these cities and some of the local politics there and the quality of life, it feels like things have started to turn there. Just kind of curious, your thoughts on the ground, how you're seeing that from a demand perspective and maybe some job growth and population flow back in.
Yeah. That's a great question. We have some just high-level migration data in our presentation, but ultimately, in terms of quality of life, the downtowns are still pretty challenging. You know, it's still the crime rate is still high. It's homeless is quite pronounced there, and there's more to work through on the downtowns, but I do think the direction that they're headed, there's a good start. The quality of life in the suburb has always been quite good, and in California, the vast majority of the large employers are in the suburbs, so that, you know, benefits our portfolio. But in terms of the demand catalyst, what we've seen is, you know, we have a slide that only talks about migration, but you really want to look at population as a whole.
But we just started with one building block, that for two decades, the average is net out-migration for California when we're talking domestic. And then but if you layer on international, then that migration turned positive. Once again, 20-year average, 2000 to 2019. The reason that's the case and the reason that even during those periods, we've had fantastic growth is because you have the Baby Boomers for the majority, you know, over the past 10 years, the out-migration has increased because their equity is mostly in their house, and so they'll sell their house, retire, and go somewhere else. And so that net migration number has increased. Having said that, that's not. That's really not the key driver of our rent growth.
We're starting to see stabilized job growth, and with the tech retrenchment now behind us, even the recent announcements has been they're letting go of a few people, but they're pivoting as many of them as they can to AI or other special projects. And so that tells us that demand is stable, and the openings of top 20 technology companies have been steadily increasing, incremental. It hasn't accelerated yet, but it's incremental improvement.
And then maybe just one other question related to kind of upcoming ballot and the potential repeal of Costa-Hawkins. I mean, it feels like déjà vu. I know we've talked about this for many years, every two years, but, you know, given population flows, maybe given kind of the kind of current climate in California, is there more of a risk of the repeal coming up? And, you know, just your general thoughts on that.
Yeah. We don't anticipate a greater risk. In fact, we see the risk lower now because when the first time it came around, it was following significant rent growth in our markets. We had a super majority of Democrats in legislature, and even in that environment, only one out of 58 counties in California voted in favor of repealing Costa-Hawkins. Fast forward to today. Now, this is the third time. You know, the legislature is not in favor. They all understand that in a market where you have acute shortage of housing, that is just not the answer. And in addition to that, there's been several amendments that's been proposed trying to amend rent control over the past six months. They all died in the legislature, so that gives us a strong indication that we don't believe the risk is higher relative to the past.
I wanted to ask about one of the things you brought up a moment ago about the out-migration. As you said, you're seeing relatively close, you know, in-migration from international. It's pretty close to what you've seen over history, but the out-migration is bigger than what you've seen throughout your history. Is that driven by, you know, sort of like what I would say problem markets where the quality of life is bad, or is that driven by markets where, as you said before, someone's sitting on a lot of their home equity and, you know, home prices have moved up to the point where they can sell their home in California and go to Phoenix or somewhere else? Like, what is it being driven by, that higher out-migration number?
I just remind you that those are statewide statistics, and it's, you know, actually in Northern California, through the same data, we saw positive in migration in several of our counties, the ones that you might think of as being more troubled in terms of quality of life. So the point of that slide for us is that it's improving from what we saw in 2021 and 2022, and we think, you know, even though international saw a little bit of a pickup in 2023, it's not back to its historical averages. And so what you really need is for these tech companies and the consultants and the finance companies that are related to the major industry in Northern California in particular to start hiring again, which they haven't done a lot of in the past year and a half.
As those companies turn to growth again and start hiring again, that's when you're going to see the uptick in H-1B applications and international immigration, which are typically renters to begin with. We think that's a key catalyst that has not yet fully returned, but we believe will occur again in the future.
Gotcha. And assuming that that does happen, you just think all the sort of submarkets that you're in will, I mean, they're obviously not going to all equally benefit, but I guess my question is, are there still certain submarkets at this point, maybe parts of Oakland or others, that you've just had to say, you know, this seems like a submarket that's not necessarily going to recover for whatever reason, or is it, and it's quality of life, some kind of issue that can't be fixed as easily as just having job growth from tech companies? Like, are there submarkets that you need to prune to sort of remove those structurally, I don't want to say broken, but structurally lower demand markets?
I think, there's certainly submarkets that are going to benefit sooner than others. I think, you know, historically, Oakland and a lot of the, you know, high-quality development downtown Oakland has benefited, and the reason there's been new development in that market has because San Francisco, when it's really expensive, it's a relatively cheap place to live and still be able to work in San Francisco. So our working assumption is that that would follow after a recovery in San Francisco and some of our peninsula submarkets. There are still some material problems in some of these submarkets as it relates to quality of life, and that's not going to be fixed purely by job growth. You really need to see some improvement on the ground in terms of, you know, cleaning up the retail scape, helping with the homeless population. And so we're still looking for signs.
I think there's growing momentum, as Angela mentioned, to create improvement in these markets. Hasn't happened yet, so, you know, it's something that we're watching closely.
There have been limited sort of transactions in your markets so far. I mean, I don't know what you'd say in terms of transaction volume being down from peak, but, you know, what do you think it's going to take to see increased transactions? Is it really a function of the capital markets uncertainty, or is it uncertainty around the fundamentals of the market? What's going to need to happen before we can start understanding where pricing is?
Yeah. I think last year, the West Coast, along with the country, transaction volumes were down around 70%. To start the year, I don't see a material change. I think there's still a lot of sellers holding on to property, hoping for prices that they saw a year and a half ago, whereas buyers, you know, on the margin, the secured buyer who has a little bit higher has higher debt costs today is trying to figure out when they can get to positive leverage. Is that one year, two years, three years away? So I think you could see, you know, the market improve several ways. Or in terms of transaction volume, you could see if we get some clarity and visibility in terms of rate cuts, I think that would bring a lot of buyers back to the market.
Conversely, we have not seen any distress or any material distress in our markets, but if some of those debt maturities were to come and create some pressure for sellers, that could be another reason to increase transaction volume. But as it stands today, it's very similar to what we saw the majority of last year, where there's a bit of a standoff between buyers and sellers. The fundamentals generally are fine, as we pointed out, in the majority of our markets, and in some cases, have been very, very strong. So it's kind of a wait and see before we see some more transaction volume.
It sounded like in the call that you were saying that, you know, you might take some of the structured finance book, preferred redemptions, the capital that you received there, and then sort of recycle it into acquisitions. You know, are you having success in that? Sort of where are you in the process of it if the transaction market's so difficult and you can't, you know, find those acquisitions? What will you do with the proceeds if you're not able to, you know, if you're not able to put it back into your portfolio?
Yeah. I think it is a more challenging environment versus a very liquid transaction market where you can kind of pick off broker, you know, assets that come to market. So we're just asking our team to look harder to turn over more rocks, to leverage our relationships in these markets. We have a concentrated focus. We have people that live and work in these markets, and their job is to find deals. So it's not easy, but we are optimistic that we're going to be able to create some acquisition transaction volume when it makes sense and we can create value for shareholders.
You said in your deck that you stopped accruing on 15% of your investments for the structured finance book, given near-term maturities. Are those the same ones that you talked about on the call, the Northern California ones?
Yeah. There's been no change since our fourth quarter update. The three we stopped accruing on in the fourth quarter, and then we're watching two others. We've reserved against it in the guidance, but we're monitoring two others pretty closely.
Got it. And are you monitoring simply because they have near-term maturities? I guess if the whole book had near-term maturities, would you be putting everything on watch? I mean, obviously, the longer time you have until maturity, you know, the, you know, the better things you get in terms of the financing market. Obviously, they're going to hopefully be growing cash flow along the way, but I'm just you know, you made it seem like you're putting them on simply because there's a near-term maturity there. Like, what's the health of the rest of the book? And if they'd had a near-term maturity, would you be putting those on non-accrual as well?
So there's a variety of factors we look at. It is the time to maturity, so that's one factor, where our last dollar sits today and where transactions are occurring. And then we look at the sponsorship, and all our sponsors have continued to fund additional equity. So none of them are in default with a senior lender, and they continue to plow money back in. But given what we know is coming from a refi perspective, whether they're going to put in money or not is something we're monitoring closely. We are in discussions with one of the sponsors, and so it depends on how those discussions go. And so the rest of the book, it really depends on what the rent growth has been in some of our properties since we underwrote them. That helps in terms of a REFI and really where our last dollar sits.
So it's a variety of factors we're watching, but no, the entire book would not be on non-accrual if it was all maturing in 2024.
Got it. And then on expenses, you had, you know, I think a 30% insurance renewal. Could you just talk about how your—I mean, it's unpredictable, but it, you know, that's certainly a big number, and I think your peers are seeing big numbers as well there. You know, just how you're thinking about that expense going forward, you know, how much risk you're willing to take with your captive insurance. You know, if you see these types of increases going forward, what can you do to mitigate them?
Yeah. It is unfortunate. The 30% is pretty baked for 2024 because we were in the market in December of 2023, and so that number is actuals. I would say what we did is we did look at our captive. We did look at increasing our first loss piece within the captive and what the premium reduction was. Unfortunately, it wasn't enough to justify taking more loss with it for the captive. I would say where we're positioned better is we do have over $100 million in assets on the balance sheet, which was the premiums we would have paid to third parties that we funded via our captive that we can use to fund losses if there were losses. We have a great loss history, very minimal losses. I don't think our carriers have ever had a loss.
So I think that helps us versus somebody who's starting a captive anew. Hopefully, with the insurance market, we'll see reinsurers come in. That's really what we need to see. Given the premiums they're charging, at some point, you will see people come back into the market because they will have profitability. When you see that flood of capital come back in, that's when you're going to see the premiums come down or the rate of increase come to a more normalized level. But we just haven't seen that yet.
Got it. And those securities, that's just that sits on the asset side. Is there offsetting liability there in terms of like, I'm just trying to where that is on the balance sheet.
It's marketable securities, and it is just, it's in a variety of funds and bonds and equity funds that we have. And we have a long horizon because, once again, it's run kind of, it's an insurance company, and so it's the horizon of when you expect your losses and things of that nature. So there is no offsetting liability. It is the cash we would have paid a third party. We fund into our marketable securities every year, and it's just grown over time.
Makes sense. And then we have an audience question. What percentage of the evictions are tenant hardship versus fraud? And then I guess maybe if I could add one onto that, I think you said there's about $130 million of uncollected rent. You know, at what point do you just say, you know, it's not worth the legal sort of trouble pursuing it, and it's just, you know, get rid of it? I know it's not, I don't think you're carrying it on your balance sheet, right? But at what point, you know, practically, do you just say we're not going to keep going after it?
Yeah. In terms of the eviction, it's the ones that have hardship. They would have reached out to us, and we always work with them to negotiate a payment plan or, you know, work around it. We wouldn't just evict somebody out of hardship without any conversation. There is a percentage of fraud, but it's not a high percentage in our portfolio. There are unique buildings that have these issues, and once we, you know, catch the fraud, they may go on for a few months, but we remedy them pretty quickly. And mostly, it relates to identity theft. And so we've been able to address those. And so it's not a portfolio-wide issue when it comes to, you know, eviction. I think the behavior is really that's been prolonged is really just the time it took to evict.
There's only so many judges and so many clerks, and so you've got the entire state of California going through eviction. That volume, that intensity has finally now decreased over time to a point where it's starting to get manageable, and that's what's driving the evictions and delinquency behavior.
And then on the $130 million, really quick, we have reserved against all that. There's no risk to the financials in terms of the revenue. And what we've done is we've hit their credit. We've got summary judgments, but we're not spending incremental dollars to go after them because it's the ability to collect is it gets lower as you go further out in terms of collecting that. So we're not incurring incremental dollars, if you will.
Thanks. We have the rapid fire to end the session. What will same-store NOI growth be for the apartment sector overall next year in 2025?
I would just say 2%-3%, but a wide dispersion.
Will the apartment sector have more, fewer, or the same number of public companies a year from now?
We're going to say fewer just because the apartment sector is just more fragmented than any other industries.
And then what's the best real estate decision today? Buy, sell, build, redevelop, develop, or buy back shares? Buy. Thank you very much.