All right, great. W e can get started here. Thanks, everyone, for joining us for our session today with Essex Property Trust. I'm Nick Yulico. I head up the Scotiabank U.S. REIT Research team. Very happy to have with us the Essex Property Trust team. I'm going to introduce. I'll turn it over to you, Angela Kleiman, President and CEO, to talk about the company and introduce the rest of the participants on the panel.
Terrific. Thanks, Nick. It's great to be here. It's great to see everybody. On my left is Barb Pak, our Chief Financial Officer, and next to her is Rylan Burns, our Chief Investment Officer. We are excited to see everybody here in this neat crowd. Just a brief background on Essex: we are an S&P 500 company and the only multifamily company focused in the West Coast markets. We have about 62,000 apartment homes with 255 communities across our portfolio. This year, we are excited to celebrate our 30th year as a public company, and our team will be ringing the closing bell at the New York Stock Exchange, so that's going to be a lot of fun. Our track record that we are even more proud of is that we are the only multifamily REIT recognized as a Dividend Aristocrat.
In 2024, we announced our 30th consecutive year of dividend increase. We have generated one of the highest total returns among all public REITs since our IPO, with 13.8% CAGR. The three key factors that contributed to this accomplishment are the markets that we invest in. F irst of all, these markets are well below U.S. average, with low levels of supply, combined with incredibly strong demand drivers in industries that produce high levels of job growth and income growth. T hat all benefits the apartment business. Second is that we are known and have a track record as disciplined capital allocators. L astly, we have a highly efficient operating platform. If you compare our Core FFO per share growth to our peers, you'll see a notable outperformance, and it is shown on page 6 of our presentation.
Moving on to just a high-level review of our current market dynamics, we publish on page 15 of our latest operating performance. We're experiencing a steady improvement throughout our portfolio, and in May, we have generated a blended lease rate of 3.7%, which reflects a solid fundamental across the company. With the exception of L.A. and Alameda, we're seeing pricing power, and we're pushing rental rates. As for L.A. and Alameda, we're continuing to deploy an occupancy-focused strategy as we work through our delinquency units, and we have been successful in recapturing the non-paying units. That trend has continued to improve as well. With that, I'll turn it over to Nick for a Q&A.
Great. Y ou mentioned some of the May and Q2 operating updates so far. Maybe could you just remind us sort of where that fits in versus the guidance in terms of some of the rate improvement as well on the bad debt side?
Sure thing, Nick. I will talk about the market fundamentals. Barb will talk about delinquency. It's her favorite topic. I n terms of what we're seeing on the ground, both our renewals and new lease rates, are coming in ahead of our revised guidance and our guidance increase, which is fantastic news. We had originally anticipated that heading into the year, the broad economy will have a soft landing. That's what all the economists were forecasting, and so we could not disaggregate ourselves from that. H aving said that, what has happened is that a soft recession did not occur. In addition to that, we're seeing strong job growth. Now, it has not accelerated, but it has come in better than anticipated. O f course, with the backdrop of a low supply level, we really didn't need much job growth for us to be able to outperform our expectations.
Where we are sitting right now, on the leasing front, the fundamentals are quite solid. On the delinquency, Barb?
Yeah, so on delinquency, it continues to trend favorably and has become a tailwind to our growth. T his year, we expect 80 basis points improvement in our growth just because delinquency—we're getting back those units and recapturing them. It was a big part of our guidance raise in the first quarter and for the full year. W e've already factored most of that into our numbers. A t this point where we're at, we're at 80 basis points. We're assuming 1.1% for the full year, but keep in mind the first quarter was 1.3%. R ight now, we're generally in line with our guidance for the full year in terms of delinquency. We do expect to continue to recapture units as the courts are starting to finally get caught up. It took a year ago in L.A. It was taking 12 months to get a delinquent tenant out.
Today, it's more like 6 months. F or us to get back to our long-term historical run rate, we're going to need to get to 2 months-3 months on the court eviction processing time. We're not there yet, but steadily making progress.
You talked about the low supply impact really helping the portfolio right now. Any stats you can share on that, how your markets screen versus others, and then even within the portfolio where you may be seeing some supply impact?
Yeah, relative to the rest of the country, the West Coast has historically and continues to be a relatively slow and low housing supply market. I n terms of housing units as a percentage of existing stock, we have increased over the past several years to about 0.6%. S everal of these Sunbelt markets where you've seen significant 6%, 7% increases, it's having a significant impact on new rents is one of the reasons why we've stayed on the West Coast and focused on our markets. As it relates to a short-term outlook over the next year or two, the downtown markets in L.A. as well as in Seattle, some pockets in Redmond will have a little bit higher supply. W e're watching those markets closely.
A t a big picture, about the U.S. b roadly, the West Coast remains underhoused, and we don't envision that changing anytime soon. When you look forward a little bit at new permits, permits have come down in our markets, the vast majority of our markets. T hat supply picture, which has been a benefit for several years, is going to improve as we look into 2025 and 2026.
One of the other factors that's helping your portfolio, your markets, is affordability. When we look at it, I don't know if there's stats you have to share as well, but in terms of renting versus owning, it feels like it's at that affordability benefit of renting feels like it's at one of its strongest points right now. How do you see that? How is it actually helping impact, whether it's renewals or new lease pricing?
Certainly, it's a meaningful contributor to our performance. I n our markets, it's over 2.5 x more expensive to own than to rent. T hat, of course, these are compelling economics. Especially, it's most acute in the northern regions, in Northern California. T he ability for us to raise rents has a much longer runway because the tenants or the potential tenants are not faced with the income pressure, if you will.
Are you seeing that, in terms of that benefit? Are you seeing any change in your rentable because of that, this idea that perhaps people are just going to be priced out of the market and actually it's the type of customer that historically wasn't priced out and now is being forced into the rentable?
Well, in terms of our demographic distribution, it has not meaningfully changed because keep in mind, in the West Coast, the supply landscape has always been much tighter. T he average cost to own a home is over $1 million in our market, especially in Northern California. T hese are older homes that still need some improvement. T he profile of our renters has not meaningfully changed. It's just in terms of just the quantity or the number of demand, that has been one of the factors that's driving demand.
One of the questions we get a lot about your company is how tech job market's going to impact the portfolio. Can you talk a little bit about an update on tech job openings? Y ou mentioned on the first quarter call that you kind of needed higher-paying jobs to pick up in order to see some reacceleration of rent growth in Northern California. Maybe the latest you're seeing on those trends?
Yes. Barb will touch on the job in a second, but just a brief background. We're seeing steady improvement, which is giving us strength and pricing power. I n terms of acceleration, we would need a larger magnitude of job growth.
Yeah, so what we're seeing on the ground is we track the top 20 tech employers and their open positions. W hat we've seen since the trough in February of 2023 is a steady increase every single month in open postings. G iving us some shadow demand in terms of new demand for housing and rentals. Then we're also seeing migration patterns reverse course, and we're seeing, especially in the Bay Area, total migration turn positive for the first time in 2023 that we haven't seen in many years, and that has continued this year. T hose two factors and return to office are leading to the shadow demand that is allowing us to push rents outside of having robust job growth, which you're not seeing in the BLS numbers today.
What Angela is talking about is we really need to see that reaccelerate in a meaningful way for us to push rents aggressively. T here is this shadow demand that is occurring that is giving us strength today that we didn't expect when we set our guidance early on in the year.
If we just go back to Los Angeles, there was a headwind to your new lease rate growth in the first quarter due to some of the delinquency backlog being worked through. How should we think about that impact just trending throughout the rest of the year in Los Angeles?
Yeah, that's a good question because Los Angeles represents about 70% of our delinquency, and L.A. and Alameda comprise about 25% of our portfolio. This overhang we expect to occur this year, we do think that that'll quickly become a tailwind. What we've seen so far is excellent improvement on the delinquency side, which is essentially a leading indicator for our ability to push rents. In terms of L.A., for example, L.A., Alameda, if it weren't for the delinquency overhang, our lease rates would be 100 basis points higher. That gives you a sense of where things potentially can be heading towards.
Is there any backdrop here was that there were court issues, backlogs. A ny improvement in just the timing of being able to process delinquencies or, evictions in the city?
Yeah, it's an interesting phenomenon because last year, when eviction moratorium expired in L.A. and Alameda at the end of April, the entire state of California was processing this situation at the same time. Well, there's only so many judges and clerks to process the eviction. F or us, we did not believe that this would be a permanent issue, which is what's been playing out. Now that it's improved, it's improved by 50%. It's now at about six months. W hat we're seeing is a continued improvement, especially as the delinquency process occurs and works its way through the system. We do think that at this rate, by, say, end of the year or early next year, the vast majority of the L.A. delinquency issue should be resolved or should be at the tail end.
Turning to Seattle, your portfolio is a little bit different than some of your peers. Can you just talk about how it is situated in the entire market and relative to some of the supply where you said it is Redmond, downtown Seattle, how you're sort of quantifying some of your exposure to the market?
Yeah, happy to. I n Seattle, and this is actually similar to our approach to investing in the West Coast. We're mostly suburban. I f nothing else, if you look at where the major employers are in the West Coast, Apple's in Cupertino, Meta's in Menlo Park, Google's in Mountain View. These are all huge companies that are in the suburbs. T here are a couple of reasons. Downtown has more supply. The quality of life is much tougher. O f course, the key major employers are in the suburbs in our market. F or those reasons, we've always favored the suburban markets. A s far as downtown Seattle and suburban Seattle, once again, it's similar. Our portfolio is more suburban-focused. Downtown is where the supply is concentrated. T here's a little bit, t here's pockets of Redmond, but it's still mostly downtown.
Perhaps turn into the acquisitions market. Can you just give us a sense for what type of transactions you are seeing in your markets? Give a feel for cap rates.
Yeah, the transaction volume remains relatively muted from what we saw in 2021 and 2022, so that has not increased significantly. The vast majority of cap rates continue to be in the 4.5-4.75 type range. The buyer pool this year is bigger and more diverse than it was last year. T he few deals that are being brought to market are generally very well bid, and we're seeing a very competitive bidding process for the assets that are coming to market.
T that would surprise people that cap rates could be that way since mortgage rates, would be secured debt would be higher than that today. A re they unleveraged buyers? How are mortgage rates factoring into this equation?
T that was the case last year primarily where a lot of the bids you could discount and say, "Oh, that was a 1031 buyer," or, "That was a large private individual that wasn't going to put leverage on there." They are still involved in the bidder pool today. W hat I say has changed is that we're seeing a lot more private capital, institutional capital that is using leverage that have come back. S ome of the factors include the fact that they've raised a lot of capital in the past couple of years and have not put it to work and are maybe feeling a little bit of pressure to come to work.
I'd say the other impetus is that in several of our markets, people are aware of the improving fundamentals and the very attractive fundamental setup as it relates to affordability, supply, and some of the improving rent growth. T hose are some factors you're seeing where people are coming in and bidding below where debt rates are today.
How much is also some discount to replacement costs factoring in difficulty building in parts of California specifically? How is that factoring into the transaction market as well?
That is a topic that's being discussed on the vast majority of deals. T hat is an anchoring point for many potential bidders. T hen with supply coming down over the next several years, yeah, people are focused on replacement costs.
J ust in terms of then how does this relate to the preferred equity book at the company, opportunities to deploy capital? How are you thinking about that right now?
Yeah, at a high level, I would say that there's been a lot of capital raised to invest in that area of the space. W e've been involved in the mezz and the pref book for a long, long history. It grew in 2016 when our development pipeline shrunk, and this was a way for us to participate in new developments, but at a better risk-adjusted return. Now, with the other participants raising capital, I'd say that it's getting a little bit more competitive. W e think there's better opportunities on the fee simple acquisition side. T hat's where we've really been focused in 2024. W e still remain out there. We'll be opportunistic if we see opportunities to invest in the preferred or mezz part of the stack.
In general, at a high level, we're excited about where we might be able to buy on the acquisition side.
In terms of affordability, legislation, rent control, right, some of that comes up a lot, particularly in California. Can you just give us an update about some of the latest potential policy out there that could affect your business?
Well, the benefit is that California has been on the forefront of that conversation. P re-COVID, legislation was passed, AB 1482, that essentially capped renewal rent increases to CPI + 5% max at 10%. To us, that's an anti-gouging mechanism, and we have always operated with a self-imposed 10% cap since I've been at the company and even longer. T hat has not impacted our ability to grow rents at all. What we're seeing, some of the conversations outside of California and other states are probably a little bit more alarming. As far as the legislation coming ahead is that there's a ballot proposal to repeal Costa-Hawkins. And Costa-Hawkins is essentially it prohibits buildings that are built after 1995 to have rent control.
I t also allows for vacancy control, which is very important because that allows us to take a unit to market once a tenant vacates if it's a rent control unit. T his is the third time that essentially what we view as an anti-growth group is trying to repeal this. F irst 2x , they were overwhelmingly defeated. Every county except for one voted in our favor. The legislature, especially the governor, is well aware that in a state where we have an acute shortage of housing, repealing Costa-Hawkins is not the solution. W e don't expect that there will be much traction on that front. Having said that, it is a noise that we have to deal with.
A ny update you'd also just share in terms of the, there already is in place a policy in California to mandate the creation of more housing over time. How is that being implemented? How do you see it affecting sort of your business, the overall rental market in California?
Well, we actually would welcome more housing, especially in the affordable component. I t is a need for California. I t would not impact our business. W e actually believe that having a more balanced housing market is not a bad thing. Generally speaking, it's good for new businesses, and it's more market-friendly. W e certainly would be more in favor of that. All the initiatives that have been approved over the past several years, by Governor Newsom, he enacted 25 pieces of legislation, it really hasn't made a dent. It is just so difficult to build in California. It's expensive. There's a lot of requirements when it comes to sustainability requirements, etc. E ven though there's legislation that makes it more easy to build housing, the cost side continues to be a prohibition.
We do have time for questions in the room. I don't know if anyone has any. I don't know how we're doing this. Are we doing it by mic or in the back or now just yell? Anyone have a question? Yeah, Seth.
Hey, Rylan, maybe you can give more detail on the cap rate and bidding trends across markets or those that are more aggressive, lower cap rates?
Yeah, we've seen a few more transactions in Northern California. When I think of Southern California, San Diego remains one of the more liquid markets given the strong rent growth that they've achieved over the past several years. L.A. has been very quiet. We saw one or two transactions earlier this year that is going to bring more product to the market. T he Pacific Northwest has been relatively quiet. When I think about where the deepest and most diverse buyer pools have been recently, it has been in Northern California. California, again, as I mentioned, where some of the fundamental setup is fairly attractive.
Any other questions in the room? Yeah.
Question is just about climate risks or transition and fiscal risks on your portfolio?
Question is just about climate risk and?
Physical and transition?
Physical and transition risks or impact, sorry.
Yeah, we actually, earlier in March, we announced that we committed to SBTi. W e're waiting to get approval on that. In terms of the climate risk change, California has always been on the forefront of that conversation relative to the U.S. G iven where we operate, we've always been focused on what we call resource management and sustainability. I don't believe our risk as it relates to that transitional climate change is as meaningful as a lot of the other portfolios out there. We have already essentially installed, for example, solar across the majority of our portfolio. We've essentially had a focus on some of the other water conservation initiatives. When we build, we always build LEED or better. W e're in a better position than most.
Any other questions in the room? We didn't talk about interest rates yet. At this point, and this wasn't on one of the questions I sent you, so it'll be a curveball maybe. I nterest rates coming down, is it even a benefit to your business at this point or not?
That's a great question. I nterestingly, we're less than 30% leverage. O ur cost of debt is not a meaningful risk. We have a sleep at night balance sheet. Barb has done a fantastic job on that front. W hen we refinance, we tend to optimize the pricing. W hat will help when rates come down is really a consideration on cap rates and the value of the company. F or us, it's really more of a perception. That's one piece. T hat drives your cost of capital, and that does have some of these external growth impact. T hat would be the one benefit in terms of the rates.
Yeah, I was thinking about on the other side too, at some point, I don't know how you thought about it, at what point does for-sale housing become affordable again, become a threat to the business? Has that sort of train already left the station and you're just dealing with an unaffordable housing market in California for buying or rent?
Yeah. For our markets, it has always been unaffordable. E ven before the interest rate increase, our move-outs to home buying was like 8%-9%. Now it's only 5%. I t just makes it that much harder. I t was already hard to begin with. O nce again, for our population, we have over 55% of the population that are renters. The U.S. average is the other way. The U.S. average is 45% renters. There's more homeownership. O ur dynamics has always been very strong on that front.
Well, we're almost out of time. W e do one more question or if there's any final, did we have another question? No? Okay. Any final thoughts that you want to report to the audience?
Well, final thoughts. I do think that California is coming out of a recession. It's behind the rest of the U.S. primarily because of the onerous shutdown. W hat we see is growth opportunities ahead of us, particularly in the northern region, which is why we've pivoted our investment to focus in the northern region. It has the lowest supply. It has the best affordability metrics. O f course, on the demand side, as Barb mentioned earlier, we're seeing increasing job hiring. NVIDIA, for example, just bought a headquarters there, even though they're fully remote. T hey spent $350 million to buy a headquarters there. General Motors just set up a headquarters in Northern California. 85% of artificial intelligence companies are headquartered in our markets. W e do see that compelling upside to our markets that's in the foreseeable future.
Great. W ith that, we'll wrap. Thanks, everyone.