Good day, and welcome to the Essex Property Trust third quarter 2022 earnings conference call. As a reminder, today's conference call is being recorded. Statements made on this conference call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made based on current expectations, assumptions, and beliefs, as well as information available to the company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found on the company's filings with the SEC. It is now my pleasure to introduce your host, Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, Mr. Schall. You may begin.
Thank you for joining us today, and welcome to our third quarter earnings conference call. Angela Kleiman and Barb M. Pak will follow me with prepared remarks, and Adam Berry is here for Q&A. I will begin by congratulating Angela for her appointment to the Essex board and for being chosen as the next CEO of the company following my planned retirement in March 2023. I have known Angela for almost two decades, and we have worked closely together since she joined the company 13 years ago. Angela embraces and exemplifies Essex's strategy and core values and is a dedicated, thoughtful leader as well as an excellent negotiator. Our recent leadership announcement was the culmination of a multi-year succession plan administered by the Essex board, and I appreciate each participant's commitment to the plan that resulted in its success.
It has been an honor to lead this awesome company, made possible by my great leadership team and the coordinated effort of every Essex associate. My thanks to all of you. Today, I will touch on our third quarter results, introduce our initial market level rent forecast for 2023, and provide an update on the apartment investment markets. Our third quarter results represent our fifth consecutive quarter of improving Core FFO per share. On a year-over-year basis, we reported Core FFO per share and NOI growth of 18.3% and 15.4% respectively, with Core FFO exceeding the midpoint of our guidance by $0.04 per share.
The positive results are reflective of the team's execution and the continued recovery throughout our markets, largely driven by the ongoing rebound in Northern California and Seattle, with Southern California remaining a consistent and strong performer. Year to date, the economy on the West Coast has shown resiliency, with job growth as of September 2022 of 4.3% in Southern California and significantly higher in the tech markets of Northern California and Seattle. The positive job growth is partly attributable to the recovery of workers lost amid the significant shutdowns early in the pandemic, especially leisure, hospitality, and service jobs that were added throughout the summer. As a result, it is not surprising that the unemployment rate in each Essex market, with the exception of Los Angeles, is under 4%, including San Francisco and San Jose in the mid 2% range.
The unemployment rate in Los Angeles is higher at 4.5%, likely related to the ongoing eviction moratorium in the city of Los Angeles, which is expected to run to end in February 2023. Job openings at the large tech companies have declined from record levels during the pandemic, although they remain significant with approximately 20,000 jobs available, roughly consistent with the number of job openings they reported between 2016 and early 2020. Thus, while we recognize that tech job growth is slowing, the large tech companies are well-capitalized and continue to expand and hire in our markets. As in previous years, we have included our initial forecast for 2023 market level rent growth on page S17 of the supplemental.
Our forecast begins with the consensus estimates of third-party economists for the national economy with respect to GDP and job growth indicated at the top left of page S-17. Based on these estimates, our data analytics team estimates job growth in each Essex metro. On the supply side, we use our ground-up fundamental research to estimate apartment deliveries, which has proven to be highly accurate over many years. Everyone's visibility into next year is limited by uncertainty related to past and future Fed actions and their impact on the overall U.S. economy. Therefore, the forecasted rent growth may vary if the key assumptions prove inaccurate. In summary, housing supply across the Essex markets is expected to grow at 0.6% of existing housing stock, with the greatest increase occurring in Seattle, with a 1.1% increase.
Job growth is expected to be new next year, growing at 0.4% overall in the Essex markets, with the best job growth expected to be in San Francisco at just over 1%. As a result of these demand and supply assumptions, we expect net effective new lease rents to increase 2% in 2023, with our California markets expected to marginally outperform Seattle. On a year-over-year basis, we expect apartment supply to decline about 10% in 2023, with Northern California having the largest expected reduction, down 45%. We also expect 2023 single-family deliveries to be similar to 2022, even with permits growing modestly given much higher mortgage rates.
With respect to for-sale housing, declining housing production and reduced affordability are tailwinds for apartments in the Essex markets, representing a small positive factor contributing to our rent outlook next year. Given economists' expectations for a modest recession in 2023, I'd like to summarize our historical experience about operating our portfolio in previous economic downturns. Generally, in each significant past recession, our weakest market has been Seattle, which is due to the confluence of negative job growth and higher levels of housing supply deliveries. Northern California follows a similar pattern to Seattle with respect to job losses during recessions, although with significantly less supply that results in outperformance relative to Seattle. Finally, Southern California is our best performer during recessions given its diverse economy and minimal supply. That being said, each recession is unique, and there are several factors that could lead to a different outcome.
First, most of the previous recessions followed a long economic expansion where rents grew substantially, and it's those higher rents that pressures affordability and fosters higher level of apartment supply. On the West Coast, rents plummeted in the early part of the pandemic, and our recovery was much delayed compared to the rest of the country, with Southern California's recovery beginning in mid-2021 and Northern California and Seattle in early 2022. As a result, the West Coast is still in the early stages of its recovery from the 2020 recession, and housing supply has not had sufficient time to fully recover. In addition, with many offices closed during the pandemic, it was common to hire remotely with the expectation that workers would need to relocate closer to offices upon re-openings, which is now occurring.
The relocation of employees back to the West Coast pursuant to return-to-office programs represents demand for apartments that is generally not included in job growth. Finally, we expect less outward migration in the next few years, primarily because those that typically leave California, such as the newly retired, probably left early in the pandemic when businesses were shut down. In a moment, Angela will comment further on migration. Turning to the apartment transaction market, we have recently seen a few deals close at valuations that were negotiated before the most recent increase in interest rates, and conditions have changed enough since then to significantly impact transactions. As expected, the immediate impact of higher interest rates will result in diverging buyer and seller expectations for property values, resulting in a larger bid-ask spread.
Generally, it takes more than higher interest rates to create financial distress, especially with recent strong rent growth given inflationary pressures. However, pockets of distress may develop from credit or liquidity events or excessive Fed tightening, although no major issues are apparent at this point. Broker price talks with respect to apartment transactions indicate that cap rates for high quality and well-located apartments are in the mid-4% range in the Essex markets. Finally, I wanted to note that our balance sheet is in great condition, thanks to the unwavering urgency of Barb and the finance team over the past several years. When the markets turn positive, we expect excellent opportunities to invest accretively, and we will be in a position to be opportunistic. With that, I'll turn the call over to Angela Kleiman.
Thank you, Mike. I will begin by expressing my sincere gratitude to Mike for his mentorship and guidance over the past 13 years. I am honored to have the opportunity to lead this organization and to build upon the company's long history of thoughtful capital allocation and operational excellence. My comments today will focus on our third quarter performance, followed by some regional highlights, then wrap up with the key operational initiatives that we are excited about. Starting with the third quarter. During much of this period, we capitalized on the strength of the underlying fundamentals in our markets by pushing rents and achieved 10.3% year-over-year growth in new lease rates in the third quarter.
Although this is a deceleration compared to the 20% growth in the second quarter, keep in mind that new lease rates in the first half of last year declined by about 6%. In the second half, new lease rates surged to positive 17%. The tough year-over-year comps is the key driver of the deceleration, and the third quarter results are in line with our expectations. In general, we have seen a normal seasonal rent pattern. Accordingly, as we approach the end of the third quarter, we shifted to an occupancy-focused strategy. Turning to the delinquency. In recent months, we have begun to recapture more units from non-paying tenants. With the ending of eviction moratorium, it is no surprise that the number of move-outs related to non-paying tenants have increased.
Looking forward, we plan for a higher volume of move-outs, which may create a temporary head-wind in occupancy for the rest of the year and into 2023. For this reason, even though we have shifted to favor occupancy, we anticipate our occupancy to be slightly lower than historical levels. The good news is that regulations are being pulled back, which is allowing us to finally make progress on delinquency. Moving on to regional highlights, starting with Pacific Northwest. After a strong start to the year, rents in this region have peaked in late July. The seasonality through the third quarter, which includes the typical decline in market rents subsequent to the peak, is consistent with what we have experienced between 2016 and 2019. However, since mid-September, we have been facing softer demand along with higher level of supply deliveries in the second half of the year.
We are monitoring this market closely. As for Northern California, this region has led our growth in net effective new lease rates since the start of the year. Strong job growth and return to office are two key contributing factors. Bay Area net immigration has continued to accelerate this year. In the third quarter, over 35% of move-ins were primarily from outside of our markets, which is an increase from 15% in the first quarter. Notably, we are seeing positive migration trends from markets as diverse as Dallas and Boston. Consistent with our previous commentary on commitment of tech giants to continue to expand in Northern California, we are excited to see Google break ground last week on its massive mixed-use development in San Jose. This development is expected to bring 25,000 high-paying jobs and effectively doubling the amount of office space in downtown San Jose.
This will be a long-term benefit for Essex as we own almost 6,000 units in this region. On to Southern California. Healthy job growth is continuing to drive incremental demand for rental housing. As such, this region continues to perform well. We are also seeing positive immigration to Southern California, with 30% of our third quarter move-ins coming from outside the region, compared to 17% in the first quarter. Turning to key operations initiatives. We have completed the rollout of first phase of our property collections operating model, which focused on leasing, administration, and customer service. By way of background, this model optimizes our geographic density and transforms our business from operating each property individually to a collection of around 9-12 properties. The shift in business strategy enables us to leverage our team and technology to improve the customer experience and achieve significant efficiencies.
I'm pleased to announce that phase one is fully rolled out across the entire portfolio ahead of plan, and the progress is beginning to show up in our financial results. Year to date, administrative expenses were up only by 1.4%, despite significantly higher wage increases along with other inflationary pressures and expenses. The next step is to apply the collections operating model to the maintenance function. As we have demonstrated previously, this model has created more career advancement opportunities for our employees through specialization while improving efficiency and customer service. The maintenance collections pilot is currently underway, and rollout is planned to start by mid-next year. Lastly, on the technology front, the implementation of Funnel software suite is progressing well. As you may recall, Funnel is a RET Ventures company with whom we have chosen to co-develop applications to enhance our platform.
The Funnel product will handle the end-to-end customer experience from initial prospect inquiry through the full resident life cycle, which will result in better experience for our customers. From an employee perspective, this technology will streamline or automate the manual tasks associated with roughly 60,000 transactions each year. Our initial pilot showed a promising 35% reduction in task time associated with these activities. Continued refinements are underway, and we are excited to work toward a full deployment by the end of 2023. With that, I will turn the call over to Barb M. Pak.
Thanks, Angela. Today, I will discuss our third quarter results, followed by an update on investments and the balance sheet. I'm pleased to report third quarter Core FFO per share of $3.69, a $0.04 beat to the midpoint of our guidance range. Half of the outperformance was due to lower operating expenses, which is timing related, and the other half was from higher co-investment income due to better NOI growth at the joint venture properties and higher preferred equity income. For the full year, we are raising the midpoint of Core FFO by $0.02 per share to $14.47, representing approximately 16% growth compared to last year. As it relates to delinquency, we are seeing continued improvement in our gross delinquency, which is helping to offset less Emergency Rental Assistance funds.
For the same property portfolio, gross delinquency improved sequentially from 4.5% in the second quarter to approximately 3.5% in the third quarter. October improved further to around 2%. We suspect the gross delinquency trends will continue to improve as we work to recapture delinquent units. However, the improvement is unlikely to be linear. One additional positive development that recently occurred is the city of L.A. approved removing eviction protection starting on February first of next year. This will allow us to recapture delinquent units in an area that accounts for approximately 40% of our outstanding bad debt and will allow us to finally get back to our historical level of delinquency.
However, it will take time to achieve this goal, and we would expect delinquency will remain elevated through the first half of 2023, with the expectation that we will get closer to our historical average of 35 basis points of scheduled rent by the end of next year. Turning to our stock repurchase and investments. Consistent with last quarter, investing in our own portfolio and select preferred equity investments offers the best risk-adjusted returns in today's market. In the third quarter, we repurchased $97 million of common stock at a significant discount to our internal NAV, which we plan to match fund on a leverage neutral basis with proceeds from a disposition expected to close in the fourth quarter. As it relates to other transactions, we closed $65 million of new preferred equity and subordinated loan investments during the quarter and committed to one additional investment in October.
These new commitments are expected to be match funded with redemptions of two structured finance investments that are slated to close in the fourth quarter. Finally, I want to provide some additional color on the strength of the balance sheet. Our net debt to EBITDA ratio remains healthy at 5.8x , and we expect this to further improve as EBITDA continues to grow. It should be noted that we operated around these same leverage levels before the pandemic, and our balance sheet metrics are strong. In addition, we are well positioned from a capital needs perspective. In October, we closed a delayed draw term loan that will be fully drawn in April 2023, with proceeds intended to repay $300 million in bonds that mature next year. We have swapped this debt to an all-in fixed rate of 4.2%.
As a result of this transaction, we have all our known funding needs addressed until May of 2024. The company has no significant unfunded development needs and can fund the dividend, operations, and capital expenditure needs from free cash flow. Additionally, our variable rate exposure, excluding our line of credit, is minimal at less than 4% of our consolidated debt. With over $1.1 billion in liquidity, no funding needs for the next 18 months, and access to a variety of capital sources, the balance sheet remains well positioned. I will now turn the call back to the operator for questions.
Thank you. Ladies and gentlemen, at this time, we will be conducting a question-and-answer session. If you'd like to ask a question, you may press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Please limit yourself to one question and one follow-up so we may get to everybody's questions. Our first question comes from the line of Nick Joseph with Citi. Please proceed with your question.
Thank you, and congratulations both, Mike and Angela. Maybe just starting on the building blocks for next year. Obviously, you provided the market rent growth of 2%. What's the earn-in expected from 2022 leasing? And then where is the loss to lease today? And where would you expect it to be at the end of the year?
Hey, Nick. It's Angela here. On the earn-in for 2023, I think if it's okay with you, I want to just step back and make sure we're using a consistent definition. For us, the way we look at earn-in is, we look to the September loss to lease. It's not too hot and not too cold, and take 50% of that. In this case, September loss to lease was close to 7%. Taking half of it would be about 3.5%, and that will be our earn-in, and we assume no market rent growth. What we've heard, you know, is there's a question about 2023 revenue growth and, yeah, and how does the earn-in, you know, apply to that.
What we've done in the past is explain that by saying, you take your earn-in, and then we look at our 2023 S17 market rent growth and take 50% of that. That would be the market rent growth is 2%, so half of that would be 1%. You add that to the 3.5% earn-in, that gives you a proxy of about 4.5% for revenue growth for 2023. As far as the loss to lease, where we are is we're about 2.5% loss to lease in October for the portfolio. You know, of course, it varies by region, but that's coming from a loss to lease in September and of 6.7%.
Definitely a deceleration, but it is expected. Loss to lease at this level for October is actually better than our historical patterns. You know, typically around this time of the year, we're at about 1% loss to lease and heading towards 0% by year-end. At 2.8%, we're feeling pretty damn good about the portfolio.
Thanks. That was very helpful. Maybe just on the transaction market, given kind of the expected rent growth and where debt costs are today, does a 4.5 cap rate make sense for most buyers? Or how are they thinking about getting to their unlevered IRRs, you know, given maybe the negative leverage situation initially right now?
Yeah. Hey, Nick, this is Adam. As Mike mentioned in his opening comments, the transaction volume is definitely down from where it was a quarter ago. There are still deals being priced. There are still deals going non-contingent.
In talking to buyers who are still active in the market, they're willing to take a certain level of negative leverage for 18-24 months, is the number that I'm hearing now. With various assumptions about rent growth, repositioning, and those types of strategies, that's what we're seeing in the market.
Our next question comes from the line of Steve Sakwa with Evercore. Please proceed with your question.
Yeah, thanks. You know, look, I guess the biggest thing that you know, everyone's focused on is the 2%, and you know, Angela, you walk through the math, and I know this is not trying to get this into a debate about 2023, but the math that you just walked through would, I think, basically imply your revenue growth is several hundred basis points below several of your peers. I guess I'm just trying to understand, is that really a function of market mix? Is that a function of the conservatism, the 2%? I don't know what the history of that number is, and if you start low and kinda work that number high over time.
you know, it just strikes me as, you know, your implicit growth for next year is kinda well below the peers.
Hey, Steve, let me try to handle that one. S- 17, beginning a few years ago, decided to start with the consensus of third-party economists as to the U.S., and then drill down from there into what that means for our markets. We obviously have, you know, Jerome Powell out there talking about breaking things and, you know, pain to come at a mild recession, which is what this is based on. Rather than using our own how we feel, we think it's important that we create a scenario that's based on the consensus of the people that are really studying these things, and certainly not ignoring what they're saying. That's where this macro scenario comes from. Do we feel like that's a little bit dire? Yes, we do.
Again, several years ago, we made the decision to start basing S- 17 on the macroeconomists' view of the world, which in fact is pretty dire. You know, it seems to us that we shouldn't ignore, you know, the Fed's comments about, you know, pain to be had, et cetera. That's where that scenario comes from. Do we feel like things are a little bit better than that? Well, yeah, we do. If we were basing this on how we feel, we would come up with something that is more optimistic than this. Again, we shouldn't ignore the Fed, and that seems like it's what's happening out there, and we think that's, you know, fundamentally misguided, I guess. Does that make sense?
Yeah. No, look, I agree that there are storm clouds. It would seem like you would need to see negative job growth occurring in order to really diminish the pricing power that's out there. When I look at your job growth forecast, or the market's job growth forecast of 40 basis points against supply growth of 60 basis points, those are largely in lockstep with each other. There's not big dislocations on the supply front in your market. It would feel like occupancy is gonna be relatively stable, and so I would have thought that rent growth, you know, wouldn't be off to the races, but that it might be better than 2%. If you told me job growth was very negative, I would agree with you.
Well, that's exactly what the third-party economists are saying. Up there on the upper left-hand corner is the consensus of the, you know, again, third-party macroeconomists that say job growth is gonna be -0.2% next year. That forms the basis of, you know, what we think. We outperform, in terms of job growth, the U.S. economy. In fact, that -2% for the U.S. is translating into 0.4% job growth for us. Not a lot, but again, this is a pretty dire scenario. That's where that comes from. Again, we don't feel like it's this bad. I mean, based on what we see in front of us today, you know, we're having some seasonality here in October. We expect that.
You know, loss to lease typically goes negative by the end of the year, you know, and it probably will this year. You know, keep in mind, you know, the demand side of the equation is driven by jobs, and obviously, you know, we pay attention to the seasonally adjusted jobs. The reality is, if you look at, you know, total non-farm employment, it gets pretty soft in the fourth quarter, and so, you know, these things can happen. Basically, we feel like this is a pretty draconian scenario, but we're trying to, you know, maintain some consistency with respect to, you know, what we are trying to, you know, put out there with respect to S- 17.
Just following through on the historical pattern and, you know, looking at what the economists out there are saying, we think this is that scenario. Could it be different? Absolutely, it could be different, and we hope it's different. Again, I don't wanna ignore the elephant in the room. It seems pretty important to actually consider what the macroeconomists are saying and what it means for us. I would add to that, everyone across the nation is gonna feel the same pain if this occurs. It's not just a West Coast thing, it's a national thing. It starts with the U.S. job growth, and then we look at historical relationships to try to determine what it means for the West Coast, and that's where these numbers are coming from.
No, I appreciate that. Thanks. I guess maybe just in terms of return hurdles and how you're thinking about underwriting, can you just give us a sense for, you know, how you guys have altered either acquisition hurdles, development hurdles in light of, given where stock prices have gone, where bond yields have gone? I mean, how much have you raised your, you know, cap rates, IRRs in today's environment?
Hey, Steve, this is Adam again. Consistent with what we just talked about, the 4.5 range is kind of where we see the market. We're probably not buyers at that range. We have better use for our capital. Development yields will need to move off of that base, if not maybe slightly higher. When we look at development deals, depending on where they are in the entitlement process, we're looking at a 20%-25% spread over to adjust for the risks related to development.
Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.
Hey, yeah, just wanted to maybe dive a little bit deeper into some of the markets. Looking kind of at the October new lease growth, kind of the 2.8% figure. Wondering if you maybe give some color just on, you know, performance across kind of the different markets. I think that'd be helpful.
Sure. Happy to. On the new lease rates for October at 2.8, it's actually a pretty wide range. I'll just go from north to south. Pacific Northwest, it's a negative about 90 basis points, and that's consistent with my earlier commentary about the softness in that market. Then, Northern California, the strongest at about 4.5, and Southern California close to 2%. Southern California, you know, continues to be the steady eddy, and Northern California is rebounding as we have anticipated.
Yeah, that's really helpful. Just looking at the occupancy figure, you know, it looks consistent kind of October versus third quarter. Maybe just comment a little bit about kind of, you know, are concessions being used? You know, I'd imagine maybe in kind of that weaker Pacific Northwest market, maybe they are being used. But I'd love to just kind of hear, you know, are concessions being used? Is that kind of being used as a tool to kind of maintain occupancy here?
Sure. Concession usage is, you know, for us, we focus on where there's competitive supply. If we're doing our own lease up, we use concessions. We rely on that as part of our pricing tool. Absent of that, it's a function of how many lease up do you have near your property, and how do we remain competitive and meet the market. In terms of the concessions usage, just the change between October and the third quarter, it has ticked up, and it's primarily driven by Seattle. Seattle, in the third quarter, and, you know, I've mentioned that we had a very normal third quarter, was less than a week, and it is now about two weeks. That's the biggest change.
With all the other markets, it's incremental, couple of days more, which is consistent with what we expected. Portfolio overall, our concessions has gone up from, say half a week to about a week portfolio-wise. You know, with the key driver being Seattle.
Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.
Hey, good morning. Morning out there. Angela, congrats, and I guess now you get the joy of answering directly to George after each earnings season, so I'm sure you'll enjoy that part. So question, two questions for you. Going back, Steve, to Steve's question. Traditionally, you guys are a conservative team. I don't wanna say, you know, I won't characterize any more than that, but traditionally you guys are an under-promise, overdeliver. Mike, I hear you on the economic forecast in S-17, that this is independent consensus. This isn't your world.
When we think about just bottom line earnings growth, because obviously the stats get warped with the COVID rebound, it sounds like you guys are saying that revenue is 4.5%, you know, while your loss to lease right now is 7%. You're only saying, hey, next year, maybe 4%, 4.5% for revenue. You know, Proposition 13 helps on the taxes next year. So your OpEx should be, you know, probably a little bit better than the national average because you don't have the OpEx, the property tax pressure. As we think about bottom line FFO growth, should 2023, assuming that, you know, it's not a bloodbath recession, should it be sort of more of a normal type earnings growth?
I'm just trying to figure out how much the year-over-year stats are impacting or clouding the FFO growth that is implied by what you guys have presented.
Yeah. Hey, Alex. There's, you know, obviously lots of moving pieces here, and you're asking good questions, kind of what does that mean for the bottom line? Let me just clarify a few things and, you know, then I'll flip it back to Mike to talk about the S-17 and maybe more up on the FFO. The 7% that you're referring to is September loss to lease. What we normally do is take half of that with earn-in. That's how we got to the 3.5. That's, you know, that's pretty consistent math for proxy purposes. As far as the expense comment, I do wanna address that for a minute.
I do think that we should perform a little better than inflation on average, and especially on the administrative side of it, you know, that should be quite a bit below inflation. Since we have not yet rolled out maintenance collections, that will be higher than the admin growth. We expect controllables to come in comparable to this year at about 4% for next year. That's on controllables. That's some of the building blocks from the P&L perspective. Then Mike.
Yeah. Angela, I just wanted to add a couple things, perhaps. First thing is that, you know, Angela, she takes for next year, the kind of proxy formula is that +3.5 half the growth of next year, which is the 2%, which is the pretty dire scenario. I'd say there is some potential upside if that dire scenario doesn't take place. That would be one thing. I just wanna mention that, you know, we feel pretty good about where the company is positioned right now. You know, Core FFO right now is at the high end of the bicoastal peers when you go back and compare it to fourth quarter 2019. We feel good about that.
You know, we've accomplished that with really Southern California at, you know, sort of full recovery, in full recovery mode, not Northern California and Seattle. You know, we attribute that to the fact that both of them, you know, fell further and have a longer, you know, period of time that's required for recovery. You know, in Northern California, for example, rent levels right now are roughly equivalent to where they were at pre-COVID. There's been no rent growth in Northern California. Historically, the tech markets are the driver of growth, and I suspect that they will be the driver of growth going forward. We're just not there yet. You know, we feel good about this.
When we think about some of the other things, you know, incomes, median incomes, household incomes in San Francisco and San Jose are now over $145,000 a year. That's the median, which is pretty amazing and screens very affordable as it relates to rental value. And that's, you know, that's what draws people to the West Coast. You know, everyone talks about, well, the costs are higher on the West Coast, but the reality is they're drawn by the incomes that are much higher as well. So, you know, we think that there's gonna continue to be a recovery as we recover jobs lost in the recession in Northern California and Seattle. We think that they will once again become the drivers of the company going forward.
Very little of that is priced into the stock, which makes us think that there's very good upside here.
Okay. The second question is on your debt and preferred equity program. You know, obviously one of your peers had a default, and they're taking the property back here in New York, you know, the office company converted to DPE positions. You guys made a number of investments. Do you see the risk profile of DPE or your view is that, as you monitor the deals, they're all financially performing the way you expect them? Meaning nothing. You haven't seen anything outside of, you know, what you've been monitoring along the way, both in performance as well as in the developer's ability to get to secure financing.
Yeah. Hey, Alex. At this point, we're not seeing any potential for material defaults. We constantly assess our preferred equity book. The short answer is no, we're not seeing anything at this point. A little more background behind it. Over 75% of our pref and mezz book was underwritten in 2020 or before. We didn't go down to the depths of, you know, the mid-three cap rates, chasing deals. We did very few deals during that time. With this recent expansion in cap rates, it really doesn't impact where we are in the stack. Then you couple that with pretty significant NOI growth, and we feel like we're in a pretty good position.
Our next question comes from the line of Joshua Dennerlein with Bank of America. Please proceed with your question.
Yeah. Hey, everyone. I wanna explore one of the comments I think Angela said in her opening remarks on the higher move-outs is I think what you're expecting going forward. Are those higher move-outs from non-payers who I guess you'll be able to address with the L.A. restriction going away? Just trying to get a sense of like, will that lower occupancy kinda impact same-store revenue?
Sure. There's two things happening on the move-outs. The higher turn-over is driven by two factors. One is, of course, the Seattle softness that I've talked about earlier, and it's attributed mostly to an elevated level of supply in Seattle in the second half. Of course, you know, when there's more supply, there's more concessions, and that draws people out of stabilized properties. That's not unusual during a period where, you know, corporate hirings are slowing. Once again, that's what's happening in Seattle. As far as California, the higher move-out is attributed to the non-paying tenants moving out, which we see is a good thing. With the LA moratorium expiring next year, we do see another opportunity there. We're able to make good progress on the delinquency front there.
That's that. Hopefully that's what you're looking for.
Yeah. No, that's helpful. Then you, I think another comment you mentioned was just shifting more to focus on occupancy. I guess what's driving that? Is it just like you wanna hang on to occupancy, assuming, like, it sounds like you guys are taking the big picture macro view that there might be, like, a recession?
Oh, I see what you're saying. Yes. So normally when we see, you know, market strength and which is usually during a period of strong demand, we push rents. As we head toward the end of the third quarter and into our season low in the fourth quarter, we historically switch that strategy to push occupancy. What we're doing here is consistent with what we've always done in the past. What we're seeing is what I'm trying to convey there is that this is a normalized market that's stable, and we're essentially shifting this strategy to maximize revenue during this period of time. The reason, you know, normally what you would see is in the fourth quarter, our occupancy may run, say, in the mid- to high 96%.
Because of this eviction head-wind, it may run a little bit lower, so maybe in the low 96%. I wanted to signal to, you know, to the community that that's not because there's any problem here. This is actually a good thing.
Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.
Hey, good morning, and congrats, Angela and Mike. Angela, I wanted to ask your methodology on the earn-in. I realize this is somewhat of a new figure, at least to us on the outside. You know, your use of taking the September loss to lease and approximating it by using half of the loss to lease. I would have thought the earn-in was basically the rent contribution this year versus next year on rents that you've signed to date. I was just wondering how this earn-in compares maybe to prior years, and then also how accurate using September loss to lease divided by two, how accurate is that to the actual contribution?
Yeah. If I look at the September loss to lease and you know use that as 50% as a proxy and I look at that number relative to prior periods pre-COVID, the September number is actually about twice as high as the normalized period. Normally around September, the loss to lease is around 3%. This is one of the reasons why we feel good about where our portfolio sits and you know as we head into next year. Absent, of course, a recession, we certainly should do quite well.
Historically, your earn-in is about 1.5% per year?
Yep. That sounds about right. Now, the one thing I do wanna clarify is that, with, you know, everybody calculates it a little bit differently. For us, we are not including concessions. If we include concessions, that earn-in number obviously will be much higher. We're trying to just keep it apples to apples, so there's, you know, to minimize confusion, so it's the same baseline.
Okay. I know this has been asked a few different times, but on your 2% rent forecast, I'm just trying to get a sense of what kind of range that you see that at and how difficult it was to forecast job growth for next year versus prior years when you come out with this initial forecast?
Yeah. Hi, John. It's Mike. You know, again, we're trying to start with, you know, third-party economists as to the macro scenario, and then, you know, what happens in the, you know, across the country will be a function of that. You know, again, typically we outperform the national economy with respect to job growth. You know, the consensus of the, you know, big economists is for U.S. job growth to be at -2% next year. You know, we think we'll do better than that. We're at +0.4%. You know, 9,500 new jobs under the 0.4% scenario is about 4,800 households against, you know, 50,000 plus, you know, new supply in the marketplace. Again, do we think that'll happen?
I mean, as of now and given what Angela just said, you know, seems like that's pretty dire. Again, we should not ignore what the economists are saying, and we should not ignore the Fed talking about wrecking things and pain points. You know, we don't know. Our visibility into next year is no better than yours. Whereas we feel pretty good today, as I said earlier, we can't ignore these numbers. Again, I'd rather have this discussion so you guys know where we're coming from than to, just, you know, create a scenario out of thin air because that doesn't sound relevant. When we do our budgeting process, we start with, you know, economic rent growth.
I don't know how you do a budget without that because you can't leave it to the property teams to try to decide what rents are gonna do. You have to have some macro view of the world, and based on that, you populate your budgets based on supply and demand at the local level. I don't know how else to do it. I'm not saying our budgets are based on this scenario, because it, again, it does seem somewhat dire. However, we are mindful of the macro economy, we're mindful of what the Fed is saying, and you know, we're gonna adjust accordingly. Does that make sense?
It does. I know it's difficult times too, so I appreciate it. Thank you.
Thanks.
Our next question comes from the line of Nick Yulico with Scotiabank. Please proceed with your question.
Oh, thanks. First question is just in terms of your portfolio, was wondering if you're seeing any differences right now in the operating trends in, you know, recognizing you have a broad portfolio that's different price points, suburban, urban. But as we think about, you know, return to office being most challenged on the West Coast, you know, in San Francisco proper, in Seattle proper, in Downtown L.A. proper, maybe downtown San Diego too. You know, how are you seeing a different performance of your apartment assets in those, you know, urban cores, than the rest of the portfolio?
Yeah. It's Mike. I'll start and then flip it to Angela here in a minute. The answer is yes, of course. We see all kinds of differences out there. I'm gonna give you the broader perspective of, you know, what our portfolio is and why it is the way it is, which is, you know, we hope to have property throughout the fastest growing metros. We look at supply demand to try to get to those numbers. That's how we deploy capital. We generally want to be in the B or renter by necessity category. Because when new supply hits or when you have a supply demand imbalance, which could happen next year, the properties that are hit the hardest are those that are near the new supply because the new
You know, when someone down the street has eight weeks free and you're a brand-new apartment competing with that, competing directly with that, you're gonna be impacted to a much greater extent. Our portfolio is mostly suburban in nature. Again, we're not trying to be in San Francisco and San Jose. We're trying to be in the whole Northern California metroplex within, you know, let's say, a one -hour commute distance from the major job nodes. That is our portfolio composition, and we think there's inherent safety in the Bs because you can't produce B quality property.
In a world where the As are more concentrated in the downtown and the newer product is more susceptible to, you know, the impact of concessions if they increase substantially, we think those are the areas that get hit the hardest. You know, the B quality property will do quite well. Angela, I'll flip it to you.
Well, I think maybe I'll just give you a quick example of what Mike is talking about. Concessions in Downtown L.A. is about one and a half weeks, and concessions throughout the rest of the L.A. area averages about a week. That gives you the magnitude and impact of the downtown versus the suburban markets.
Okay, great. Thanks. My other question is just in terms of, you know, move out activity that you're, you know, seeing on like a real time basis in the portfolio. I mean, how much of that would you attribute to people who have tech jobs? Are you seeing any signs yet of, you know, tech freezing layoffs hitting your portfolio?
Nick, yeah, I'm gonna start with that too. I mean, our portfolio is not positioned to be near the tech companies per se or to cater to the tech employees. We are trying to cater to the broad range of employment within our market. We do have a couple buildings that are predominantly, you know, tech related employees, but it's the exception, and actually not even close to the average. We are a reflection of the broader economy, and therefore, you know, the tech component in Northern California and Seattle will be more, but there's a pretty diverse job base there in general. Again, that goes into the philosophy of the company. I don't think that we're particularly exposed to tech.
We are more exposed to supply-demand imbalances and, you know, which we hope won't happen, but again, the dire financial scenario on S-17 sort of contemplates that scenario.
Our next question comes from the line of Chandni Luthra with Goldman Sachs. Please proceed with your question.
Mike, first of all, congrats on the retirement, and Angela, congratulations on the new role. Team, what are you guys seeing on the preferred book? You obviously raised your commitments for the year. How do you see appetite for your investments next year, obviously with higher interest rates, and how have returns changed? I know this came up briefly on the call, but do you see any distress-related opportunities generally in the broader market as you think ahead?
A couple questions in there. I'll try to go backward. As far as distressed opportunities, we're not seeing them as of yet. There's talk of the potential for rate caps expiring and a need for that kind of rescue capital. We're not seeing it yet, and haven't really heard from anyone else who has seen it. There's definitely talk, but I haven't seen any of those opportunities come to fruition yet. As far as. Let's see. I think your other question was just what we're seeing right now on our prep side. We have increased returns. For deals that we are currently pursuing, we've increased returns between 100 and 150 basis points.
I would say where the market is today, there are opportunities given the difficulty of debt today, but underwriting is a little more opaque. I think for the fourth quarter, we have one or two deals in our pipeline right now. I don't probably see more than that coming into the fourth quarter. I think things will slow down a little, and people may take a pause. Going into next year, I think it'll start back up and we will see more opportunities.
Okay. This one's gonna be very quick follow-up. I completely understand and appreciate the use of third-party economists and kind of, you know, the view of the world that is out there right now. If we don't go into a full-blown recession next year, is it fair to say that there is more potential for rent growth in 2023, given the market never fully recovered for some of your key markets, or is that a fair assessment?
Of course, it is. Yes. I mean, I would say when I look at supply at around 0.6% of stock, that looks like it's probably the lowest, you know, anywhere in the U.S., is what I'm guessing, or on the low end, let's say. Supply is the enemy in our view, and you know, trying to avoid supply is a key part of why we're in these markets. If we get a little bit of demand growth, I think we'll do just fine, and/or if the recession is just a short recession and we're in and then back out of it, you know, that scenario would be better than what is on page S-17. It appears that S-17 is probably close to the worst-case scenario, but of course, none of us really know.
Appreciate your question.
Our next question comes from the line of Robyn Luu with Green Street. Please proceed with your question.
Congratulations, Mike and Angela, and thanks for taking my question. I wanna start off with the preferred investments and subordinated loan business. Are you seeing any capital providers that you normally see in bidding contests drop off as you, I guess, pursue the preferred deals going forward?
Great question. The answer is yes. Predominantly the debt funds, they have disappeared. I know we would go into some of these deals, and especially the debt funds, they would provide what we call stretch senior. It would be zero to, call it, 75%. They're no longer in competition, so we're seeing more opportunities coming to us because of that.
Do you mind just expanding whether those debt funds are purely domestic players, as opposed to also foreign players?
Yeah, this is Mike. I think most of them were domestic players. I mean, I'm not sure that we know exactly where they're coming from, but you know, we know that we were refinanced out of several deals with high yield funds, and we don't know exactly who they were, but it seemed like they were domestic funds, you know, domestic high yield funds. There were a lot of them out there. These redemptions have come to an end, you know, consistent with what Adam said, and you know, it looks like you know, the market is much less competitive now and going forward, which we think is a good thing.
Our next question comes from the line of Neil Malkin with Capital One Securities. Please proceed with your question.
Thanks, everyone. Yeah, Mike, I'll echo everyone's sentiment. You know, congrats. Enjoy not having to prepare for earnings. Angela, looking forward to continuing to work with you. I guess just along those lines, you know, I think that California's struggles, you know, aren't lost on people, and you're still kind of working through that, and there's still a lot of uncertainty. I guess, Angela, do you think that the Angela Kleiman era will see Essex venture out from California, maybe like a Phoenix, Denver, Salt Lake, maybe even a Texas, you know, where a lot of the businesses and populations are going?
You know, I understand that it's, you know, easier to build supply, but, you know, Sun Belt markets are supposed to have, I mean, have been outperforming you guys for, like, the last three years and looks like they're going to again in 2023, and they have a lot of supply. So just if you could maybe comment on how the Angela Kleiman era, you know, could look regarding portfolio composition.
Hey, Neil. You know, this is kind of a broader strategy question, and so let me start with why we are here. That's to you even said it, you know, the Sunbelt has outperformed for three years. Well, to us, three years isn't exactly long term. What drove these three years is a pandemic. You know, the way we look at the world is we don't expect to have regular pandemics that will completely change behavior and legislation. But in terms of this general discussion about other markets, this won't, you know, looking at other markets is not a Angela Kleiman era, you know, specific pointing to that. It's a discipline that we've always had.
You know, Mike's been doing this for a very long time and I will continue that work and make sure that we are in the right place and where we can generate the highest long-term CAGR for our shareholders. You know, supply is definitely something that we cannot ignore because that is a key reason of our outperformance, combined with being in a center of innovation that drives demand and income growth and job growth. I mean, they're all interrelated. We'll continue that discipline. If we do end up venturing outside of California, we will also do it in a very thoughtful way and, you know, consider our cost of capital, consider future growth and of course, the basic supply-demand dynamics.
Okay. Yeah, I appreciate that. I guess the other one is on. I don't know if we talked a lot about the delinquency in California. The February 2023, is that for sure gonna burn out? Because I know that throughout the pandemic, you know, there have been a lot of fits and starts and, you know, lines in the sand that have been quickly erased. Is that like a firm date? It just seems like obviously every company is different, but, you know, people have had pretty varied opinions on how long it will take to sort of get back to pre-COVID bad debt. I don't know. Do you guys. Is that like a certainty?
I mean, you know, how do you think about that? Potentially did that go into any of your the market rent forecasts by chance?
Hi, Neil, it's Barb. Yes, the February 1st, 2023 date is set with L.A. The city council has approved that, so that is not changing at this point. If a tenant has not paid current as of February 1st, we can start eviction proceedings. We do think delinquency could remain elevated in the first half of next year as we work through L.A. and the rest of our portfolio in getting tenants out. We are making progress, but it's gonna take time. We think the second half of the year, things trend closer to our long-term average as we get the non-paying tenants out and replace them with paying tenants.
As Angela said, there could be some temporary impact to occupancy, but we don't expect it to have a huge impact to the market and to our results. We think the delinquency trend is favorable. The one offset to 2023 that you have to keep in mind is we don't expect to receive emergency rental assistance next year, which we received quite a bit this year. That's why we think delinquency won't be a significant positive or significant negative in 2023. It should be pretty much a push, we think, at this point.
Our next question comes from the line of Brad Heffern with RBC. Please proceed with your question.
Hey, everyone. Just going back to an earlier question. Are you seeing any sort of elevated levels of move-outs due to lost jobs? Not necessarily tech specifically, but just in general?
No, we really haven't. What we're seeing the move out, it's really re-attributed to just normal market activities and then, you know, layer on to that the other dynamics that I mentioned earlier.
Okay, got it. I heard concession stats for the Pacific Northwest and for Southern California. Can you give where things stand in Northern California?
Sure. Northern California is sitting about a week, and that is a slight like two days uptick from last quarter. It's just not a meaningful change.
Our next question comes.
You know, keep in mind.
Oh, go ahead, I'm sorry.
That's okay. I was just gonna add that, keep in mind our Northern California portfolio is mostly suburban and, you know, San Francisco consists only about 2.5% of our portfolio.
Our next question comes from the line of Austin Wurschmidt with KeyBanc. Please proceed with your question.
Great. Thank you. Mike or Angela, I know you guys are talking about that 2% market rent growth feeling a bit dire, but I guess how do we get comfortable with the fact that the loss to lease was 7% in September of this year versus a historical level of 3%, yet you still expect the loss to lease to go negative in December, which would imply kind of a proportionate slowdown here. How do we get comfortable with that? You know, why do we expect it to get better, you know, as we enter into early next year?
Yeah. I'll start, and maybe Angela will have a comment. You know, it's a seasonal pattern every year. It's not the same every year. There are variations. It's really defined by you know, the drop-off in demand, i.e. jobs, from October to December, and supply continues on being delivered during that period of time. That causes the seasonal slowdown. It's not perfect, it's lumpy and all that other stuff. We're just commenting on the historical patterns. By the end of the year, probably loss to lease is zero or negative, a gain to lease. January hits, and we start getting all the new budgets, all the new hiring, et cetera, that occurs in that first quarter, and we're, you know, that makes the markets recover.
That's how it works. It's been like that for many years. Is there anything, Angela, specific to this year that looks different?
No, other than that, it's so far better than historical patterns. I don't see anything different.
Okay. Just secondly, you know, you certainly congrats to you both. I'm just curious, you know, Angela, with you moving into the CEO role, you know, what are sort of the plans or are you planning to elevate somebody internally to take your place to oversee operations and how should we think about sort of the timing of that announcement?
Well, the transition is about six months, and Mike is still the CEO until March thirty-first. I'm gonna I plan to enjoy every single day of that until then. As far as the team is concerned, we are not going to make any changes to the operating team. We have a terrific team and great bench and, you know, it's if you look at our company history for Mike's first nine years as CEO, we did not have a COO. This is not. We're not doing anything unprecedented.
Our last question comes from the line of Richard Anderson with SMBC. Please proceed with your question. Richard, are you there?
Apologies, I had a mute issue here. Congratulations to both of you, Mike and Angela. Angela, maybe the first order of business, can you simplify the page numbering, you know, S- 18.2. There's an infinite number of numbers, just so you know. It can make it a little simpler on all of us. But that's just a little side note. When I think about this 2% number that we're all talking about, if you were to go back and say, in a normal time, and you were to look at S- 17, and you look at the supply number that you're referencing of 0.6% and the job forecast of 0.4%, and it's a normal time, what would be the number? So what's the number?
In backing into that, what would be the Fed impact that's come to the 2% number? If it were more of a normal type of a world, would that be 4%? Would that be 5%? Would that be 8%? Could you comment on that?
Hey, Rich. I just wanna make sure I understand the question. You know, we have this 0.4% and 0.6%, and that results in a 2% rent growth, primarily because, you know, we're mostly in the B area, where most of the stock on the West Coast is a B by definition. There's just a huge housing shortage. It's the backdrop behind all of this. We think that we can get some rent growth. Obviously, moving into for-sale housing is, you know, people are locked into the renter pool in the B space. As a result of that, we think we can get a little bit.
I think no matter what, we think we can get about, you know, somewhere around 2%. Then we never, you know, except in recessions, we always have job growth and household growth using sort of a 2.1 ratio. It's almost always well above the supply. It's only in a recession scenario that that occurs. If there isn't a recession next year, we'd expect job growth to be much better, and that, you know, pretty quickly covers supply. And again, in other markets, you're gonna have a lot more supply, and they're gonna have the same demand issue. On a rough basis, we still think we do better.
Yeah. I'm just asking.
Does that answer your?
Yeah, not really. The 2% is, you know, impacted by Fed action, as you described. I'm just asking, you know, what's the factor in that 2%, and what would it be if in the absence of this environment, based on the building blocks?
I know.
No, no
That's fine.
Well, I'll go back to what Angela said then. You know, you start with the earn-in, which is somewhere around 3.5, using the methodology that she gets to. Then you would take roughly half of the economic or rent forecast. It would be, you know, based on the better scenario. If you know, the supply-demand is better next year and that 2% becomes 4%, we would expect the building blocks to be 3.5 plus 2 or 5.5.
Yeah. Okay.
Got it.
All right. Second question, is, you know, we did some work on where all the REITs stack up relative to the entirety of their markets, not just competitive to your existing portfolio, but the entirety of the market. You guys registered the best, in my opinion, just running, you know, from a rent perspective, just below the market average. I think that's a good place to be if people trade down to a cheaper alternative, if you're operating at the very top of the market, you know, you could lose some people, not have others coming in the front door. I assume you agree with that.
Second, do you see any of that happening where people are coming from a more expensive unit and coming to your more Class B varietal, and that creates an extra leg of demand for you guys as we go into this rough patch?
Yeah. I think, Rich, it's a great question, by the way. I think you have to throw affordability into the mix. You know, incomes are, you know, especially in the tech markets, they're extraordinarily high. You know, the screening on rent-to-income is very low as a result of that. I mean, during the pandemic, even though, as I said earlier, you know, rents in Northern California are about where they were pre-COVID, but the median household income has moved materially. It screens very affordable. That's not the case in Southern California.
I would expect to see, and I don't have any direct, you know, indication or reporting on this, but I would expect to see some doubling up and/or moving to more affordable units, given the very large, you know, rent growth, you know, 35% from pre-COVID, roughly. At that level, even with some income growth, there still probably is affordability pressure in Southern California. I would definitely start to see some of those other things that happen. People move farther away, they double up, they trade down, et cetera. I think that's what you're getting at, and I totally agree with the premise.
That concludes our question and answer session. I'd like to hand it back to management for closing remarks.
Okay. Yeah. This is Michael once again. You know, I wanna thank you for joining our call. We, Angela and I both really appreciate all the congratulatory sentiment out there. Much appreciated. We look forward to seeing many of you at Nareit in a few weeks, and have a good day. Thank you.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time.
Goodbye.
Have a wonderful day.