We're green. I think we're live here, so we'll go ahead and get started. I'm Michael Lewis, Managing Director of Equity Research at Truist Securities. I'm pleased to present today Angela Kleiman, President and Chief Executive Officer of Essex Property Trust, who's immediately to my right. To her right, I think, is Barb Pak, Chief Financial Officer. And then to Barb's right is Jessica Anderson, Senior Vice President of Operations. And we also have, well, I was gonna introduce you guys too, but I'll leave you to remain anonymous for now. Essex Property Trust, ticker ESS, is a multifamily REIT headquartered in San Mateo, California, with about a $14 billion equity market cap.
I thought before we got started and dig into fundamentals and other topics. I'll turn it over to Angela to provide a brief overview of the company for those, anybody in the audience who may not be familiar.
Great. Thank you, Michael, and thanks for having us here. It's great to see everybody here at the Essex Company Presentation. So the team here that Michael mentioned, you know, Barb's been with the company for, you know, she's going on 12, 13 years. Jessica, our Head of Operations, has been with the company for 20 years. Been with—and I've been with Essex for about 14 years as well. And so we've been together for quite some time and been through a couple of cycles. And so I'm looking forward to how things are turning, pivoting at this point in time. As far as a brief background of Essex, we are an S&P 500 Dividend Aristocrat with about $20 billion in total market cap. We recently announced our 29th dividend increase, which essentially means that we've been raising our dividend every year since our IPO.
It's a track record that we're quite proud of. We own and operate over 60,000 apartment communities, and we are the only public multifamily REIT dedicated solely to the West Coast, focusing on select California and Washington markets where job and income growth exceeds the U.S. average, combined with low supply of housing. This favorable supply-demand dynamic has provided Essex with sector-leading long-term kickers of growth, of rent growth. So with that, I'll turn it back to Michael.
Yeah. Great. Thank you. So sorry, we're accommodating everybody on the webcast as well. So, the first question about the latest and greatest, right? So update on May leasing, how occupancy and rent spreads are trending, in the busy spring leasing season, and then maybe any details you could share on how that compares to the original guidance that you provided for the year.
Sure. I'll take that. This is Jessica. So things have been progressing so far this year in alignment with our expectations. We've seen pretty healthy average new lease transaction rent growth through the year. And we've also seen sequential progression in alignment with what we would expect. And if we look back to pre-COVID, 2016 to 2019 average, we typically would see growth between December and May at about 5.5%. And this year we're at 4.6% through May. We did have a slight decline in April, but that was purposeful point-in-time strategy where we introduced some leasing incentives that average about one-week free concession. And that was just to temporarily deal with some concentration in eviction. So things are progressing well. We are sitting at 96.8% occupied today, so well-positioned as we move into our peak leasing season.
And we expect to focus on rent growth over the next 60 to 90 days. We've been largely focused on occupancy for a number of reasons, one of them being the evictions, which we will continue to face through the year. But with our current occupancy level, we can focus on rents over the next several months.
Great. Kind of a high-level question, but I'm sure everyone has regarding, you know, tech layoffs that we've all seen in the news, what the employment picture looks like for your West Coast footprint. And, you know, related to that, are you seeing any cracks in demand? You kind of touched on that a little bit. And do you expect to see some?
Yeah. That's a good question because demand is, you know, fundamental to our ability to continue our rent growth. And, as far as the tech layoffs, I know there's been a lot of headlines. And ultimately, why just provide a little context? You know, during the pandemic, California was shut down, which means all the hiring that took place occurred elsewhere. So if you play that forward with the announcements, you would expect that the vast majority of the layoffs did not occur in our markets. And when we look into the WARN notices, which is, you know, especially in California, there's some pretty restrictive guidelines. You have to file them. We saw that only 16% of the WARN notices impacted California directly or our markets.
And furthermore, what we have seen is, and I think some of you may have seen this already in the Wall Street Journal, 90% of the layoffs in our markets, they've already been rehired. And this is not unusual because during COVID, the biggest investment theme was VR, Virtual Reality. And it's, and then with these companies that have massive capital and infrastructure, for them to quickly pivot to, at the end of the pandemic, realizing that, "Nope, that is not where we wanna head. Now we wanna focus on artificial intelligence," they deprecate an entire department, you know, reinvest and retool, and that is not unusual to us, but that's what we're seeing right now.
Thanks. I wanna follow up and focus on San Francisco specifically for a second 'cause I think that's kind of become the poster child for work-from-home concerns, concerns about crime, you know, whether the city can recover. And I think it's also topical 'cause I hear some misconceptions sometimes about where your properties actually are located. So maybe talk a little bit about, you know, the city versus the burbs, how your portfolio's positioned in San Francisco, and what you think about that market specifically.
Sure thing. That's. It's good to have an opportunity to clarify our portfolio. We're only about 15% in the downtown, so the vast majority is in the suburbs, and part of the reason is that we track where the key employers are, and California's a little different where the major employers are not located in the CBD. You know, Google's in Mountain View, which is a suburb. Meta's in Menlo Park, another suburb, and Apple in Cupertino, so that has a profound impact on how we decide to invest, and we've done this for, you know, many, many years. As far as San Francisco, it's a tale of two cities, and I think that's a similar theme, not unique to San Francisco. You know, we're seeing this with downtown L.A., downtown Seattle a little bit better, but definitely, you know, downtown San Diego as well. There's homeless and crime issues.
There's a whole quality of life that's impacting, you know, how people behave on whether they wanna move back there regardless of where their job is, and so ultimately, you know, what we have seen is the Bay Area in itself has disconnected from the downtown, so if you look at the downtown performance, rent growth is still very muted, and the Bay Area, as a whole, has started to recover. It's slightly above pre-COVID, but, you know, as the recovery continues, we do expect more further acceleration.
Thanks. Jessica mentioned bad debt in her comments. You know, are the bad debt issues in Southern California now behind you? And does that become kind of a, you know, shift to a tailwind rather than a headwind? And also, this is a question I've been asked, which I thought was interesting. You know, speaking of concerns about California, you know, could this be an excuse for the government to suspend rent payments, you know, use this as a tool if there's an earthquake or if there's a recession or, you know, now that the seal has kind of been broken on this forgiveness of rents? Do you think that's a risk?
All right. I'll tackle the bad debt first and hand it over to Angela. So we did hit a major milestone earlier this year. So the County of Los Angeles eviction moratorium finally expired. So that was the last holdout. And L.A. shortly after—or Alameda, rather, shortly after that. So that was at the end of March. So we were finally able to start making progress with evictions in Los Angeles. And but we are looking at roughly six to 12 months on average is the time that it takes to work through the process. So it is going to be a headwind for the bulk of this year and actually spill over into 2024. We were able to make great progress in some of our other areas. And so we're seeing every month our gross delinquency is going down.
So the number of residents that haven't paid rent for three-plus months has been going down every month. And just for some context, outside of Los Angeles, from our peak over a year ago, we're down 65%, the number of delinquent residents. And then L.A., we're actually down 35% from our peak. So that's definitely a headwind we're facing this year. We're projecting 2% delinquency for the year. So that's the headwind that we have to our gross income in 2023. And it will certainly become a tailwind, although the timing is unknown.
Thanks, Jessica. Angela here. On the legislation, you know, the move to suspend rent was unprecedented. And it was in direct response to a pandemic where everything was shut down. And I believe that a look back on this case study, California legislators recognized that what happened here was a losing proposition for California. And what I mean by that is people left. They needed to find jobs, and they had to go elsewhere to do so. And so I don't believe they will do that again. I do think that with the legislature, even though it's two-thirds Democratic, there are more Democratic moderates there. And they're much more sensible about legislation. And the one example I can point to is recently there have been several measures to amend Costa-Hawkins and our rent control, which is CPI, AB 1482.
That's CPI plus 5% capped at 10%. It's actually a very reasonable measure. These measures did not make it out of the Senate. They, you know, the legislature's now closed. And so that gives us the assurance that there are reasonable people there and trying to make sensible legislation at this point in the state.
Thanks. So earlier, I was talking about how many of these REITs I've come to. So I have a long history with covering the company as well. And, you know, two of the first things I think about when I think about Essex are very low new supply in your markets and caps on property taxes. So, you know, maybe an opportunity to talk about your kind of built-in advantages here. Is supply still low? Is that—is that still an advantage? And, you know, separately, how are operating expenses trending?
Yeah. You are correct, Michael. Supply is a competitive advantage for us. Historically, we deliver less than 1% of stock every single year. And the reason for that is it's very difficult to entitle and build in our markets. And it's no different this year. In 2023, we're expected to deliver 60 basis points of new supply. We don't see that materially changing over the next several years. Permits have been low. And typically, supply follows where you have significant rent growth. And so you're seeing a lot more supply being delivered in the Sunbelt, all else being equal relative to the West Coast, where rent growth has lagged. And so we don't see that. We think the supply is a competitive advantage for us at this point.
And then on the expense side, property taxes are a benefit as well because, in California, property taxes are capped at a 2% increase max every single year. And so, you know, we don't see that as, we see that as being a good thing. It is the lion's share of our operating expenses. However, you know, operating expenses are increasing this year due to other factors. The evictions are causing some increased operating expense costs relative to historical norms. But overall, we're trying to be as efficient as possible and keep those costs down. And we rolled out a new operating platform that has led to operating efficiencies. But it so we're able to control the expense side, which is what we can control in this environment.
Thanks. I'm gonna shift a little bit to capital market conditions and asset pricing, and I should have mentioned upfront, I'm gonna try to leave a little bit of room for questions as well if anybody wants to come back to anything, but you know, what kind of opportunities are you seeing for investments, whether it's acquisitions, redevelopment? Even you've done some securities investments in the past. You've done share repurchases in the past. I know you sold one asset in the first quarter and used the proceeds to repurchase shares. So you know, kind of in general, how do yields on the opportunities square with your cost of capital and what looks attractive to you?
Yeah. That's a great question. And I would say on the acquisition front, it's very challenging at this point to make the math pencil. Cap rates are in the, you know, high 4% range today. And given where our cost of capital is, we can't make them, make it work. And so what we've done in the fourth quarter and in the first quarter, we sold assets and we bought back our stock. And that was the only way that we could create value in this environment, given what the shareholders, you know, are, the signal the shareholders are giving us with our stock price. And we will continue to look for opportunities to do that, but we're gonna be measured with it. We wanna maintain our balance sheet structure, our liquidity, and not lever up the company to do so.
We'll need a source of proceeds in order to continue that plan. I would say structured finance is still interesting. We're seeing a few more deals, but we're very diligent and thorough in our process. We may find a few more deals on that front. It does take a long time to have those deals come to fruition. You know, redevelopment is interesting. It's just hard to put a lot of dollars to work. We have a pretty big plan to densify some of our properties. We're working through some of those plans. I think there's some exciting opportunities on the redevelopment front as well.
Great. That's a good lead, and I think to talk about your financing strategy. So in terms of the balance sheet, I'll leave the question sort of open-ended. You know, is there anything to talk about on this front regarding how you use the balance sheets, thoughts on your financing strategy now that, you know, we're in a higher interest rate environment, at least today? Although if you look at the forward curve, maybe you'll get a little bit of relief. Any thoughts on that?
Yeah. I'm pleased that we entered this higher interest rate environment with low variable rate debt exposure, limited maturity schedule, and ample liquidity. So we're in a very strong position from a balance sheet perspective. We've taken care of all of our 2023 maturities, and we have limited maturities next year as well. So from our perspective, we wanna maintain access to a variety of sources of capital, which we have done on both the debt and the equity side. We have a fairly large private equity program. Then, in addition to, you know, we can sell assets or issue equity. Then on the debt side, we have ample sources of debt capital, both secured and unsecured.
I think in the multifamily sector, having Fannie Mae and Freddie Mac right now is a huge benefit because they're very active and they are, you know, a great source of capital in this more capital-constrained market. So, you know, from our perspective, having a strong balance sheet where we can take advantage of opportunities if they arise is where we wanna be. It is where we are today. We feel good about how the balance sheet's positioned.
Thanks. So in every meeting, I like to, I like to ask about risks and about opportunities. Let's start with the risks. You know, what do you see as the potential risks? Or, you know, sometimes people will phrase it as what keeps you up at night, whether it's, you know, capital markets you touched on a little, potential recession, migration patterns. We talked about government policy a little. So, you know, what kind of concerns you as you look out?
Different points in the cycle, different things keep me up at night. And at this point, actually, I think the biggest unknown or uncontrollable to us, and probably all of us here, is the recession landscape. You know, we had good jobs report recently. So that means the Fed is probably not too happy with us. And so what are they gonna do next? That's a question. And that is something that, of course, will impact California. On the legislative side, I do think that things are starting to moderate a little bit. It's gonna take a long time to get there. But at least from what we have seen, that extreme pendulum swing certainly has abated. And so, you know, that's really the key risk remains the overall economy.
Now the more positive question. On the flip side, what's the bull scenario and what are you most excited about?
I'm most excited about really two things. Our operating platform. We have transformed our business in how we operate it. Essentially, with the Property Collections model, we operate 8- 12 properties as one business unit. Creates a lot of efficiencies, a lot of opportunities. Furthermore, we now are expanding that and, you know, piloting the maintenance side of it. So if we have a presentation here, you'll see that we have one of the best operating margins, absent of even just the tax benefits. We only, you know, looking at only the controllables. So there's more room, runway there. In addition, you know, with the layering on the technology functionality, and the revenue management side, I think that the potential will be compelling for us.
And the second factor is really the continued innovation in our markets, especially with the proliferation of artificial intelligence. You know, it's a relatively new area. And so capital investments and the need for talent will continue. And 70% of the AI companies are in our markets. And so we do see that as a strong demand driver. Of course, combined with our low supply growth, I think that is going to be been very beneficial for our markets.
So anybody who knows me knows I overprepare. So I have a whole other list of questions I could go into. But I thought maybe I'd pause here, to see if there are questions from the audience. They're a big audience. If you guys are shy, I think you've gone. We have one here.
Yeah. Everyone talks about entitlements and the challenges, adding new supply. But residential is a little different, right? You've got household formation, foreign students, immigration. It would seem to be an easy win for any local politician to streamline entitlements to create more residential supply. So what is truly the durability of that as a competitive advantage given what we're seeing in terms of population growth and the scarcity of supply in the last, oh, 10 years?
First of all, I would like for you to run for office in California because I will vote for you. But secondly, you know, what do you say makes complete sense? Because people do need housing. And for, you know, various reasons, we have NIMBYism is very strong in California. There's a long entitlement process, and it's complicated. And so I know that, you know, Governor Newsom, pre-COVID, announced several initiatives to try to streamline that process to try to, you know, force housing allocations to the cities. And it's been just a tough battle because people don't, you know, they like things where they are. Which is why when you look at the historical growth of supply for California, it's been about 1%. It's one of the lowest in the nation. And so, I do think, you know, we could use more supply.
And frankly, even with more supply, it's probably not going to have a dramatic impact to our business. It probably would be a helpful thing.
Yeah. I think everybody knows what NIMBY is, but that's Not In My Backyard.
Not in your backyard.
Just in case. Do we have anybody else? Otherwise, I'm gonna otherwise, you have to hear me keep going.
What do you see the AI initiatives impacting your strategy? Specifically, what are you focusing on in that area?
We first of all do use ChatGPT, and so there's lots of applications for that. There's, of course, the BI side of it for analytics. It's a great aggregator of data and information, you know. We could essentially look at correspondences from all our tenants and pick out themes, and so it allows us to be much more efficient, so that's the first step. I actually have colleagues in other businesses where they have big labor force, and they're using it to help them to evaluate their labor force or, you know, reviews and talent assessments, so it has a much broader implication than just what Essex is using.
We are now looking at expanding our technology department to have a, you know, AI specialist or an AI collaborator, if you will, to look at the potential and how else we can optimize our business using AI.
Great.
Can you just talk a little bit more about your cost of capital relative to private equity and then your partnership with them and the opportunities? Is that something you could divide them out later down the road or just flesh that out a little bit further? Thank you.
Yeah, so on the private equity front, you know, we have, I think, $5 billion in assets that are in joint ventures. Typically, they're in a 50/50 structure. Our partners are good long-term partners. There is the opportunity to buy them out. You know, we're, but right now, you know, that's not on the table at this point. They like the assets. They wanna stay in the assets. You know, our cost of capital and what our implied cap rate is well north of the cap rates I quoted in the high four range, which is where we're seeing transactions close. Now, keep in mind, transaction volume is more muted than it has been, but I think that's because there isn't a lot of distress, and people aren't forced to sell. And so people aren't gonna go sell in this market unless you have to.
And so, I think that's the difference is our cap rate is much higher and our stock, based on our stock price relative to where we could transact, and I think private equity is still very interested in allocating to the West Coast. We've had recent conversations with several funds that want to find assets. It's all about finding new product, and that's where it's more challenging given the limited amount of assets on the market today.
Given the hiatus during COVID and evictions that has improved, approximately how far below mortgage rates current rents? And is that an opportunity going forward over the next couple of years on these and those properties?
To give you a background on our guidance this year, we assumed 2% of scheduled rent as our delinquency. So our midpoint is at 4%. If we didn't have that 2% delinquency, our rent growth midpoint would be closer to 6%. That gives you the magnitude and the impact of that delinquency, which is a one-time issue. Our historical run rate is only about 35 basis points. It's a big difference. Fortunately, at this point, all the eviction moratoriums have been lifted. With L.A. and Alameda, the most recent in, you know, just in the past couple of months. Now we have the opportunity to really work through it. It's gonna take time, and it's going to be lumpy. Which is why we're not committing that, "Oh, it's all gonna be done by this year.
And also, on one of the, is Airbnb or any longer-term rentals that impact supply growth in your area?
It really doesn't. In fact, we have some areas that prohibit short-term leases. And so it's, it really does not impact our business.
David?
Yeah. Just as a follow-up to the question about your private equity partnerships. What are unlevered IRR expectations today for that group? How does that compare to the 18 months ago?
Yeah. Those have increased as cap rates have increased. And so I would say they're in the low 8% range unlevered today. And that's up from, you know, sevens unlevered, you know, a few.
100 basis points?
Yeah. Consistent with cap rates. Yeah.
Can the private equity business you guys have the ability to help do some gap financing for developers that might get stuck or need to pay down stuff that seems to be with your platform, leverage that platform to do some pretty special things?
We already have that platform in place. We call it our structured finance business. You know, we've historically done this for many years where we will provide that gap financing on a construction on a new property, where the senior loan will go up to 50%. We'll take the next tranche. The developer will have at least 15% equity based on our underwriting. We're looking at those opportunities. We haven't seen a significant amount of them, but we're ready if they do come to fruition. Our portfolio today is all in our market. It's properties we would wanna own. We could take over if we needed to if that opportunity arises. We're already well-positioned to take advantage of that.
Is there a discrete pool for that, or is it sort of just general corporate funds etc.?
In terms of how much?
Is there a pool of capital that's backed by your traditional backer, or is it just general? Generally, within your balance sheet?
Oh, it's within our balance sheet. It's not within the joint ventures. We have done one with a joint venture, but we don't, our current portfolio is on balance sheet with them.
big is the gap financing program? Like, is it hundreds of millions a year?
Our current book is about $650 million, and in terms of the amount we can do each year, it does vary based on the deal volume, and it does take a long time to have these deals come to fruition. We do expect about $100 million in redemptions this year. I think it'll be tough to get all of that redeployed this year back into new investments, but we're actively looking for opportunities.
We got one minute, so I'm gonna ask one last question. I wanted to ask sort of along the line of opportunities. You know, in some of my other meetings, it's been coming up about how, you know, this group has kind of innovated. And you were talking about technology enhancements and how high your margins have gotten. You know, do you think there's a chance, you know, an opportunity to push margins even further? I would imagine it gets harder and harder as you get higher and higher. And then also, you know, to recycle capital, maybe you could sell at a five-cap and buy at a five-cap. But if you put it in your platform and achieve your margins, that can become a creative. So,
Yes. We definitely see opportunities to continue the margin improvement. And they'll show up in different ways. Some will be on the top line, and some will be from, you know, expense reduction through efficiency. In terms of recycling capital, you know, the way we think about capital allocation is really arbitraging between the cost of that capital and whatever the investment opportunity is. And so for our initiatives that we have going on and also for redevelopment, we actually have been funding it with internal free cash flow. And frankly, that's the, you know, the most efficient way. And so it's really the external growth where we need to, you know, contemplate how we wanna fund the investment through whatever the then cost of capital is, whether it's issue equity or sell stock or via joint venture.
Great. Thanks. So, thank you to Angela, Barb, and Jessica. And thank you to everybody who joined and asked some good questions. I think we're all set. And enjoy day two in Nareit.
Thank you.