Welcome to the 4:20 P.M. session at Citi 2023 Global Property CEO Conference. I'm Eric Wolfe with Citi Research, and we are pleased to have with us Essex Property Trust and CEO Michael Schall. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. As a reminder, the questions I will ask during this session will not reflect or imply views or opinions from myself or Citi Research. They're being asked for informational purposes only. For those in the room or on the webcast, you can sign on to Live QA and enter a code. As a reminder, the code has changed now to GPC23 if you want to submit questions instead of raising your hand.
Michael, we'll turn it over to you to introduce your team, give some open remarks, and then we'll go into Q&A.
Okay, wonderful. It's great to be here as always. This is a great conference, and we look forward to it every year. By way of background, let me do a couple of introductions. So Barb Pak, CFO to my right, and Angela Kleiman, who will succeed me at the end of the month as CEO to my left. And in the audience is Jessica Anderson, who is the Senior Vice President responsible for Property Operations and Rylan Burns IR. So a little bit of background on Essex. We're an S&P 500 Dividend Aristocrat. We own around 60,000 apartment units on the West Coast from Seattle to San Diego. We target areas with the strongest long-term rent growth, and we do that by utilizing supply and demand research.
Candidly, amid the pandemic for the last few years, supply and demand research was not all that helpful because pandemics do strange things, and the regulatory environment was changing so rapidly. But as we look forward, we think we're at the end of those pandemic-related influences, and therefore we see conditions normalizing going forward. Notably, a couple of updates on the eviction moratorium in California. So Alameda County, which contains the city of Oakland, has announced the end of its eviction moratorium. It was one of two very highly restrictive eviction moratoria in California, and so that will come to an end here in about a month. And the other city that had a highly restrictive eviction moratoria was the city of L.A., and that has already expired.
We noted on the Q4 conference call that each of the Essex metros has recovered all the jobs lost during the pandemic. And for reference, we noted that California itself had lost about 3 million jobs. That's super important because we are driven by job growth in general, and we try to equate job growth to demand. And when you have negative 3 million, that represents negative demand. And the resulting rent growth that you saw over the last couple of years is, I think, mostly attributable to that. And now I'm happy to say that each of our major metros have recovered all the jobs that were lost during that pandemic. And as a result of that, we expect supply-demand relationships to be much better going forward. And so we're very optimistic about the future. I wanted to hit track record very briefly.
Despite the challenges of the last couple of years, our track record remains strong. We just announced our 29th consecutive dividend increase to $9.24, and to put that in perspective, our IPO price in 1994 was $19.50, so that is about a 47% return on the original IPO price. We have a very strong balance sheet, and we, again, are recovering from the extraordinary delinquency that we've experienced during the last few years in the pandemic, and so as soon as that is materially dealt with, we look forward to much better operating conditions. We also have a page 12 of the presentation provides an operating update. January-February rents are up 7.8% given that update, and so draw your attention to that, and then finally, there is a CEO transition that is underway, and as of March 31st, I will be retiring as CEO.
Angela here to my left will succeed me on April 1st. I must say I'm incredibly proud of Angela and her effort over many years. We are very close and have worked well together for a long period of time. I know that the company is in great hands being led by Angela. With that, Eric, I'll turn it back to you.
Great. And congratulations on the retirement. I guess the first question is we normally ask for the top three reasons to buy your stock, and I'll ask it in a second. But I guess is this going to be your last Citi conference, or are you coming back next year?
Well, I think pretty much I'm looking to Angela to answer that question. What do you think, Angela? She has to ask me back from this point on. So I don't know the answer to that. Angela?
I think I'll have to come up with good incentives for you to compel you.
Incentives are good.
Yes.
Okay. So with that top three question or top three reasons to buy your stock today.
Yeah, I think there are a lot of things that would fall into this category, but certainly I would point to track record over a long period of time, the consistency and raise the dividend 29 years every year from the IPO going forward. The valuation and discount to net asset value that we have on the West Coast is largely attributable to conditions that we see as improving as we work through this delinquency, this final delinquency issue, and so improving conditions would be the third one: valuation, track record, and improving conditions.
If I think back 10 years ago and when I was doing this before, I think every single coastal company was always trying to convince me how much better the coasts were going to be: low supply, good demand. Of course, now all of them, except yourselves, are getting into the Sunbelt. Do you think they're wrong to do that? What's your view? I mean, do you think that California is going to outpace the Sunbelt going forward and nothing's really changed from COVID, or has something that actually happened during COVID structurally changed your markets?
It's a good question. There are some things that are different. You'd say work from home and hybrid-type work are different from before and potentially could change the course of the past as you look going forward. I would point out that most of the time, most of the investors, I think, believe that the West Coast are more volatile, and especially the tech markets are more volatile. My perspective on that would be that historically, they've been more volatile after a very significant run-up in rents. Rents after the dot-com era, let's say, went up 40% over two years, and we gave all of that back. I think they're looking at the negative of what happened after a very significant run-up in rents. I think this time is very different because there is no run-up in rents.
Our rents in Northern California and Seattle are basically where they were pre-COVID, which means that that expectation or the possibility of a significant rent drop is very unlikely. And I'd say conversely, in Southern California, where we have areas that have grown rents 30%-40% from pre-COVID levels, we would be more concerned about those markets because, again, developers will target those markets given the extraordinary rent increase. Every developable site is immediately pencils out in terms of cap rate, etc. You don't have that in the tech markets this time. And so we've always been sort of countercyclical in terms of how we think about the business. We want to be aggressive in the areas that are sort of depressed, let's say, and then be opportunistic in terms of redeploying capital when things get very expensive.
So I would say I would apply those same conditions, not just to the California and West Coast markets. I would apply them universally across the country.
You've been asked this question a lot in the past, but I think as you get asked it more often, it sounds like you're more willing to say that the possibility of entering new markets is a real possibility. Again, I know there's new leadership, but it did sound to me, at least on the last call, that it was more open to that. So can you talk about any sort of framework you would have for entry to a new market, sort of which markets you're tracking? And if you did go into markets, sort of what would be the sort of minimum size that you need to be there to be efficient?
I think maybe I will turn to Angela and let her answer that since, again, I will be advising her, but she's going to be the leader going forward. So, Angela.
Thanks, Mike. I think what I meant on the conference call is not so much that our view of entering the markets has been absolutely different from the past. We've always been open-minded to entering other markets. Case in point, we at one point made a bid on Town & Country. There are certain conditions under which it would make sense. For example, we would look to markets that have comparable growth characteristics as our markets and comparable impediments to supply because, frankly, in our mind, that is a much more challenging competitor, if you will, than anything else available out there. The other thing that I wanted to emphasize is that we wouldn't drastically shift our strategy just because we had a pandemic.
We have a much longer view, and we're going to maintain that discipline in terms of just continuing to find markets where we can have that outperformance on a growth per share, a core FFO per share, and NAV per share. So therefore, those are the constraints. Comparable CAGRs in terms of the size, there's an entry point. I don't think it's going to be a size constraint. Obviously, there's got to be some economies of scale. So we probably wouldn't go somewhere just to buy one property. But we're not going to wait for a large public-to-public opportunity. We will look to wherever the opportunities are that would make sense.
Which markets do you think have those same supply characteristics? Because I guess I've always viewed California as being a little bit unique in that regard, just given the tough regulatory environment. So I guess which other markets actually share that same sort of very difficult to develop?
So far, we have not seen other markets that have the exact same. Having said that, we are in Seattle, for example, which is not a supply constraint. However, it has the innovation of technology. It has the wealth creation. And so that market, obviously, is more volatile. But when you look at that market as a whole, it has a very it provides a solid long-term CAGR. And so we would look at all the different fundamental pieces to make sure that the end result is long-term outperformance and rent growth.
Then if you were to enter a new market, is this something you think that would come as a surprise to us, or is this something that you would say a year or two at a time, "Hey, we're thinking about going into Denver, or we're going into Vancouver," or whatever other markets you find that have that great growth process? I'm just wondering in the sense of how prepared will the market be for when you do potentially go into a new market?
That really depends on the opportunity and the situation. So if we're making a private bid, we would be prohibited from disclosing that, right? But I would just emphasize that however we do it, we would make sure that we do it in a thoughtful way. So for example, when we pursue Town & Country, we do it via a joint venture structure. And so the goal would be to make sure that we do it in a way that's thoughtful in a disciplined capital allocation way.
One of the things I think has been unique about Essex is that you've always been willing to sort of sell assets, repurchase your stock when there's a disconnect there. You really haven't shied away from it. A lot of others just sort of have a blanket sort of bias against doing that. I guess as you look at sort of your stock today relative to NAV, how great of a disconnect do you see right now, and how big of it is an opportunity relative to history? Is this the biggest disconnect you've seen, or is it sort of smaller where you'd only be doing sort of bite-sized purchases? Just want to understand how big of a disconnect you think there is today.
Yeah. You've seen us over the last year buy back the stock and sell assets to fund it. We will always do it on a leveraged neutral basis. We want to maintain our balance sheet strength and our liquidity profile. So we're going to match fund the asset sale with the stock buyback so we can lock in the value creation for shareholders. We're not going to speculate on where things are going to go. And so I would say we're trading at a pretty big discount to NAV, bigger than we've historically been at. And we will look to sell assets to buy back the stock if it can make sense. And so it's an exercise we're very disciplined about going through. And it really comes down to where we can find the opportunity to sell assets at today.
We did sell in the fourth quarter an asset in Orange County that was at a very attractive price. It was a unique buyer. And we're looking for other opportunities in order to take advantage of this disconnect. I think what makes us unique is that we look to create value in all environments. And so this is the environment what we are dealt with is this selling assets to buy back the stock. That's the only way we can really create value today. And we'll continue that.
Maybe you could just give us a sense for right now what sort of level of assets you have on the market. I mean, are we talking about $50 million- $100 million, or something more significant? What type of pricing you would need in order to execute? Are you only selling assets that don't have big embedded tax gains? How are you going about?
Yeah, I'll take that one. Good question. We always have something that we're considering selling. So there's sort of an ongoing list of properties that we'll have in the market. We'll test the market. We will try to find unique opportunities, unique buyers. And so I would say it's a general philosophy that we are just like we're transacting on the buy side, we're always looking on the sell side too. And where we find the unique buyer and we can transact at an appealing rate, we will do so. The buyer in Orange County asset, for example, was a school, a university that was looking for student housing. And they had a sort of a strategic reason to be the buyer there. So we will always look for those types of opportunities. And our general nature is to always have something that we're trying to sell.
Now, within our company, we've reorganized the entire company around property collections. So these are properties generally within five miles of each other that are operated from one central location. And as a result of that, there are several properties that don't fit within that asset or property collection model. And so they would become potentially disposition candidates going forward. So philosophically, we are not opposed to selling at all. And it's a matter of creating value. I don't think I recall ever trading at a 20-ish% discount. I'm not using your numbers. I'm using our internal numbers. A discount to NAV, that to me is an extraordinary opportunity.
If you looked at the flip of that, you said, "Okay, well, that relationship is much bigger than what we typically have gotten at any time on the buy side when we're buying something, the spread between our cost of capital and the return on the property." So I think there's a good opportunity to continue and continue selling selectively and looking for unique situations and special buyers. I think that's philosophically how we've approached it for many years.
And so even with the sort of Prop 13 adjustments, transfer taxes, and sort of other costs of disposing of assets, even with all that, you think you're still trading at a north of a 20% discount?
Yeah, we run an NAV model. We have a top-level adjustment for Prop 13, what we think it's worth as a valuation. We do definitely consider that. The range of Prop 13 benefits is pretty wide within our portfolio. It's a factor. It's not the deciding factor because there's other factors as well. For example, selling Southern California property, given that rents are up 20%-30%, sorry, 30%-40% from pre-COVID levels, to us makes sense because the upside on those properties is somewhat limited. In our view, rents and incomes have to grow together to prevent people from doubling up, moving farther away, or pursuing other types of housing.
Therefore, all things being equal, we'd look to dispose of property in Southern California or areas where there's been a very significant increase in rents in the past few years.
Got it. And then before we shift over to operations, it looks like we're getting a few questions there. So I'll ask them in a second. Just on the structured finance portfolio, obviously, the returns seem to be going up there. It seems like you maybe can get in sort of north of a sort of 10% type return on a pretty good part of the capital stack. I mean, how attractive is that today to you versus other sort of capital options that you have?
Yeah, we like that business. I think our pipeline of new investments has shrunk more recently. I think that's a function of developers pausing. The change in cost of capital for developers has been pretty abrupt. And so we still like the business. The returns we earn are north of 10%. And so we do think it's a good risk-adjusted return, especially in light of new development. We don't think we get a good risk-adjusted return today. I would say, though, that the opportunities to put capital to work today are limited, but it can change. We've seen it ebb and flow from time to time. And so right now, it's more muted, but it could come back here quickly.
I think switching to operations, you got a question. It says, "Can you walk us through the delinquency trends in your markets? February update was better than January, but still worse than 4Q. What is baked into your guidance as far as 1Q?" And then I think after that, it's basically asking sort of, as the year progresses, sort of where would you expect to end the year in terms of bad debt so we can think about what 2024 might look like on a more normalized basis?
Yeah, so page 13 of our presentation that's posted online has some of the delinquency items and what's in our guidance for 2023, but in terms of what happened in the fourth quarter, our net delinquency was 1.1% of scheduled rent, and then in January, it did go up to 3.1%. That is actually not abnormal for us to see a big increase in January. It's happened in the past few years, and I don't know if people are paying off credit cards or what they're doing, but we have seen it, and then in February, it did come down to 2.3%. In the fourth quarter, we did have some, we were successful in some of our strategies to collect on bad debt, and that's what led to the 1.1% number. We're not always successful. You never know what's going to work with our tenants.
But I would say overall, we expect for the year, 2% gross delinquency or net delinquency. We're not expecting any emergency rental assistance as those funds have pretty much dried up. And then in the first half of the year, it's going to be more elevated as we work through the eviction process. So 2.5% in the first half of the year, and then trending to 1.5% in the back half of the year. And it's just taking time for the evictions to work through the court system. As Mike mentioned, Alameda is lifting here at the end of April. L.A. is lifting at the end of this month. And so we will continue to make progress in those counties, which we haven't been able to make much progress over the past few years. So it is moving in the right direction.
As we get these tenants out, we're getting a tenant in that's paying. It's just going to take this year to kind of work through it.
Actually, I wanted to add just two quick things by way of background. This is all in the reported information. Our long-term delinquency as a company is about 35 basis points. So we're in a whole different universe that we candidly have never seen before. And on balance sheet, we have about $90 million that's owed to us in delinquent rent, of which we've recognized $3.4 million. So most of that delinquency is not recognized as revenue.
You've dealt with tough regulatory environments for a while. And COVID was certainly no exception. But I'm just curious, is there anything that you're watching or looking at today that could sort of change your view of any of these markets where you just say, "Look, it doesn't make sense to be in this market or sub-market anymore"?
Based specifically on regulation, you mean?
If you want to go beyond that, then that's helpful as well. I was thinking more in terms of regulation. Yeah, if there's other things that you're looking at on the corporate side or otherwise in the macro that would change your view, then that would be helpful as well.
Certainly, the mansion tax in L.A. is something that we don't like. We tend to advocate, and I think that there will likely be a referendum on that in 2024, so part of being in a high regulatory environment is pushing against it, and there's pretty good organizations that have been effective at dealing with some of these extraordinary pieces of legislation that have come down, so I think it's going to be an ongoing battle, but other than vacancy decontrol, which is super important in California, I mean, we have to focus on the big things, so the mansion tax, at the end of the day, is not going to change. We're less likely to sell things in L.A., for example. And there's a whole bunch of owners that are trying to sell quickly so they don't have to deal with it at all.
But I think we can play the long game there given the company and its long-term mandate. And so I don't see anything there. It would be other things. So the other fairly common thing is just cause eviction and certain other regulations, which in the scheme of things don't have a great impact. The really ugly ones are what we're focused on. And they're also the ones that we think, from an advocacy perspective, are less likely to happen.
And then I often hear people say that the solution, obviously, to high rents is obviously just more supply, which makes a lot of sense. And it seems like apartment groups are always advocating to make it easier to build, especially in states like California. I guess my question to you is, why would you ever want something like that? I mean, it seems like one of the greatest advantages of the market is that it is so tough to build. So why advocate to have more supplies? It's just that the other options that would come in terms of politics, mandating certain rent levels or doing things that are not in your favor is worse. So just curious, why would you advocate for more supply in your markets?
I mean, you have a couple of different forces there. You have the YIMBYs, which want more supply, and the government, which will say that they want more supply. But in reality, things have only gotten more difficult to build in California. Flat rents in Northern California plus BMRs and other environmental and other regulation, I think, prevent that from happening. This is nothing new. This is something that for many years you've had. Well, I'll give an example. Governor Newsom, when he was elected, what was probably the better part of 10 years ago, said he's going to develop 3.5 million new homes in California. Did that happen? Not even close. I think there's a lot of discussion because obviously, the politicians understand supply and demand for housing and the need for more housing. But the policies don't support that.
Again, having BMR requirements, for example, that are pretty extreme in some cases, etc., actually work in the other way, and for whatever reason, the political structure doesn't seem to equate these two forces as being related to one another, so I think it's incredibly unlikely for California to ramp up production of housing anytime in the near future.
Just before we run out of time, I know you guys put out a presentation with all your new operating stats. So I won't make you regurgitate that. But maybe if you could tell us how things are looking over sort of March and April. You should have some visibility into that based on where you're putting out renewals, also where you're signing new leases. So just early signs of what the peak leasing season might look like.
Sure thing. Yes. We have an update on page 12 of our presentation on the operating environment. And in summary, we're seeing very solid demand. And you can see that with the fact that we are increasing occupancy at the same time increasing rents. And typically, those don't work in tandem unless you have very strong fundamentals. And the other piece of data that I'll point to is that in December, we had a 2% gain-to-lease. And now we're looking at a 1.5%. So 50 basis points increase. Concessionary environment has improved from two weeks in the fourth quarter to a couple of days now. So this all essentially will benefit our ability to raise rents. We purposefully ran a higher occupancy in anticipation of some eviction-related headwind because there will be vacancy coming at us.
We wanted to be in a position to be able to continue to raise rents and capture that rent growth, especially as we head into the peak leasing season. We are well-positioned to do so.
We have a question on Northern California. How long is it, well, actually, if Northern California can catch up to L.A. in terms of the 30% rent growth that L.A. has achieved over the last couple of years? If so, why and how long?
Oh, sorry. You want to?
No, no. Go ahead.
All right. It's a good question, obviously. The tech markets are more volatile, have been more volatile. And when they move, they tend to move very quickly. And actually, all you have to do is go back to last year about this time through about July. We had a huge surge in rents in Northern California. And so I don't know exactly when that's going to happen. But again, it doesn't take that many jobs or that many people moving into California. And again, the significance of recovering all the jobs that we lost early in the pandemic when all the restaurants were closed, all the businesses were closed, etc., the significance of that is that we're not approaching the world from a very low point. We are now back to kind of where we were at the beginning of the pandemic.
And so if, for example, AI takes off or something else occurs on the West Coast, we know that there's been a pretty significant amount of venture capital that has been raised for AI-type companies. There's a page in our presentation that deals with this. And it has broad applicability across many different types of companies and markets. And if that starts taking off, I think roughly 70% of the jobs that are or the venture capital deployment, which would lead to jobs, is in the Northern California market. So again, I view it as we're sort of at equilibrium where we don't have a lot of power either way. And again, which is different from what it was a year ago. We had that strong surge from March through August. And then I think the Fed and financial conditions slowed us down for the end of the year.
So I think it's potentially right around the corner. Again, the thing that is difficult to predict is how far is the Fed going to go and what does that exactly mean in terms of timing of major hiring and other factors. So we'll wait and see what happens there.
I guess in the short term, is there anything that we can be looking at to sort of understand when that inflection might happen? For instance, occupancy gets to a certain level or a certain amount of job growth. What would be sort of the trigger do you think that would create that sort of rent spike? Because you said it doesn't take much to really get it because there's such low supply. So what would that be?
Yeah. Well, we ran this year's scenario. So we published a scenario on the third quarter call. This year, that scenario was for market rent growth of 2% based on essentially zero job growth. As we come into 2023, job growth is somewhere around 4% or high 3s to low 4% range. So obviously, we're well above that expectation for our scenario for the year. Again, because it's so Fed-dependent, I can't say exactly how that's going to play out. And I don't think anyone in the room can either. But I can say is every month that goes by that we see the resiliency in jobs would be a positive step, being stronger than what we anticipated for the year. Part of it been what? I'm sorry, John. Yes, it is. But again, we had the work-from-home scenario like a year ago this time.
And we saw, again, a big surge in rents in Northern California. So I don't think it's—I think return-to-office programs that were in place there continuing because from our perspective, what I've seen is companies trying to increase the amount of time in the office, not go the other direction. So I think we're in a reversal of the work-from-home model. I don't think we'll ever go back to five days a week. But certainly, I think the movement is going the other direction this year versus even last year.
All right. I'm going to ask some rapid-fire questions here. I'm sure you'll be happy not to have to do that. Well, maybe you will. You said you might come back. So first question is, what will Same-Store Property NOI be in 2024 for your sector, not for your company?
Yeah. Again, wide range, feel free to take the midpoint of this. I'll say 3%-6%. Again, the Fed impact being the determining factor.
Yeah. What's the best real estate decision today? Buy, build, sell, redevelop, or hold? Or I guess I'll add repurchasing stock.
Yeah. Yeah. We're going to continue down the sell property, purchase stock, and/or perhaps some redevelopment and preferred equity would be the choices.
Next year at this time, do you think there's going to be more at the same or fewer apartment companies in this space?
I would say.
How's it traded?
Yeah. I would say certainly not more, maybe less.
That's great. Let's see if there's any—no. Nothing else. Great. Thanks very much. Appreciate your time.