Essex Property Trust Inc (ESS) — Q2 2016 Earnings Call Transcript

Thank you, operator. And thank you for joining us today, and welcome to our second-quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments, and John Eudy is here for Q&A. I'll cover the following topics on the call: First, our commentary on quarterly results and market conditions; second, an investment market update; and finally, the latest on rent control proposals in California. So, on to the first topic. The second quarter was challenging operationally, as job growth was weaker than expected in several key markets, often coinciding with peaking apartment supply deliveries. With that said, we're pleased that we exceeded our core FFO per share guidance for the quarter and are increasing our 2016 core FFO guidance by $0.06 at the mid-point. We are also tightening the revenue guidance range, leaving the mid-point of our revenue guidance slightly lower, largely attributable to reduced rent growth expectations in northern California. Once again, I thank the Essex team for their focus and effort in driving bottom-line growth in a demanding and changing environment. Generally, speaking, the West Coast economy continues to outpace the slow growth national economy, which we now estimate will produce 2016 job growth of 1.8%, down from our prior estimate of 2%. Throughout our California markets, we have pockets of strength and weakness, coinciding with the quantity of new apartment deliveries, and the level of concessions being offered by landlords. In response to these conditions, we have lowered our 2016 market rent forecast by 50 basis points to 5.5% on Page S-16 of our supplemental package. Generally, B-quality apartments and locations continue to perform better than A's, as lower price points become more important to renters as affordability pressures increase. In my 30 years at Essex, I have not seen the divergence in performance between Seattle and northern California that we're currently experiencing, and our Seattle results have been a huge positive surprise. The economies of Seattle and northern California have a large tech component and thus usually follow a similar path in terms of rent growth. Seattle generates more housing supply measured as a percentage of stock, which has historically moderated its long-term rent growth, again relative to northern California. The cause of this divergence is largely on the demand side, driven by job growth. To demonstrate this, I'm going to refer to non-seasonally adjusted job growth from January to June, primarily because the year-over-year job numbers are significantly influenced by the strong second half of 2015. Seattle had the strongest job growth for the first half of 2016 compared to each of the past six years, and the margin of out-performance is notable. In 2015, which you likely will recall was a very good year, Seattle increased total jobs for the first half of the year by 30,000. The comparable job growth for 2016 was 43,400, or 44% more jobs added relative to 2015. To contrast this with Northern California, in January through June 2016, we added 27,000 jobs, down from 44,100 in the comparable period of 2015. Based on this activity, we are changing our 2016 forecast on Page S-16 of the supplement as follows. In Seattle, job growth increases 15% to 55,800 jobs, and our 2016 market rent forecast increases to 8.5% from 6.1%. In northern California, job growth is reduced from 93,100 to 74,200, and our 2016 market rent forecast goes from 6.5% to 3.8%. We still believe that our apartments located in the centers of technology and innovation will deliver above-average rent growth. This belief is supported by the integration of technology into virtually every part of our lives, resulting in high growth expectations, higher income levels, and better wage growth. Southern California remains on track to achieve our targets for 2016. There are, however, pockets of supply that impact prices in certain sub-markets. Overall, we had solid results through the south land, especially in L.A. and San Diego. As a result, we're leaving our 2016 rent growth expectations unchanged. As noted on our last call, apartment supply deliveries are inherently lumpy, which affects market rents based on the concession level and other pricing considerations. Last quarter we estimated that approximately 70% of the 2016 supply will occur in the second and third quarter in San Francisco, San Jose, and Los Angeles. In San Francisco and San Jose, we expect apartment supply to begin to moderate in the fourth quarter of 2016, and we expect new deliveries of apartments in 2017 will fall about 20% to 30% in San Francisco and 30% to 40% in San Jose. Second topic, investment markets. Our 2016 guidance called for $400 million to $600 million in acquisitions, and $200 million to $300 million in dispositions. Through the second quarter, we've acquired around $150 million and disposed of about $110 million, including our pro-rata share of co-investments. We've also added approximately $67 million to the outstanding balance of our preferred equity investments. We are working on several acquisition deals that we expect to be largely funded through dispositions. With this activity, we should be in the range of our guidance assumptions for acquisitions and at the high end of the range for dispositions. We also have about $50 million in potential preferred equity transactions that are being underwritten. During the quarter, the stock traded at or marginally below net asset value, making accretive acquisitions and dispositions challenging to execute. We continue to wait for market conditions that allow accretive transactions, strongly preferring that to acquisitions or dispositions that accomplish little with respect to growth in NAV and core FFO per share. We will also continue to selectively call the portfolio, re-investing in lower-risk or higher-growth opportunities. Cap rates have been stable for the last quarter, with A-quality property and locations trading around a 4% to 4.25% cap rate using the Essex methodology. From time to time, more aggressive buyers will pay sub for cap rates. B-quality property and locations typically have cap rates 25 to 50 basis points higher than A-quality property. While rental growth rates are moderating, so is the cost of debt, such that the percentage of positive leverage on real estate deals is approaching record highs. We continue to see fewer development starts in northern California, largely attributable to increased cost of construction and discipline shown by lenders. We expect a small increase in apartment supply in Seattle and southern California in 2017. Market clearing cap rates for development deals typically generate a 4.5% to 4.75% un-trended cap rate, which is below our yield threshold. We continue to look for development opportunities that meet our underwriting criteria, and we are not likely to lower targets in the near term. And then finally, third topic, rent control. Generally, there appears to be less urgency related to rent control now that rents have moderated in northern California. However, the process started by tenant rights groups in several northern California cities has led to several ballot initiatives. So far, qualified initiatives exist for the ballot in northern California cities of Mountain View, Richmond, San Mateo, and Alameda. Burlingame remains in the qualification process. Generally, these proposals provide for CPI-based rent increases on renewals only, subject to a cap. These are in addition to changes to the rent control ordinance in San Jose that I discussed on last quarter's call. It is important to note that all local rent control ordinances must comply with state law, which mandates among other things that vacant apartments are prohibited from rent control. We believe that these various ordinances will have limited impact on Essex, primarily because the vast majority of our properties are newer than the rent control cut-off dates and the various stabilization ordinances or state law, whichever applies. Finally, in our experience, rent control ordinances generally shift the pricing burden from the renewing renter to the new resident. In other words, while rent control reduces renewal rent increases, it also reduces turnover in all rent control property, which means that fewer apartments are available to rent for people looking for a new apartment, which likely pushes rents upward on the vacant and available apartment inventory. Thus, while renewals will often occur at below-market rates, this impact is partially mitigated by higher rents on new leases, reflecting the unintended secondary effect of rent control. That concludes my comments. Thank you again for joining the call. I'll now turn the call over to John Burkart.

Thank you, Mike. We experienced another strong quarter, achieving same-store revenue growth of 6.9% and NOI growth of 8.2% compared to the same quarter last year. While northern California has shown some slowdown due to the factors Mike outlined, Seattle has seen an increase in strength, and Southern California continues to deliver solid performance. I will now provide highlights for each region. The robust demand in Seattle, driven by a surge in employment in the first half of this year, exceeded our expectations, allowing the market to absorb new supply and continue revenue growth. Our Seattle portfolio's revenue increased by 7.5% in the second quarter of 2016 compared to the same quarter last year. The sub-markets performed similarly to last year, with the CBD seeing revenue growth of about 5.4%, while the east side, north, and south sub-markets, which house over 80% of our portfolio, experienced revenue growth between 7.7% and 9% for the second quarter of 2016 relative to the same quarter last year. The Bay Area market has strengthened since the first quarter, with July rents rising approximately 5% since the start of the year; however, due to tough comparisons from last year, net effective rents have only increased by about 0.5% from last year's figures at this time. In San Francisco and San Jose, new supply continues to be absorbed at rates of about 19 units per month and 30 units per month per lease-up, respectively, according to Axial. Concessions have decreased from six to eight weeks down to four to six weeks. The East Bay has shown stronger performance but faces challenging comparisons during the peak leasing season. Our two lease-ups in the East Bay, The Galloway and Agora, are leasing according to plan, with The Galloway absorbing about 30 units per month and the 49-unit Agora leasing around 15 units per month. The Bay Area economy remains vibrant, benefiting from ongoing technological expansion into traditional industries. Several corporations have established innovation outposts in the Bay Area, including General Electric, Walmart, BMW, Nissan, and General Motors. A recent study indicated there are more than 50 corporate innovation outposts in the Bay Area, far surpassing the next largest concentration in London, which has only 10. Office absorption was positive across all three Bay Area MSAs, with 321,000 square feet absorbed in Oakland MSA and 790,000 square feet absorbed in the San Jose MSA. Many leases were recently signed in the Bay Area by companies such as FitBit, Lyft, Stripe, LifeLock, Tesla, Uber, and Twitch, collectively leasing over 1 million square feet of space during the quarter. Currently, approximately 10.8 million square feet of office space is under construction in the Bay Area, with 46% of that pre-leased. LeEco, a Chinese electronics company, has acquired nearly 50 acres of land that was formerly Yahoo’s near Levi Stadium in Santa Clara, California. This acquisition adds 3 million square feet of space for LeEco's operations, which encompass smartphones, bicycles, virtual reality headsets, and future electric cars, enough to accommodate about 12,000 employees. Additionally, the city of Santa Clara has recently approved a $6.5 billion major project just north of Levi Stadium, which will be the largest private development in Silicon Valley history. This project comprises 5.7 million square feet of office space, 1.1 million square feet of retail space, 1,360 apartment homes, 700 hotel rooms, and 450,000 square feet for restaurant and entertainment purposes, with construction expected to commence in late 2017. The southern California region continues to perform well overall. In the L.A. MSA, the CBD's revenues grew by 3.8% in the second quarter of 2016 compared to the prior year's quarter as it continues to absorb new supply. Woodland Hills and Tri-City sub-markets exhibited the strongest performance in the L.A. MSA, with revenues increasing over 7% compared to the same quarter last year. Silicon Beach is attracting new investments from technology companies; for instance, Google is outgrowing its 100,000 square foot space in Venice and is expanding into the 319,000 square foot hangar where Howard Hughes built the wooden sea plane known as The Spruce Goose. After purchasing the adjacent 12 acres of vacant land next to the hangar a couple of years ago, Google is enhancing its footprint. In the Orange County and North Orange sub-markets, the North Orange sub-market outperformed the South Orange sub-market in the second quarter of 2016, with revenue growth of 5.9% and 3.1%, respectively, compared to the previous year's quarter. Meanwhile, revenues in San Diego's MSA increased by 7.4%, with the northern sub-markets outperforming the CBD and southern sub-markets relative to the same quarter last year. Recently, Google signed a 60,000 square foot office lease in northern San Diego's tech-centric Sorrento Mesa area, marking its first expansion into San Diego. Currently, our portfolio stands at 96.2% occupancy, and our availability 30 days out is at 5.2%. Our lease renewals are being sent out in the 5% to 6% range in both northern and southern California and at a 6% to 8% range in the Pacific Northwest for the third quarter. We are well-positioned for the latter half of this year, and we anticipate a decrease in supply in northern California in 2017. Thank you, and I will now turn the call over to Angela Kleiman.

Thanks, John. Today I will comment on our second quarter results, the state of our balance sheet, and the updated full-year guidance. Once again, our core FFO per share for the quarter exceeded the mid-point of guidance by $0.08, although $0.04 of the outperformance primarily related to property tax refunds and timing of expenses. The remaining $0.04 was driven by stronger than anticipated operations, capital, and investment decisions, which benefited the bottom line. In addition, our total FFO for the quarter was actually higher than core FFO per share by $0.07. This was primarily attributed to successful insurance recoveries for lost rents, due to the MB360 fire, which occurred prior to the BRE merger. As for our balance sheet, during the quarter we issued $450 million of 10-year unsecured bonds at a coupon of 3-3/8%, and retired our Series-H preferred stock. Our only remaining debt maturity this year is a $200 million term loan due in November, which we plan to refinance with a new five-year unsecured term loan, and we expect to obtain a more attractive pricing than the current 2.4%. So far this year, we have funded our development equity needs with disposition proceeds, and have not issued any common equity. Currently, our debt-to-EBITDA ratio is inside of our target range, and we are comfortable with this ratio resting in the high fives, as this range has proven to have successfully weathered the great recession. With our $1 billion revolver undrawn, a strong balance sheet, and numerous sources of equity and debt capital, we continue to be well positioned for future growth. Turning to our revised guidance for the full year, as Mike commented, even though northern California is facing headwinds this year, we still expect the region to perform well relative to the nation, and produce over 7% same property revenue growth. However, the lumpiness of supply deliveries in northern California, coupled with lower job growth in the region, will impact our full-year same-store rent growth. Therefore, we have tightened our range and lowered the mid-point. Our expense growth assumptions remain unchanged at 3.8%. The resulting expected NOI growth is now 8.1% at the mid-point, which remains within the guidance range provided at the beginning of 2016. From an FFO perspective, the projected reduction to same property growth rate is approximately $0.05 per share to the full year core FFO; but due to favorable year-to-date results which have exceeded our original forecast and accretive capital markets and investment transactions completed so far, we are able to raise our full-year core FFO mid-point by $0.06 per share to $10.98. For 2016, we are projecting core FFO growth of 12%, which represents our sixth consecutive year of double-digit growth. Thank you. And I will now turn the call back to the operator for questions.

It's Austin Wurschmidt here with Jordan. I was just curious if your guidance in northern California assumes steady-state rent growth, or what you've achieved in 2Q or July in the back half of the year? Would you expect there to be a re-acceleration, since we've surpassed peak supply now, and it sounds like concessions are abating a bit?

Yes, this is John Burkart. We're not necessarily expecting acceleration up in rents, but we are expecting to have a better fourth quarter than last year. So our guidance assumes that the rents don't fall off as much as they do normally seasonally, that we maintain rents a little bit better than we have in the past, that we take advantage of increasing occupancy a little bit, and that we continue to achieve what we've been achieving on our renewals around 5% to 6%.

And then just switching over to Seattle, you mentioned increased supply in Seattle in 2017. Is there any concern that Seattle could see some similar headwinds that have been seen in northern California next year?

Hi, Austin, it's Mike. It's interesting, when we talk about how unusual this has played out this year, it almost means that we have to determine whether it's a one-time occurrence, or if this is part of trends going either direction, both in northern California and Seattle. And the answer to that is it's I think unknowable. And it becomes one of the things that we're very focused on trying to figure out. But I think the expectation would be, well, let's go back to where we started the year. We started the year with the expectation that Seattle would have continued good job growth. And because of the supply, there would be pressure on rents. I think we started the year with a rent growth expectation of around 4.9%. So what happened is we got the supply, but we dramatically exceeded the job growth, as noted in my comments. I suspect that some of those conditions will even out. Again, I've been here for 30 years, just had my 30th anniversary here at Essex, and I've never seen this divergence. And so I would say two things. One, we don't know. Two, we suspect that we will see a more normal balance, more consistent with 29 of the 30 years I've been here. And number three, we're going to be studying it to try and determine what we think the longer-term trends might be. Does that make sense? So the answer is we don't know.

Yes. No, that's helpful. Not to jump around here, but last quarter you talked a little bit about a disconnect between the supply and the demand. Has that started to correct a bit here into the second quarter and early third quarter?

I'm not exactly sure what we're discussing, but it seems like we have observed a concentration of supply. Are you referring to northern California? Let me clarify.

Yes.

Yes, Northern California, part of the issue was that 70% of the supply in San Jose and San Francisco hit in Q2 and Q3. We've had some slow down in jobs. Again, I suspect that will work itself out. The supply picture is declining, fortunately, next year. So I think we start seeing a little bit better pricing environment beginning in the fourth quarter of this year.

So a couple of questions on investments, I think you talked about cap rates for As and Bs. But I was wondering if you would comment on any changes that you have seen in cap rates in northern California, given a slow-down there?

Yes, this is Mike. We have not seen changes in cap rates, and I think you've got, as I tried to comment in my prepared remarks, you have two forces. I think on the one hand, you have lower growth rates. Although, to put that in perspective, the growth rates that we saw over the last four or five years are extraordinary in northern California. So I don't think that most of the private investors that were buying property in northern California had the expectation of the rent growth they got over the last several years. So, I think the growth that we got over the last several years was an anomaly, not a normal thing. And I don't think again that most buyers have that expectation. Having said that, as it relates to the longer-term picture, the private markets tend to be long-term oriented in terms of making these investments. And I think they still see northern California as one of the strongest long-term CAGRs of rent growth generators that there is in the United States. And so they know that, and they play a long-term game. And so I don't think that the attractiveness in the investment markets of property in northern California has changed very much. And then finally, the third factor is you have debt costs that are lower now. And so the amount of positive leverage you have on apartment properties is pretty extraordinary. And we're 26% levered. A lot of investors out there are 60% or 70% levered, and obviously that makes a huge difference. So I don't see anything in the near term where you can buy a property that yields somewhere around 4.5%, finance it with a lot of positive leverage with some growth over time. I think in this environment that looks like a winner, more broadly. So I wouldn't expect cap rates or valuations to change very significantly at all.

And as a follow-up on the preferred equity transaction side, are you seeing more products? And what's your appetite to grow that platform?

Yes, we are observing an increase due to some conditions we discussed earlier. The rise in construction costs and lenders reducing loan-to-cost ratios on construction loans have compelled property owners or developers to seek more equity. This is a focused program on properties that we are interested in acquiring, which align with our portfolio. It's a distinct opportunity in the marketplace. Regarding our capacity for this, I would estimate it likely falls within the $300 million to $400 million range in total outstanding, but probably no higher than that. It's limited because we will not extend beyond our markets and will continue to evaluate properties that we could potentially own if circumstances don't turn out favorably.

I wanted to discuss a broader issue that we haven't focused on much recently, which is Airbnb. Have you considered the new regulations in San Francisco and Anaheim? It seems there are also developments happening in Seattle. I'm curious about how these changes might influence the overall market dynamics, especially with many short-term rentals potentially shifting to the long-term rental market. Do you believe this has positively affected your performance in recent years? Do you anticipate any challenges arising from these regulations in the next 12 to 18 months?

Yes, this is Mike. It remains to be seen. Obviously, any product that enters the market for rental is incrementally, puts more pressure on the market, and provides more availability or more supply, so that is a given. It's hard to extract or to focus on that component and determine what impact it is having, other than that general statement that I just made. We continue to study Airbnb, and we have some experience in the area as a pilot program type of thing. And I think that there is so much noise and so many issues as it relates to an apartment community, where if you have people showing up with their roller boards day in and day out, it's generally not a good thing. So we continue to evaluate Airbnb. We realize that again, as you point out, long term more rental has a pricing impact ultimately on the marketplace, but I think it's fairly minimal. And it's going to be something that we're going to continue to evaluate. Over the next several years we'll make some decisions about to what extent we want to participate in that area.

I guess I'm coming at it from the perspective of there's some reports that there are over 12% of Seattle stock has been pulled out of long-term rentals in favor of using Airbnb for short-term rentals. People are running businesses renting out apartments instead of long-term competing with you, short-term competing with hotels. In San Francisco, we've heard something like 9,500 apartments that don't have registrations. And with all the regulation, have you guys looked into trying to figure out what the number, the amount of supply that really would be competitive with you guys is out there that's working in the short-term rentals, or is that something you haven't focused on yet?

In a supply and demand analysis, there will always be factors that are difficult to quantify, leading to broader assumptions. I agree with your point regarding Airbnb, especially since more apartment units are being repurposed for hotel-like uses, which benefits us. However, in San Francisco, as regulations tighten and units revert back, it could negatively impact us. We have not pursued that angle, but there are similar factors to consider, such as people living in shared arrangements and employers allowing remote work several days a week, which enables longer commutes and can lead to less in-office attendance. We aim to understand the relationship between job growth and household demand, capturing various influences. If Airbnb or similar factors significantly affect this dynamic, we would adjust our understanding of the relationship, typically a two-to-one ratio—two jobs for every household—since this covers both for-sale and rental properties. We would modify that ratio if we believed any factor was gaining importance.

But it sounds like that's not something that you guys have looked into making any changes to yet?

No, that's not the right answer. In fact, right now we're, as I mentioned on the last call that, based on the job growth in various sub-markets, we could not explain why X amount of job growth, well, let's take L.A. for example. 176,000 jobs, given what I just said, should give us somewhere around 85,000 households, and they're producing 32,000 units of total supply, so there should not be an issue there. So, having said that, that's at a two to one ratio, our tendency is actually starting to push the two to one up to a higher ratio, and actually doing that in connection with affordability, as well, because people make different decisions based on relative affordability of apartments within a marketplace. It's all part of a discussion, but it's a larger discussion than Airbnb, is my point.

I guess, sticking with affordability, can you talk about how rent to income metrics or any other ways that you measure affordability have changed over the last year?

Yes, they are increasing and have increased. This is Mike Schall again. Looking back at northern California last year, we saw a significant rise in rents, pushing affordability in San Francisco to levels beyond what we typically see. The current affordability is almost 29%, compared to the long-term average of 26.5% and a high of 33.1%. We're exceeding the range that most people can manage. Our perspective is that affordability is essentially limited. However, it's important to note that extremely low ratios of community can indicate an oversupply of housing, which is also problematic. Certain markets in San Francisco and the Bay Area are reaching ratios not seen in decades, raising concerns. That said, with rents stabilizing this year and personal incomes rising, it alleviates some pressure on that ratio. Last year, we experienced what could be considered two years of rent growth in northern California, and we're now seeing a slight pause. This is partly due to affordability issues and also because renters are migrating to markets like the East Bay, where we’re witnessing the strongest rent growth this year. This factor weighs heavily in our considerations, especially as we approach ratios where individuals are spending 25% or more of their median income on rent, which becomes a significant problem.

When was that 33.1%, what year was that?

I don't have the exact year, but it was around 2000 during the dot-com era. It's interesting to note that Southern California's compound annual growth rate for rent growth has been similar to that of Northern California over the past 15 years. However, this overlooks the fact that rents in Northern California spiked by 40% in just two years to establish the 33% ratio I mentioned. The 15-year analysis fails to capture that surge, focusing instead on the subsequent decline in rents. So, these factors must be taken into account, as they are important to understand in context.

And then quickly on the transaction market, have you seen any changes in the buyer pool, either in terms of the number of bidders, or the composition of those bidders?

We have. I mean, in general there are a few bidders. But there are certainly plenty of bids out there and it's still an active marketplace. Again, I would characterize it as going from a marketplace where you have many bidders, several rounds of best and finals et cetera, to a marketplace that has fewer bidders, still pretty aggressive, still looking for product. Still see a number of the institutions involved in transactions. Some have talked about foreign buyers and investors being active in the marketplace. I think the REITs have generally taken a step back here.

I just wanted to follow up on your commentary on Seattle, Mike. This period you took up your market rent forecast by 240 basis points. But it sounds like you're a little bit cautious on the potential impact of supply, in an answer to a prior question. Is this because this is very sensitive to employment growth? And can you also talk about the rent-income ratio in Seattle versus San Francisco?

Sure. Going back to the start of the year, Seattle was our weakest market not due to any drastic issues, but rather because when we evaluated the supply and demand ratio, it seemed more vulnerable compared to Northern and Southern California. This assessment is based on historical experience, and while we can make mistakes, that’s where we currently see Seattle. Moving forward, we anticipate a 3.5% growth in Seattle which should accommodate any supply the market can offer. I believe it may perform better than expected, but I'm uncertain about maintaining that 3.5% growth. I still consider Northern and Southern California more desirable markets due to past supply imbalances in Seattle. California markets are also undergoing a shift from suburban housing to urban high-rises near transit, which will take time and could limit supply releases. That’s why we view the urban core markets in coastal California more positively in comparison to Seattle. Currently, Seattle's rent-to-median income ratio is about 21%, while the long-term average is around 18%. This illustrates that the long-term average isn't always a reliable indicator; although it suggests room for rent increases, the reality is that the 18% rate exists due to an excess of affordable housing. Lower ratios typically mean less pricing power in the market. Hence, while Seattle has high median household incomes ranging from $80,000 to $90,000 and relatively attractive rents, I don’t see that as a limiting factor.

So sticking to Seattle, it's not part of your development pipeline, so is your preferred method to increase exposure through the preferred equity investment and through selective acquisition?

Yes, I think we would look to trade assets in Seattle and actually we're looking at the same strategy up and down the coast, not necessarily for example trading out of Northern California and in the Southern California which we have done in the past, we don't think we are the point at that point in time. Again the thing that makes us more cautious in the Seattle in the long-term its ability to product a lot of housing, so it's going to probably remain our third choice looking at things very big picture relative to the three markets, Northern and Southern California and Seattle.

I guess, first, it looks like a lot of the supply is concentrated in San Francisco proper and San Jose. What are the necessary conditions for that oversupply issue to being the spread out size of San Jose and the Bay Area? And what is the looks like the scenario for further slowing in quality jobs?

This is Mike again and John Eudy who heads development and is Chief Investment Officer along with Craig Zimmerman can maybe comment this as well. I think it's just rent and cost to bill, so you need really high rents in order to pencil a development deal and where do you find those really high rents, you find them in San Francisco proper and on the peninsula and in San Jose and to some extent in various parts of LA which again it has more supply than that has had over the last several years. So that's what moderate construction outside of the core areas, the rents are quite as high, construction costs are pretty around similar. And I guess the issue that this brings up is how deep is the A tranche of the rental market because now that it has several years of delivering aids into that top tier. How deep is that, how long can you continue to get those, achieve those rents before you really deepen down into the B part of the rental pool and you're making some of that top lines of Bs and they're pushing them into the A product which is I think part of the problem here. So again we're watching that, I think there is a certain level at which California need is more affordable housing and the current solutions to this situation are to produce more very high-end luxury housing. And so there is an obviously disconnect that needs to play out. Do you have any comments for that one John Eudy?

The only other add would be the exactions that cities are getting now on the entire side and the burden of the cost and with construction lenders going back as Mike mentioned earlier. You all add that up and that speaks to why we're seeing you need supplies next year in the fall and compare to what we're seeing this year in the fire. And there is a lot fresher to try to put deals together but at the end of the day the 4.5 cap development transaction allow them are going to come to fruition that maybe being entered about but have to be executed on.

Appreciate that and then my second question having to do with income actually you guys are clearly doing demand forecast, but for this incremental job what is the income mix of those jobs and still how is that shifted over the last few quarters and how does that affect your future outlook?

Hi, it's Mike. We don't have perfect information there. I think the comment we would make is that there is some indication with the quality jobs and Northern California has deteriorated, so in other words we're able to rank in all the different industries and what they the average wages are within the industry and so there is more for example in Northern California more lease or hospitality jobs there have been typically technology jobs, but again in the short-term lots of things can happen, actually the flip is also true in Seattle but in the short-term lots of things can happen and if I learned anything in this business, it's don't take couple of bullet points or data points and start creating a trend on because you're going to also be wrong. I realized that human beings are making decisions have a number of biases and then we try to work through biases as thoughtfully as we can, but I would hate to take some very short-term information and then try to extrapolate what it means. And that's all we have at this point in time and I don't think that any of it is conclusive, but I say we're looking at it and trying to see if we can determine what those longer term implications of this diversion that I talked about in my open remarks. We conclude what you're talking about now, so we just don’t know at this time.

Just a few questions here for you, first, just going back to Seattle historically Seattle, San Francisco sort of linked as far as health of tech, but it sounds like those trends may have disconnected a bit, so it's your view that the market is disconnected or is there just again to your earlier point about don't take a data point and make a trend or is it just there is a little bit of nuance here and therefore the markets are still late over time to tech but right now there is just a little bit of decoupling?

So again I get to celebrate my 30-year here and Mr. Eudy is here for 30 years too and he has been an amazing partner and Mr. Burkart for 20 years. We haven't seen this onetime in 30 years, so now we're going to pay attention to this one diversion and ignore the last 30 years. I mean, that's essentially the dilemma that we're talking about. I mean tech is tech. Businesses are going to make decisions. People are going to make decisions based on the opportunity before them and live where they can afford to live in a good place, high quality life et cetera. And wherever that opportunity presents itself, they will find people smart. They are smart when it comes to make rental decisions. They're smart when it comes to make close decisions with most part. And so I wouldn't see any diversions at all. I think the market is fluid and things change. I think you could have some tech companies opening more office space based on where their people want to take that's the possibility. Having said that, as John said, there is millions square feet in commercial space deliver here and you have these tech giants which have enormous amount of cash and enormous financial capabilities that are building deal that are investing in these office buildings. Every part of the Silicon Valley I think has been essentially remade in a number different ways. They work at another staff that hasn't come up on these calls before but there are at least 50 non-tech companies that have innovation standards here, actually John you have mentioned this in his remark. But non-tech companies within innovation centers here because technology is so integrated into everything we do. So Alex my belief is that this is an anomaly not a trend.

Okay and then going to Southern Cal where it's like LA you had a lot of permits I think for biggest metro for permit, you have given what we've seen of the overbuilding of the high end San Francisco and New York where that's all that penciled, is your view that the supply coming online in LA again is all high end and do you think it's going to be an impact as those permits are putting to the ground or because either where it's located or just the size of the market that supply will be absorbed in a normal fashion?

This is John. Number one you ride in LA as far as the total number of permits, but it's a huge market, so we always look at it in sense of percentage and then that kind of changes its perspective, but where the supply is located in those pockets very competitive. There is no question about that. The downtown location and other playa Vista and so it's submarkets by submarket, but in the supply U.S. what is it even in the sense of AB pretty much anything get delivered these days A quality, so the competition is high if you're an A-quality building across the street from a lease up it's very high and to the degree that you're B and submarket away is not so much. So as we said Woodland Hills performed well, CBD a little bit lesser, so does that answer your question?

So John as if this stuff comes online, are we going to see in 17 or we're going to hearing about horror stories about two months free all over LA impacting apartments or it's just not big enough to really impact the way we’re seeing and impact San Francisco and San Jose?

I don't expect that Alex. I think that was combination of little bit less job growth and the supply hitting in the fourth quarter and then Nor Cal and Seattle tend to be more seasonal and So Cal is less seasonal so Southern California I don't expect to see horror stories in the fourth quarter.

There was an article on the Wall Street Journal talking about Facebook building 1500 million is for the general public on its land and number of park, I know it's coming along with 6500 new jobs from them, but tech companies obviously is a low cost capital incentives to accept to lower return, do you see this as potential source of new supply in the Bay Area?

It's clear that there is new supply coming in, but when you mention competition from technology companies constructing multifamily housing, I didn't see that in the article I read. It seems their goal was to secure approvals for their development. Given the current pressures on rents, they aimed to create a more balanced development that includes both housing and related construction jobs for the office sector. Therefore, I don't anticipate them becoming involved in multifamily construction.

Are you hearing of any other tech companies looking to do something similar?

I haven't, no.

My second question is just for Mike. Just going back to the cap rate question, in your experience how long of the year and have a prolonged would the growth slowdown need to be before we should expect to see a change in cap rates?

That’s a good question and I am not sure I have an easy answer. Cap rates tend to be pretty sticky that's the first thing that happens is buyers and sellers do not agree with the prices so sellers remember the last 10 transactions and buyers think the world has changed. And so that can go on for some period of time and you would see that in transaction volumes of deals closed. Normally the thing that motivates transactions are financial distress and those type of things which in a world of positive leverage we don’t really see that happen and I am really great economic as well. So I would say that you would have to see maybe I'd say a year before you really saw a real directional change in cap rates. This is again I think you're going to end up with the dearth of transactions in the meantime. Maybe the dearth of transactions will be the indicator that maybe something is changing, but you won't actually see a change for some period of time.

Looking the concession comment you said they were down just curious if it starts to spread though other sub-markets outside the core?

No, the concession really started, the standard of course was developed at least that's typically commonalty it's four weeks what happen is, concession moved up, people had a little bit aggressive when the demand was in the slow season and so that moves up to 6 to 8 weeks and it's moved down, but other than assets that are head on competition to brand new assets next to a lease up. There is not a lot of concessions in the market and we do not see it spreading outside of those very competitive zones we believe lease-ups are.

Okay and do you have a loss to lease for the portfolio and maybe Northern California?

Sure loss to lease for the portfolio overall is about 5% and for the Northern California right now it's about 5.2%.

Thanks, still good morning out there, I guess. Angela, maybe you did this and I missed it, but can you break out that $0.11 that offsets the down-draft that allowed you to raise guidance this quarter? Are there factors outside of same store?

We exceeded expectations by $0.08 last quarter and again by $0.08 this quarter, totaling $0.16. Additionally, we raised our guidance by $0.06 for the year, leaving us with a remaining $0.10. Of that amount, $0.05 is related to timing, which involves general and administrative expenses and other costs that will be incurred in the latter half of the year. The other $0.05 is primarily due to one-time expenditures. Therefore, the $0.05 with the lower same-store growth accounts for the remaining amount.

Yes, okay. Maybe I'll talk to you offline. Let's imagine for a moment like you said that we go to a more normalized balance between Seattle and San Francisco in the future. I guess it's a question for Mike or whomever. How does that not mean there will be a meaningful deceleration next year if that does in fact happen, since Seattle has basically come to the rescue so far this year?

Rich, this is Mike. I don't know it's interesting. If I would have said to you that we got 5% rent growth in Northern California this year and 12 last year that's 17. Let's say happen 8, 8.5, I think we all are going to be really happy with that because we can't sustain the amount of growth that we've had. Again I think that we missed how incredibly great northern California has done and we've assumed to cut maybe partially because it's done so great that has to very poorly in the future. I don't follow that logic. I don't think that's right. I think that we can end up with a more normal growth rate in Northern California and this business works just fine. So I'd be the first to tell you that getting 12% rent growth in the year we did in 2015, it's great while it's happening but it has a secondary effect and we're seeing part of that secondary effect this year because again it stretches affordability, it has implications beyond that one year. So I don't think that the fact that you see in flow of slowdown this year again relative to what happened last year as extraordinary that we have last year as being somehow indicative of what's going to happen next year.

All right, so you're saying that the closing of that gap is a decline in Seattle and a similar level of improvement in the Bay Area. Is that what you're saying?

Well, let's say that the Bay Area transitions to a more typical market instead of the extraordinary market it has been for the past several years. Our business was not built on sustained high rent growth over extended periods because income levels are related to rent levels for affordability. There are limitations within this industry and the housing market that will ultimately restrict growth. This does not imply that we will shift from a strong market to a poor market; investors might be focusing on the great recession, which was an unusual time, or the internet boom and bust, where rents didn't decrease by 40% in two years only to drop back down in the following years. Those experiences are often remembered, but I believe that normal market cycles won't be as severe. So, I think Northern California will revert to being a more typical market. What does that mean? It suggests 3% to 4% revenue growth, potential value added through renovations, and possibly value generated through transactions, all contributing to a healthy business performance.

How are you managing the supply fluctuations in the Bay Area this year? Can you assess whether this will be an issue again next year, or is it too uncertain to predict?

In the sense what buildings are out there it's pretty easy to judge or people drive pretty easy to judge, people drive all the sites that they know what's out there. The thing that moves around a little bit relates to construction timing. What we expect to happen to happen because it necessarily happen, things get tend to be slowdown a little bit and they get pushed into a future period, so to the extent that things get slow down they get pushed into a future period it sort of benefited the current are, right. And that's a little bit what happen last year, so it's not perfect but I don’t want to give the impression that we can't know the building, we know the building very well. We literally drive the buildings and detail spreadsheet outlined in each building, what's going on and shift as part see those and when they start to lease up and get occupy that moves around a little bit. That frankly always moves out never really surprises us in the sense of being sooner.

No one expects you to have a perfect prediction, but based on what you're observing now, do you believe the fluctuations we saw this year might align more closely with a typical pattern next year?

Currently yes. I think it's really difficult.

Actually it's interesting, in our economics department we have it broken down by quarter, but they said please don't give that out the phone call because it's not only in timing of construction, but phasing in, absorption rates and all those things get into the equations as well. So it's really challenging to get this exactly right.

Come on, 30 years, you can't figure this out by now?

Way to rub it in.

Okay, great thanks operator. So thank you once again very much, appreciate for your participation on the call, I have to say that I am incredibly grateful to be able to lead such an amazing Company over the last several years and really over 30 years has been quite an experience. So that said, we wish you all a safe and relaxing end of your summer of 2016. And we always look forward to continuing the discussion next question. Thank you and good day.