Essex Property Trust Inc (ESS) — Q3 2016 Earnings Call Transcript

Thank you for joining us today, and welcome to our third quarter earnings conference call. John Burkart, Angela Kleiman and I will make brief comments followed by Q&A. I'll discuss the following three topics: the third quarter results and current conditions; our 2017 preliminary market forecast; and an update on investment markets. First topic, we're pleased with the Company's performance during the quarter in which we reacted opportunistically to rapidly changing conditions. As a result, we exceeded our core FFO per share guidance for the quarter by $0.05. I thank the team for their great effort and result. Similar to the second quarter, Q3 was challenging from an operations perspective against a very tough comp in 2015. Job growth remains strong relative to the U.S., especially in Seattle where September month-over-month job growth increased from the prior year to 3.5% in 2016 versus 3.2% in September 2015. Northern California continues to significantly outperform the U.S. in job growth, although it has decelerated. For example, in San Francisco, September 2016 job growth was reported at 2.6%, significantly below 5.1% reported for September 2015. Southern California job growth was significantly better than the nation in Orange County and San Diego and slightly behind in Los Angeles and Ventura. Overall, against the backdrop of decelerating U.S. job growth, the West Coast economies continue to outperform. Rent growth continued to be muted in Northern California, which we attributed to the large concessions being offered by lease-up communities. Job quality ranked by annual salary levels for each industry was another issue in Northern California as there were more service jobs and fewer tech jobs being produced. In San Jose, for example, approximately 10% of the jobs created year-to-date were in the highest paying information and manufacturing industries as compared to about 32% in 2015. Less significant deterioration in job quality occurred in San Francisco and Seattle. It’s surprising that more service jobs are being created given the wealth effect related to the financial success of so many tech companies and their highly compensated workforce. Our venture capital contacts tell us that there is considerable movement of personnel within the technology industries as the next wave of new product services and companies emerge. Recent loss of pricing power in Northern California and a few other submarkets could indicate that we have achieved equilibrium between housing supply and demand. We don’t believe that this is correct, and we use historical data from San Francisco and San Jose metros to demonstrate. For the period 2011 to 2016, San Francisco and San Jose have produced about 440,000 jobs; assuming two jobs equals one household, that would equate to demand for about 220,000 homes. The actual total housing units built over that period was about 65,500, or less than a third of the expected demand that would ordinarily result from 440,000 jobs. We experienced exceptional pricing power in San Francisco and San Jose from 2011 to 2015, and the delivery was about 10,000 apartments in 2015 included in the 65,500 previously noted, which has done little, we believe, to eliminate pent-up demand in prior years, which leaves us with the question of why such concessions are required if there is so much pent-up demand. We believe that the answer to that question relates to the concentrations of supply, the fundamentally different financial objectives of the apartment lease-up versus stabilized community, and affordability factors. Apartment developers, in an effort to minimize overall free rent over the lease-up period, typically set absorption targets of 25 to 30 leases per month. In some markets, as many as five leases are directly competing for this lease volume. That means that over 100 leases per month are needed in that submarket to achieve leasing velocity to meet target. Recent job growth has not generated sufficient demand, and the large concessions run out of stabilized communities. Two months of free rent equates to 16% annual rent drives that absorption and, at least temporarily, resolves the affordability problem at the same time. We see this as a short-term phenomenon that will likely clear the market as supply deliveries decline in 2017. Higher incomes are probably the most important solution to the affordability issue. Many renters are displaced by large rent increases and search for more affordable housing when rents grow faster than income levels. The opposite occurs when income begins to grow faster than rents, which is now happening. In Q3 2016, as compared to the comparable period of 2015, San Francisco and San Jose are estimated to produce 6% growth in median household income, which is a huge growth rate that improves affordability relative to a year ago. As for supply, we expect about a 20% drop in apartment supply in San Francisco and nearly 30% in San Jose in 2017, and fewer deliveries in each quarter for our 2017. Therefore, we expect supply pressures to moderate in Northern California, especially in the second half of the year, assuming, of course, the job growth remains on track. Southern California apartment supply will be similar to 2016 and will decelerate throughout 2017, with the exception of Orange County, which is expected to have a 30% to 40% increase in supply. I wanted to provide a quick update on rent control; there are ballot proposals during that rent control in five Northern California cities, while slower rent growth has removed some of the motivation for rent control. There are well-organized and financed groups that are pushing ahead. At this point, we expect some but not all of the ballot proposals to pass. In any event, these measures are not expected to have a significant impact on the Company for the reasons provided in previous conference calls. And then my second topic is market outlook for 2017. Page S-16 of the supplemental provides an overview of the key housing supply, demand, and economic assumptions supporting our market rent growth expectations for 2017. As before, our macroeconomic scenario for the U.S. relies on leading third-party sources. The Essex economics team has been estimating how the national economic picture will impact housing supply and demand for each submarket we have selected for potential investment. For 2017, the U.S. economy is expected to experience muted growth with U.S. GDP and job growth of 2.2% and 1.6%, respectively. This year, we made three notable changes to our assumptions that are incorporated in the S-16: first, we have modified our definition of multifamily supply to be similar to a few metrics, which include multifamily properties under development with at least 50 units and excludes senior, student, and 100% affordable communities. We diligence this information by driving each property to understand delivery schedules, saving, and removing project duplication. Therefore, our supply estimate should differ from the data vendors. We have observed that various research providers estimate supply in a variety of ways, often with materially conflicting conclusions. We hope others will follow our lead with respect to using a similar supply methodology. Second, as we approach the top of the cycle, development deliveries are often delayed due to shortages of trained construction personnel. This causes some development deals to be pushed into the following year. With that, some of our 2016 scheduled deliveries have emerged into 2017, and the same thing may happen at the end of 2017. Therefore, our supply estimates may be too high. Third, as noted in my previous comments, the typical relationship between supply and demand is disconnected in Northern California. In 2016, there is no historical precedent for the adjustments we made to consider affordability; they represent our best judgment. Notably, on Page S-16, each of our West Coast metros is expected to outperform the national average job growth. In each metro, again assuming two jobs equal one household, housing demand exceeds total expected housing supply, both rental and for sale. The resulting 2017 market economic rent growth is slightly above the long-term CAGR of rent growth in Southern California and Seattle, and slightly below in Northern California. In summary, 2017 seems likely to produce a soft landing; thus, the extraordinary rent growth from several years should transition to the long-term averages in the Essex portfolio. And now the third topic is investments. We experienced a relatively quiet quarter from an investment standpoint as outlined in the press release. During the quarter, the stock traded mostly at or below net asset value, making accretive acquisitions challenging to execute on a match-funded basis. We expect to be more active in the fourth quarter, with all new deals being funded with disposition proceeds. Cap rates remain stable in the last quarter, with A-quality properties 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 4% cap rates. Generally, there are fewer motivated apartment investors in the market as compared to a year ago. We don't see cap rates changing materially given the extraordinary amount of positive leverage that is generated when cap rates average around 4.5% and a seven-year fixed year loan is approximately 3%. In connection with our preferred equity program, we look at both existing and to-be-developed apartment communities that are consistent with the Essex portfolio. Recently, we've noticed an increasing number of development transactions that don't meet our criteria, typically due to increased construction costs and conservative construction lending practices. This supports our belief that 2017 will represent the peak of supply in Coastal California. That concludes my comments. Thank you for joining our call. I'll now turn the call over to John Burkart.

Thank you, Mike. The Essex team had another good quarter, delivering total same-store revenue growth of 6.9% and NOI growth of 8.3% relative to the comparable quarter. I want to thank our associates for their daily commitment to providing exceptional customer service and for their enthusiasm in achieving our company objectives and helping make this possible. Our markets are reaching a point where the strong performance in Southern California will enable the region to outperform Northern California. Although this quarter, they both were equal at 6.5% revenue growth. In Seattle, the strong demand in the market fueled by above-expectation climate growth enabled the market to absorb the new supply and continue to grow revenue. Our Seattle portfolio grew revenue 8.5% in the third quarter of 2016, relative to the comparable quarter. The CBD submarket outperformed expectations, growing revenue approximately 7%. East side, North, and South submarkets, which hold over 80% of our portfolio, all grew revenues between 8.4% and 10.8% in the third quarter of 2016 relative to the comparable quarter. During the quarter, the market absorbed 950,000 square feet of office space or 1% of total stock. Amazon continues to expand with over 10,000 posted job openings and signing another 360,000 square foot office lease for a building under construction located in Bellevue, where the Company was founded. Currently, there are approximately 7.2 million square feet of office space under construction, with 41% preleased. In contrast to the strength of Seattle, the Bay Area rental market has been impacted by affordability and aggressive lease-ups. Currently, Axio shows September rents in San Francisco and the San Jose market to be relatively flat compared to the beginning of the year. Submarkets that are most impacted are those with higher levels of new lease supply and related lease-up concessions. Concessions in the marketplace vary; they are driven by the concentrations of high-end lease-ups, which largely feature podium and high-rise buildings. To achieve this difficult typical occupancy, the entire property needs to be largely completed, resulting in hundreds of rent-ready units in each property hitting the market simultaneously. Generally, lease-up managers generously give away concessions to achieve certain coupon rent and absorption goals. In certain markets with concentrations of supply, such as San Francisco and South San Jose, we are seeing selective cases where managers are providing two months of free rent or more. During the quarter, we completed the lease-up of Agora, a 49-unit luxury property in downtown Walnut Creek, and continue to successfully lease up the Galloway in Pleasanton. Currently, Galloway is 63% leased, and to maintain leasing velocity, we have increased concessions to about six weeks for lease, which is up from four weeks offered during the peak demand season of the summer. Office absorption continues to be positive in all three Bay Area markets, with over 800,000 square feet being absorbed in the quarter. Some of the quarter’s leasing activities included General Electric expanding their footprint by adding an additional 100,000 square feet in San Ramon, and Google signing a lease to occupy the entire Moffat Gateway campus, which is approximately 612,000 square feet. Currently, 11.5 million square feet of office space is under construction in the Bay Area, of which 46% is preleased. Moving down to Southern California: the region continues to be a solid performer overall. In the LA market, CBD grew revenues 4% in the third quarter compared to the prior year’s quarter, as it continues to absorb the new supply. The Woodland Hills and Tri-City submarkets continue to be the strongest in the LA market, growing revenues about 8%. In Orange County, the North Orange submarket continues to outperform the South Orange submarket in the third quarter, with revenues growing 6% and 4.4%, respectively. With 1.9 million square feet of office space under construction, this will support the addition of approximately 11,000 jobs in the Orange County market. Finally, revenues increased 8.4% in San Diego, with the Northern submarket outperforming the CBD and Southern submarkets relative to the comparable quarter. Third quarter office absorption in these three Southern California markets was over 1.4 million square feet, with San Diego leading the way with almost absorbing 1% of the total stock. Currently, our portfolio occupancy is at 96.7%, and our availability 30 days out is 4.4%. Our renewals on average are being sent out at about 4.5% for Northern California, a little over 5% for Southern California, and about 6.3% in the Pacific Northwest. We are positioned well for the end of the year and 2017. Thank you, and I will turn the call over to Angela Kleiman.

Thanks, John. Today, I will discuss our quarterly results, the full year outlook, and comments on the balance sheet. We are pleased to report that our core FFO per share exceeded the high-end of our guidance. The outperformance this quarter was primarily attributed to favorable operations, accretive investments and lower G&A, some of which is timing-related. Turning to the full year outlook, we are reaffirming the midpoint of our same property guidance of 6.8% revenue growth and 8.1% NOI growth. As for our core FFO, we have increased the midpoint by $0.05 per share to $11.03. We are now projecting a 12.3% year-over-year core FFO growth, which represents our sixth consecutive year of double-digit growth. As for the balance sheet, our net debt-to-EBITDA ratio improved to 5.7 times this quarter from 5.9 times last quarter, primarily due to continued growth in EBITDA. In addition, we received upgrades on our senior unsecured debt rating from Moody's to Baa1 and from S&P to BBB+ with stable outlook. The upgrades substantiate the strength of our balance sheet and our improved debt metrics. The rating agencies also based their upgrade on the solid operating track record and long-term favorable economic fundamentals in our select markets. We believe this upgrade will enhance our cost of debt capital going forward. That concludes my comments. I will now turn the call back to the operator for questions.

So, I want to just get a little bit more color from you about the comments about the peak in supply in 2017. Does that mean you see supply pressures still accelerating into 2017 and then looking forward into 2018, when do you really start to see these supply pressures starting to decelerate and maybe providing a little more relief in the reasons that you mentioned?

This is Mike. Thanks for joining the call. I would say what we are seeing is movement of some of the supply from 2016 into 2017, and we see it continuing at a pretty significant level through about midyear in 2017 and then dropping off significantly from that point. And again, I think that there is a lot of deals being discussed here on the West Coast; the issue is because of construction cost increases, delays from the cities because the cities are very busy, and the construction lending environment which is becoming more and more conservative that is starting to make deals push them off or hand over they are not achieving the level of returns required to make the deals work. So, we are seeing those deals being pushed off. And so that gives us confidence that the supply is underway; it will be delivered late and hence the movement of supply from 2016 into 2017, but it gives us confidence that we are going to see a pretty significant slowdown in the middle of 2017.

And just two quick follow-up questions about that. Your same-store revenue growth and same-store NOI growth, should we think about that as sort of the steady state right now, with supply pressures being moved into 2017? And then I have a follow-up to that. Thank you very much for the disclosure on high-end job growth, that's really helpful. Did I hear you correctly that you thought the high-end job growth would begin to reaccelerate as some new products are coming to market?

We're hitting that one first; we don't know. We can't tell you. We think that there will continue to be more service jobs created and more services consumed for the reasons noted, namely that we have a very high-income workforce, and we're going to consume more services, so we feel pretty confident with that. We do think that there will be more tech jobs; again, we think that tech is going through a retrenchment or really defining what the next chapter is going to be, in fact, which is a variety of things. For example, the Internet of Things, the use of Big Data, more mobile applications, sensors, and security devices as they relate to many applications, including apartments for example, sustainability, and cyber. So there's a whole bunch of things that are happening in the tech world that are being pursued, but we're not really seeing it in the job numbers yet. So, again, we view the tech industry as an ongoing revolutionary type of process, but it's not a straight line. And so, but we expect it to take on more momentum as we get through the next couple of years.

And the same-store revenue growth, is that sort of a steady state that we can expect at this point, do you think? I know it's hard to project.

Yes, it's hard. I mean we don't want to get into giving guidance at this point in time, but from our perspective here, we think that probably Q1 and Q3 will be a little weaker. You have our market forecast expectations for 2016, so you know what the overall view is for the year. But if I were to look at the first part of the year versus the second part of the year, I think we'll have somewhat of a slow start and then pick up momentum as we go through 2017.

I guess just sticking with that theme, what's the loss to lease for the portfolio today versus at this point last year?

This is Mike. Welcome to the call. In September 2016, loss to lease is about 1.9% and 7.2% last year. And it was back in July; typically, if we had the peak of loss to lease in July, it was 4.9%. So, it's been a fair amount of deceleration since just July.

And then, for the 2017 economic rent growth forecast, when you think about the potential variability of each region, which region are you most confident in, and which is the widest range of potential outcomes?

Let's see, that's a good question. I would always point to Southern California as being more stable. It doesn't have really the upside or the downside typically because you've got more pieces to the economy, and they trend a little slower. When I think about Northern California and Seattle, I think overall over the long term it grows faster, but it's more volatile and is generating faster growth over the longer period. So, I think that’s always the case. I don’t think there is anything unique about right now. Southern California is closer to the U.S. economy; Northern California has the ability to move aggressively a little bit in both directions. And you’re seeing part of that; I mean affordability is the concern about Northern California because demand grew so quickly, and we have the great pricing power that rental growth is much faster than incomes, and you can do that for some period of time. But at some point, rents and income have to reconcile with one another over the long haul.

Yes. Good morning on your end. First of all, big congratulations on putting up such great numbers against the backdrop you’re operating in. Just on Northern California in general, again, you look at the aftermarket data on the pin to a very green picture. If we look at your results and you guys are still doing very, very well. Just trying to understand again how you're managing against all that pressure from aggressive developers trying to fill up their buildings, the concessions, the slowdown in job growth. I mean, is it just the quality of the portfolio in regards to owning a lot of the assets not at the very high end of the market? What is it actually you guys are doing that is creating this kind of massive alpha?

Well. Thank you, Tayo for bringing that up. I would like to believe it’s because we have the smartest operations team led by Mr. Burkart. So, I’ll get hit more shut out on that point. But I think that if you look at the Axio charts, what we saw this year was a pretty weak peak leasing season and so I think John and his team anticipated and really understood and executed around that. And so, but I don’t want to steal John's thunder. John, what do you think was magical this quarter?

I prayed a lot. As Mike said, we think our reaching strategy typically typifies where we’ll do what I call is actually closing the leasing door, where it takes certain units and holds them out above the market, trying to identify top potential market rents. And so we made some changes in the settings to bring those units to market which enabled us to gain occupancy during the peak demand period and positioned us very well going into the fourth quarter. That strategic change, plus the loss lease that we have, taking advantage of that, as well as quite frankly nickels and dimes executing in many different places from collections to reducing models, etc. We worked very hard, and I’m very proud of the team, they did a very great job.

Thanks. A couple of questions, first on the 2017 market forecast that you gave on rent growth. Are those numbers only for like new lease growth or is that some sort of blended rent growth?

Yes, Nick, it's Mike. This is supposed to be market rents and not the asset portfolio but all the assets in the submarkets in which we are invested weighted as if it was our portfolio. And so we’re not trying to make a comment at all about Essex or As versus Bs or anything else. Just broadly speaking, what do we expect the submarket to do taking market rents from the beginning of the year versus the end of the year.

Okay, so I guess when we look here at Northern California at 2.5%, that's higher than I guess where the latest sort of monthly Axiometrics data has been, which is sort of no growth or slightly negative. Is there some sort of difference, and then you are assuming that rents actually are growing across the market next year? Just trying to kind of reconcile.

I think the question is that I would ask historically back to you is how many straight lines do you see on these rent graphs? And pretty much the answer is none; they don’t act in a straight line, they move. So yes, if you look at September alone, you'll say, okay, this is extrapolate and figure out where things are going from there. I think you end up with the bad answer because I would say what impact does September have on the overall results we already know, but we have affordability issues, we have too much supply in the form of these lease ups to operating typically 16% off on your annual rent. And then now we have the affordability factors layered on top of that. No one can aggregate what each of those pieces means, so by focusing exclusively on September, I think that you are making an implicit assumption that, hey, this is the way it's going and it's going to continue that way. We don’t believe that if you look at just the Axio chart for San Francisco, San Jose, and in California markets. There was a point on which we were getting 2% to 4% rent growth. And again, trying to stagger leases so that you take advantage of that and make good decisions with respect to building occupancy during the right period of time allows you to have some ability to manage around that. And so, I wouldn’t focus too much on the one September number, but look more broadly at where rents have gone this year. And I would expect that next year again will be a little bit challenging in Q1 and Q2 because we're going to be dealing with this issue of too much supply and big discounts because lease-up operators are heavily incentivized, they have a bunch of big units to discount and absorb apartments. And this dynamic is not going to change and that will have the effect of dampening our results. However, we start building demand in February or March, and we would expect that to happen and that will temper that. So again, we try to understand these relationships and how the rents vary throughout the year and try to make good decisions and execute well around what we expect to happen.

Okay, that's helpful. Mike, just as a follow-up I don’t know if I missed this, but can you give a sense for where new lease growth was in Northern California through your portfolio in the quarter and how it's trending in the fourth quarter so far? Thanks.

Sure. This is John. Our new leases in the third quarter for Southern California were approximately 3.6%, for Northern California about 1%, and in Seattle around 5.6%, which results in an average increase of about 3% year-over-year. As we enter the lower demand periods, I don't have the exact figures, but typically we expect the trend to be somewhat lighter. It's important to note that the same quarter last year was weak, which should positively influence our year-over-year comparisons.

I think people are trying to understand whether the supply curve peaks in 2017 or extends into 2018, and how that develops over time. Some believe there may be a smoothing effect as delays occur. My question is, do you think we could end up in a different situation in 2018 depending on whether it rises in 2017 or gets smoothed out? Is there a preference in your market for one scenario over the other, and does it impact the overall outcome?

It's Mike again. I think it does matter, and I think that it's very difficult to look too far out there because conditions change. And back to the point I was trying to make before, there are no straight lines, and we react based on what we see happening on the market day-in and day-out. Again, what we see and we see a lot of this with good visibility onto what's going on in the development deals, because of our preferred equity program where we are coming at that 55% to 85% loan to cost ratio on development deals, and so we're seeing a lot of deals and we're originating these preferred equity loans on properties that would be very consistent with the Essex portfolio. But I guess the point is that a number of those are ready-to-go development deals that don't hit the yield thresholds that make them buyable in the marketplace, and therefore they're being pushed off. A lot of that is when you get into the discussion of reconciling costs, a lot of land owners think that the costs are much lower than they really are when they sit down and actually price things out. That process I don't think is going to change any time soon. It's possible, for example, that the construction industry will have fewer projects, and that could possibly become more competitive from the cost standpoint, and some of these land deals could start working. But we're certainly not seeing that at this point in time. So, what we’ve before us is a number of, I'll say half the deals that we're scheduled or could come to market are actually being done because of these constraints. Given rising costs and silly delays from city planning departments that are really busy and the impediments from conservative construction lenders, I feel confident in our forecast that the first half of 2017 will be a bit heavy and then abate each quarter throughout 2017 in the second half of the year. So, I feel very confident in that. Although again, like we’re seeing before, there could be some movement of projects quarter-to-quarter as delays and other things happen.

Okay. That’s helpful. And then you did mention the preferred equity program. Can you just give us an update on how you see that pipeline? It seems this quarter was a resignation quarter and heavy relative to the outlook that you gave last quarter? Are you seeing more opportunity or is that opportunity expanding?

Yes. I think what I would say about that is we’re at 186 million outstanding and we did a few deals that funded a few million dollars this quarter. We have a pipeline of around 50 million, but in talking to our team there, they are again looking at a lot of deals, but not many of those are making sense. And so it's not like we have 30 deals and we're picking the best of it; we’re looking at a lot of deals and somewhere around half of them are making sense, while the other half are again not producing the returns one would normally expect from development deals. But that's against the context of looking at acquisitions; with an acquisition, you can lock in an average cap rate somewhere around 4.5%, with a seven-year loan around 3%. So you have a huge amount of positive leverage. I think that the alternatives with respect to where capital gets allocated are putting interest in and it means that development deals are only a handful compared to better economic alternatives and certainly better risk rewards.

Hi. Thanks for taking my question. Most have been answered already, but I just wanted to address stock buybacks since your share price still looks relatively discounted. Any update or thoughts on that?

Well, as you may recall, we have a $250 million program in play, and we’ve always been opportunistic when it comes to capital allocation, and we plan to continue to do so. We had a small purchase, but not enough as it relates to subsequent investments to the very small amount. And like I said, we're just continuing to be opportunistic on that front.

And I guess where the stock is trading today, how do you evaluate that as an opportunity against your overall investments?

I think we like the stock better than yesterday. It's interesting; I mean the one thing I would add, that it's a continuous conversation between Angela and me, is that it's not like we can sell our whole portfolio primarily because of the cost to routine tax planning, etc. We have somewhere around a billion dollars, so we call that selling relatively easily. You need to pay us special dividends and/or buy shares back; we don’t really care about which of those we might want to do. But I guess the point is, there are many assets that we have huge gains on, and there’s a large difference between what we pay as property tax versus what the buyer pays his property tax, and the buyer will cap out that difference and get a lower value. So there is a headwind in California to large-scale dispositions. We’ve gone through our portfolio and categorized them by type, and so we have a list of assets that we know we can sell, a calling portfolio, we have an opportunistic sale portfolio, and again we are just trying to get the relationships right, but we are not going to do it if it has a very small impact; we would much rather wait for opportunities to see meaningful differences between the value of the real estate portfolio and the value of the shares. So, we are going to be patient on that. As Angela said, we did execute on debt repurchase, so that will give you some ideas that we're interested in following through.

That's really helpful. And just one last one from me; I think you mentioned the aggregate loss lease figure earlier in the call, but I was wondering if you can provide that between your three portfolio segments?

Yes, sure. This is John Burkart. So, the aggregate, as we said, is about 1.9%, and that breaks down with Southern California at about 3.4%, the Bay Area with slight gains in lease at this point in time of about 40 basis points, and then Seattle at about 2.6%.

So, another sort of twist on the loss to lease question, so and I don’t know if you can answer this readily on this call, but I'm trying to get a sense of what loss to lease has represented in terms of Essex's outperformance in terms of your rent growth versus the market rent growth or your competitors' rent growth over the past couple of years. If you could attribute that outperformance to loss at least, if you can attribute part of it to that a revenue management just trying to get a sense of the split there, again attribution of outperformance, I guess.

I'll take a shot at it and if Mike wants to follow up; but ultimately, loss to lease is the product of rent growth, right? So, it's assets being acted in the marketplace and are we investing in the right locations? What's the rent growth look like? And then loss to lease drives what we actually rent at versus where the markets at? So, at Essex, we've had very strong markets. As Michael said many times on the call, we had a self-imposed rent cap that we imposed at basically 10%, which has led to loss to lease growth over time. About a year ago, we were about 7.2% loss to lease; now we're about 1.9%, so you can see that a big portion of that has rolled through to the bottom line. Does that basically answer your question?

And then my second and final question is just on Seattle. I think you guys quoted renewals running around 6% and change in the Pacific Northwest earlier in the prepared comments, and then when I compare that to the market forecast for next year around 4.5% and then also measuring that again it's around 8% which is what you guys have done so far in 2016. I'm just wondering what all that implies in terms of new lease growth in Seattle for next year? It sounds like it should be pretty low to get to kind of those numbers when you tie it all together?

We believe we have outlined rental growth rates, projecting 4.6% for the marketplace next year. Regarding the renewals for the fourth quarter, our current expectations are influenced by the existing leases. As we approach the fourth quarter, it's important to be cautious, but we are determining these figures now, about 60 to 90 days in advance. The renewals are quite strong, and I do not interpret this as an indication of weakness in the market.

I think, let me add something important to that. In Seattle, we have two couple of things that have happened. So, we have supply in '16 estimated as 9,800 units, this is multifamily. So we have that increasing to about 10,900 units and we have job growth decelerating from 3.5 to 2.7. So, now will that happen, exactly like that? I'm not sure, but again our market forecast is based on a scenario and those are the two key inputs in the scenario. So we have some moderation of market rent growth in Seattle; again this is market growth on fiscal 2016. It does not include loss to lease.

I think John mentioned in his prepared remarks, that pick up in office net absorption in some of your markets, and I realized there's different supply and leasing dynamics, but I'm just wondering if office leasing has the leading or lagging indicator to your market?

This is John. From our perspective, we look at that. We try to look at a variety of pieces, and that's one of them to understand, A, do we have enough space that's going to be available? Which is via optimal measuring construction, because we've got such strong job growth; we've enough space for the people. And then B, is that space being leased up? In other words, companies are making decisions—real capital decisions preparing for growth in hiring people—and so that's why we bring that up and somewhat is a leading indicator, confirmation of our jobs numbers.

And then on Page S-8, you had an increase sequentially in both turnover and financial occupancy and I'm wondering how we should read that?

Turnover, yes, I look at it from a yearly perspective. So, if you look at year-to-date, our turnover for the portfolio is about 55%, that's up about 1% from last year year-to-date, and it's pretty consistent there.

But are you leasing second year faster or turning over units quicker?

We are, and it's kind of about to the change of strategy where the software would typically hold units vacant at above market rent, trying to find the peak of the market so to speak. And so, we're making that modification and a few others; we’ve reduced our vacant days down.

Thanks. And still good morning. So, it’s unlike if we use a word analogy you were a mood ring; did you wear that in the last year it would be kind of nice shade of blue, and it’s now kind of brownish. I don’t know if you wear a mood ring, but that would probably be the right analogy. And you’re talking about the soft landing scenario in 2017. But so often our expectations of whatever happens to the future, it’s hard to identify until they actually happen. So, the point is, I know you’ve mentioned behaviors of municipalities and behaviors of lenders to kind of cut off the supply chain to some degree. But is that all that’s kind of pinging on what could either pivot from being a soft landing to something materially worse than that because if you were to kind of just plot how your view has changed over the past year, it would suggest that it could be something worse than that soft landing in 2017?

Well, Rich, only you could phrase a question like that. I appreciate it. I guess I would say I’m not sure what color this should translate into is, I would say we are cautiously optimistic.

Well, green is jealous.

Okay. Well, you need to send me that wheel, the motion wheel. But I think we are cautiously optimistic. We think it feels timing to be late cycle and that is one element of caution. The weaker GDP report looks great, but the jobs are decelerating. So we see a lot of inconsistencies out there in the marketplace, and that causes a great deal of concern. We feel pretty good about the supply projections; there has been a lot of time spent on them. If we miss that, it’s our bad. The broader issue I think is what goes on in the economy. We’re always concerned about that. Especially over the last several years, where we just every time it seems like we’re getting a little bit of momentum something comes out of the woodwork to knock it down. So, I guess cautious optimism is what I would get; as it relates back to supply, just look back. If you get, what there's been, 7% to 12% rent growth in Northern California for four years, guess what’s going to happen? Every piece of land it's available to put some apartments is going to be built. And that is predictable. The current pipeline deliveries is really a function of the extraordinary rent growth we had over the last several years. Normally, half of those sites, or some portion of those sites, would not have been buildable, and this is what always seems to happen: they get delivered in a different economic environment and soften conditions further. This is what causes greater volatility in Northern California and Seattle again, with better long-term growth rates over time. So I think it's just a various function of what's happened in relation to history. Again, huge rent growth making every deal work and then having all of that hit the development pipeline at the same time and then delivered at the same time. Again, as you’re looking at development deals today versus looking at it two or three years ago, it is a completely different world out there; you don’t have the expectation of rent growth that you had a couple of years ago. You don’t have this financing infrastructure from the banks and specialty that have become much more conservative, and you got a backlog in the cities and a variety of other constraints. So we feel very comfortable that we are not materially up as it relates to with the current conditions and what's going to be built that comes out of this for those reasons. So again from my perspective, it's all about the economy.

And as you guys, you mentioned the development is leasing up and the aggressive pace or at the pace that they had to do there. How do you guys anticipate things going when most of these lease-ups turn within a year of the development? Do you have any idea what impact that will have on the market or are you trying to position yourself for that in any way?

Conor, it's a great question. I will just start trying to figure out how to put that into my call comments because I think it remains to be seen. It's an enormous question. Developers, there's a limit on which they can offer concessions, and that limit in effect, what it does is it pressures the first renewal to a huge extent. If you're in essence; it becomes a situation that fills up their buildings quickly sometimes with the wrong tenants, and so when their first lease renewal comes, you end up with either another concession or people that have to leave in fairly large numbers. So, I'm not sure exactly how that's going to play out, and I think that has been a big problem with a lot of people that are moving into San Francisco, for example, or San Jose because they can now afford it. Even though they are relying on that 16% concession to make those numbers work, I think you're going to see a change because each of those newly developed apartment communities go from being a leased-up with their very unique financial equations to being stabilized owners. And when they do, I think there are going to be a lot of people who are going to be shocked within their resident pool. In our experience, one month is no problem; two months becomes a problem as it relates to your tenant base that cannot generally pay market rent, and they end up with a problem on the renewal. You start getting above two months, you end up with a real problem. I think we're starting to see that, as John noted in his comments. There are some two-plus-month concessions out there when we add free parking and a variety of other things, and I think that's going to make for a very ugly first renewal on those buildings.

And the impact that'll have on your pricing power; or is that sounds like negative for owners who've stabilized that?

No, no, I don't think so. I think you go back into normal supply and demand. People that can't afford it have to move into more affordable housing, which means longer commutes for them and/or double ups. And so I think it's a good thing for us because again they become stabilized owners—they're right now disconnected from the stabilized ownership. We've got two different constituencies with dramatically different financial objectives. So as soon as they become stabilized owners, they are interested in generating the most rent they can. They're going to have a messy situation in dealing with the people that they let in. They can't afford to pay market rent, and you're just going to see another transition within the renter pool. I think it's all better because net-net, the places that are properties of best locations and the best properties will go back to having the pricing power that they normally have, whereas the secondary or tertiary areas are going to have people moving to them that will probably underperform, and the better areas will recover these 16% rent discounts or some portion of that. So it's good for the area.

And then with the diminished outlook on rent growth in the Bay Area, 2017 does that change your ability to do revenue-enhancing CapEx in the region or the economics there?

I'm afraid it does; because again if they can offer on your A product a 16% discount, you're going to compress As and Bs and the—we have premium somewhere between the difference between the A rent and the B rent. So your premiums that you're going to achieve on your rehab properties will likely change a little bit, and then be lower. And so from our perspective, I would expect the volume of turns in our rehab program to moderate or decline, and as we become more selective and find the market that can get the premiums that we need in order to make the numbers work for us.

Hi. Quick question on your expense growth side given the market forecast for deceleration next year; is there anything you might change next year relative to this year in terms of running expenses that you’re doing specifically there?

Yes. This is John. A couple of comments there; if the market gets slower, there is commonly and there has been a little bit more on marketing and that could be cutting back on necessarily work in that spend. But, we are pretty focused on procurement and pricing and really refining some of our pricing and taking advantage of our larger scale here. So, that’s working for us at this point in time. And I think that two will work together to end up that at a reasonable spot. Normally, when the market slows down, there's been a little bit more in marketing and that tends to drive expenses up a little bit. And the other thing just to note, in California we have the minimum wage growth, so that is affecting lower wage positions like turnover, landscape, and security; those effective rates are going up at about a 7.5% rate a year. It's not the same each year, but effectively that’s what's happening for several years, so that is putting upward pressure on those areas, and we’re working to offset that in various ways.

Okay. That’s helpful. And secondly, Alameda County had posted—it wasn’t the worst, but had a decent amount of sequential revenue growth deceleration. Is that a product of Alameda County just having the most robust growth last year? Or is that an indication that the new supply in downtown San Francisco, San Jose is applying pressure but not to draw from lower price points further out in the suburbs?

Yes, it's more of the latter. It's benefitted from people moving out there for affordability, and now you can see the reverse of that as people search them back as there is not as much rent pressure in San Francisco and San Jose.

Hi. Thanks for taking my question. I just have one quick one. And I’m sorry if you answered this previously, but in your developments at 500 Folsom, I believe costs went up about 35 million on the underlying assumptions changed. Do you know what drove that cost increase?

I do. This is Mike Schall again. The same things that we’ve been talking about as it relates to the broader issues in development—it was driven by delays, number one, in terms of getting through the city process and construction costs growing at double-digit rates which outstrip our expectations for that property. Again, back to these conditions that are leading to lower supply; obviously, we’re not immune from those conditions, and that 500 Folsom deal is a good example of that.

And is the same thing kind of happening with the Galloway Hacienda in Pleasanton? I mean, is that part of the same issues there?

No, it really isn’t because that was started a couple of years ago, so again 500 Folsom, we just signed the contract with the general contractor. Finish up the city requirements. We hope to have done that several months ago. And again, the delays and movement of cost increases are really the reasons for that cost bust. Hacienda was fortunately done before that. Again, this is one of the reasons why we are trying to decelerate the development pipeline. The bottom of the cycle, we end up with really good crews because there's not that much going on. Cities are helpful, trying to push deals through. At the top of the cycle, it’s sort of the opposite. The cities are trying to increase fees, increase supportability requirements; have greater say in the product that’s been built. They are less motivated actually to get the construction workers back working because the construction workers are really busy. And so, this is why we tail back the development at the top of the cycle.

Hi, guys. It's Austin Wurschmidt here. Mike, you mentioned earlier in the call that the concentration of supply is contributing to the heavy concessions by developers, and I was just wondering if that concentration spreads further out. And if so, could we see that concessions start to abate before our overall supply actually abates?

That's a good question; we do have some increase in Oakland, for example, in terms of development, but again, off a very small base. We don’t see that as a major issue. I think it has more to do with California's Global Warming Solutions Act of 2006, where California is trying to create a residential model that is going vertical as opposed to horizontal and trying to eliminate urban sprawl. The way to do that is to have high-density projects on all the major transit hubs. So, later we're seeing greater concentrations of apartment buildings and actually condos and other housing in an effort to become more efficient from an environmental perspective. And I don’t think that that changes, so I think that again, in the Bay Area we need to go through a map which is the upgrade of our public transit system. But I think you're going to see more and more residential construction just along the main transit line in that urban core. I do not think that's going to change anytime in the next several years. And I think if that access a further supply constraint is a more recent phenomena.

Thanks for that. And then just lastly on the investment side, you mentioned last quarter you were previously working on some acquisitions. Did those just get pushed further out or does anything change with the deals you were previously looking at?

No, we do have some acquisitions that remain in the process. We're trying to execute on a 1031 exchange which has caused us to push out some of the closing dates. Again, we'll be more active in the fourth quarter, so you'll start seeing a few deals closed, again funded with disposition proceeds.

Thank you. While in closing, we appreciate your participation on the call and look forward to continuing the conversation with many of you at the NAREIT Conference in a couple of weeks. So have a great weekend. Take care. Thank you.