Essex Property Trust Inc (ESS) — Q4 2016 Earnings Call Transcript

Thank you for joining us today, and welcome to our fourth quarter earnings conference call. John Burkart, Angela Kleiman, and John Eudy are here for Q&A. This morning, I will comment on Q4 results, market conditions, and investment activities. 2016 was another successful year for Essex even though the operating environment became more challenging with each passing quarter. Apartment supply deliveries with large lease concessions intensified the normal seasonal slowdown in apartment demand that occurs every fourth quarter. These factors underlie our Q4 same property NOI results, which hit the midpoint of the guidance range and a $0.01 per share beat to core FFO. I believe that our operations team did a good job of managing the portfolio given these conditions and we greatly appreciate their effort. We have noticed that consensus estimates for our 2017 FFO have risen in the past six weeks, attributable to an expectation that the U.S. economy will strengthen, improving the outlook for apartments. Clearly, we agree that a better economy will produce more housing demand, although the timing of that improvement is debatable. As anticipated and discussed on last quarter's earnings call, we experienced a challenging fourth quarter and a slow start to 2017. In the near-term, we continue to experience deliveries of apartment supply with large concessions, particularly in Northern California. Loss-to-lease, which is defined as market rents minus scheduled rents, was negative as of year-end and should rebound as we approach our peak leasing season. Therefore, any positive impact from an improved economy is not apparent at this point and will likely not materially impact our outlook for 2017. Generally speaking, our 2016 expectations for the U.S. economy were too optimistic both in terms of GDP and job growth. With respect to job growth, the most disappointing result last year was Los Angeles, which we expected to outperform the nation much like it did in 2015. Unfortunately, LA's Q4 2016 quarter-over-quarter job growth was only 1.5% versus our 2.2% year-ago estimate. Measured against its historical relationship to the U.S., job growth in the tech markets over the past several years has gone from extraordinary to good. Although the U.S. underperformed our outlook in 2016, the San Francisco Bay Area produced 2.8% job growth, nearly matching our year-ago estimate, and Seattle outperformed with 3.7% job growth. We have continued to overweight the tech markets from an investment standpoint, largely because it is one of the very few industries with above-average growth prospects. In a slow growth economy, which we expect for the next several years, we believe that tech continues to be the best alternative. Thus, we view this economic cycle differently as we have not increased our Southern California portfolio allocation like we did during the later and in prior economic cycles. On last quarter's call, we discussed our 2017 market forecast and F-16 is materially the same with the exception of lower market rent growth in Los Angeles due to lower job growth as previously noted, which resulted in LA's 2017 market rent growth forecast being reduced from 4.2% to 3.7%. We still believe in our overall thesis regarding Northern California that rents will improve as apartment supply deliveries decline, and with reduced supply, the large concessions should also decline, providing stabilized owners greater pricing power. While affordability will remain a key issue in Northern California, estimated median household incomes improved in the three Bay Area metros by between 5% and 7% in 2016, leading to an overall improvement in affordability. We expect wage pressures for tech workers and minimum wage increases to push incomes higher. As noted last quarter, we have confirmed our supply definition to Axiometrics. Although there are differences from Axio due to project completion timing, in general, apartment supply is expected to increase about 11% in Southern California, and most of that increase is attributable to a 65% increase in Orange County. The Bay Area should see apartment supply decline about 9%, and we estimate that 64% of the total 2017 supply in Northern California will be delivered in Q1 and Q2. The greatest reduction in apartment supply in the Bay Area will be in San Jose with a 28% drop. This leads us to believe that pricing power in the Bay Area will improve in the second half of 2017. Venture capital investment remains healthy, although each of the recent six quarters saw less VC investment compared to its peak of $8.5 billion in the second quarter of 2015. We share concerns about a potential slowdown in the technology industries. We still see tech as the world's leading economic engine and believe that leading tech hubs in the U.S., including the Bay Area and Seattle, will be the primary beneficiaries. The least part of the slowdown in job growth appears to be finding workers who have the skills and backgrounds needed by the top tech companies. We track the number of job openings at the top 10 tech companies, all of which are located in our target markets, which indicates approximately 21,000 open positions compared to 17,000 last summer. We anxiously await news on immigration policy, especially regarding H-1B visas. An example of tech potential is the Internet of Things (IoT). It has taken about five decades to bring microprocessors to their current state, and its usefulness is about to expand dramatically. Coupling microprocessors with sensors and actuators while connecting to the internet creates a different kind of machine, one that can accomplish a wide variety of tasks in almost every industry and household. The estimates of its growth are extraordinary; for example, a report from PricewaterhouseCoopers suggests a massive increase in devices connected to the internet from 14 billion in 2014 to 50 billion by 2020. IoT products that relate to housing have hit the market and are mostly focused on single-family homes at this point, involving devices that can remotely control a variety of systems including locks, alarms, blinds, and garage doors. It is not difficult to imagine a refrigerator that reorders essential food items or a device that reports a malfunction or leak. With reductions in cost and integration of common items into comprehensive systems, we will start to see IoT devices in apartments. They should allow us to utilize our resources productively by understanding traffic patterns, improving property security, while reducing costs, and becoming more efficient and knowledgeable in our use of utilities. We expect our tech markets to be at the forefront of this activity and are well-positioned for the related economic growth. Our next topic is investments. We noted on our Q3 earnings call that we expect to be more active in the transaction market in the fourth quarter. This relates to increased disposition activity, necessary given that we did not issue common stock in 2016 and we won’t in 2017 unless our cost of capital significantly improves. Recent dispositions are outlined in the press release, and Angela will discuss them further in a moment. As for acquisitions, we bought two communities in Valley Village, a submarket of Los Angeles, for $185 million. The San Fernando Valley continues to perform well, and this area has minimal apartment supply expected for the next several years. We also converted our preferred equity interest in the recently built 166-unit Marquis Apartment in San Jose into a common equity interest. Being a good partner allows us to be part of the discussion when construction ends, which in this case provided an opportunity to acquire half of the property. Cap rates remained stable last quarter with A quality properties and locations yielding around four to four and a quarter percent using the Essex methodology, and from time to time, more aggressive buyers are paying sub-four cap rates. B quality properties and locations typically have cap rates from 25 to 50 basis points higher than A quality properties. With most of the REITs on the sidelines, there are fewer motivated apartment investors in the market compared to a year ago. Recent increases in interest rates have caused some noise in negotiations, but ultimately cap rates have not changed. As noted before, we continue to be active in our preferred equity and subordinated debt program, which aggregates around $250 million in outstanding including the two new investments closed during the quarter. As noted last quarter, we continue to see headwinds to new development deals and believe that the trend for apartment supply is downward in 2018. That concludes my comments. Thank you for joining the call. I'll turn the call over to John Burkart.

Thank you, Mike. The Essex team had another solid quarter, delivering total same-store revenue growth of 5.8%, and NOI growth of 7.1% relative to the comparable quarter. Our performance was, in part, related to our strategic decision to save our occupancy. The team did a great job executing our strategy and increasing occupancy by 70 basis points relative to the comparable quarter. In 2017, to maximize revenue, we will favor occupancy yet take advantage of market strength as the opportunity presents itself, typically in the summer. I'll now comment on the each of the major markets from the North to the South. The economy in the Seattle MSA continues to grow at a rate well above the national average, fueled by both the major well-known technology employers as well as the developing technology ecosystem that is nurturing numerous startups and smaller technology firms similar to the ecosystem in Silicon Valley. There are over 30 technology-focused co-working office spaces and about 20 accelerators and incubators. The top nine angel networks and 15 venture capital firms have made over 1,200 investments in the Puget Sound area. Employment grew at a rate of 3.7% for the fourth quarter of 2016 over the prior year's quarter, adding 59,300 jobs. Office absorption was 2.6% with 5.9 million square feet under construction, 46% of which is pre-leased. Numerous leases were signed in the quarter by companies such as Facebook, Amazon, Pokemon, Snap, Big Fish, and Big Titan, with activity focused in the South Lake Union and Bellevue Market. Each of the market performs well with respect to the fourth quarter revenue growth, with the CBD submarket achieving 6.6% and the East, North, and South submarkets achieving between 8% to 10% revenue growth relative to the comparable quarter. Moving on to the Bay Area, where the economy continues to grow with employment growth of approximately 2.8% for the three Bay Area MSAs—San Francisco, Oakland, and San Jose for the fourth quarter of 2016 over the prior year's quarter—substantially outperforming the nation's employment growth of 1.5% for the same period. During 2016, the Bay Area office market absorbed 4.4 million square feet or 1.9% of total office space. Currently there is 15.3 million square feet under construction, 43% of which is pre-leased. As Mike mentioned, in 2016 median household income grew in the three Bay Area MSAs while market rent declined approximately 1.8% in December relative to the prior year's period, improving affordability. The decline in market rents has created a gains release in our Bay Area portfolio; therefore, although we're expecting market rent to increase 2.5% in the Bay Area in 2017, the impact on Northern California gross revenues will be muted and are expected to be less than the market rent increase. In 2016, our Bay Area revenue substantially outperformed the market due to loss-to-lease. In 2017, the conditions are reversed, and we expect the growth loss-to-lease, setting the portfolio up for a better 2018. The impact of the lease-up is now reflected in the market rent. The supply deliveries are expected to be greater in the first half of the year, subject to weather delays, with some of the pressure abating in the second half of the year. The likely impact will be a reduction in concessions for the product impacted by the new supply, ultimately positioning the market for a stronger 2018. During the quarter, we started lease-ups at Century Towers, a 376-unit high-rise in downtown San Jose, which is currently 13% leased. Galloway at Owens continued to lease up during the slower demand period and is currently at 87% leased with concessions of six weeks on selected units, which is consistent with the new lease-ups in the local market. Finally, as planned, we are pre-leasing Galloway at Hacienda, a 251-unit podium building adjacent to Galloway at Owens. Moving down to Southern California, each of the markets performed well this last quarter. Despite LA’s slower job growth, the MSA achieved 5.5% revenue growth in the fourth quarter relative to the comparable quarter. It is noteworthy that West LA achieved 4.6% revenue growth in the fourth quarter, below the average, while our CBD assets achieved 6.1%, above the average. The best growth during the quarter was in the Tri-City submarket where we achieved 8.3% revenue growth, all relative to the comparable quarter. The technology footprint continues to grow in Santa Monica, Hollywood, Century City, and other West LA locations. WeWork, Fandango, Snap, and Netflix all added space during the quarter. Additionally, City National Bank, which is headquartered in downtown LA, signed a lease for 300,000 square feet of space on Bunker Hill as part of an expansion plan in downtown LA. George Lucas has chosen Exposition Park to be the future home of his $1 billion Museum of Narrative Art, with the groundbreaking expected before year's end. In Orange County, the market continues to be a solid Southern California performer with year-over-year job growth for the fourth quarter of 2.3%. The North Orange submarket outperformed the South Orange submarket, achieving 6.4% revenue growth compared to 4.1% revenue growth. In 2017, there will be a significant increase in supply being delivered in the Orange County market, with the greatest concentration of almost 2,000 units being delivered into the Irvine market, where we have limited exposure. Finally, in San Diego, the performance across the submarkets was fairly consistent, leading to a 6.3% revenue growth relative to the comparable quarter. In 2017, the supply increased significantly, with approximately 1,700 units being delivered into the San Diego CBD, which will clearly impact the CBD market as those units are absorbed into the marketplace. Currently, our portfolio is at about 96.6% occupancy and our availability 30 days out is at 4.8%. Our renewals are being sent out at about 4% for the portfolio overall, which breaks down to 2.4% for Northern California and 5% for Southern California and the Pacific Northwest. Thank you, and I will now turn the call over to Angela Kleiman.

Thanks, John. I’ll start with a brief review of 2016 results then focus on 2017 guidance, capital markets activities, and the balance sheet. 2016 was another good year for Essex. We generated same property revenue and NOI growth of 6.7% and 8.1% respectively. In addition, we achieved core FFO per share of $12.4 for the full year, which exceeded the midpoint of our original guidance by $0.12 per share. Turning to 2017, our same property revenue growth of 3.0% at the midpoint reflects our view that rent growth in our market will moderate to the long-term average following five years of exceptional growth. We also expect same-store revenue growth to be lower than the market rent growth published in 2016 as current in-place rents are slightly above the market. Our operating growth forecast is 3%, resulting in NOI growth of 3.4% at the midpoint. As for the FFO guidance, we continue our track record of driving operating results to the bottom line and are projecting core FFO growth of 5.8% at the midpoint, which is 240 basis points higher than our projected NOI growth rate. A complete list of assumptions supporting our FFO guidance range can be found on slides 16 and 14 of the supplemental. Moving to capital and funding activities. In 2016, we funded our investment activities with disposition proceeds and joint venture capital in lieu of issuing common stock. We expect to maintain this funding plan in 2017 if common stock pricing remains unattractive. We are cognizant of changing market conditions and focused on allocating capital appropriately. For example, in the fourth quarter, we completed the $185 million acquisition in Valley Village by contributing four wholly owned properties into a newly formed joint venture where we have retained majority ownership. This is what we've been referring to as a disposition joint venture. In general, the disposition joint venture provides for an alternative source of capital to help fund our investment activity instead of issuing common stock. Key considerations to transact via a disposition joint venture are to divest from properties with lower total return expectation relative to the portfolio, minimize dilution, and rationalize sales cost via management fees and other economic benefits. Leverage is not a key driver to transact in an off-balance sheet vehicle. In fact, our joint venture platform leverage is only about 28%. Lastly, our private equity platform has done well, currently with a total estimated promote ranging from $30 million to $50 million. We will look to optimize our returns as we evaluate opportunities to monetize this value creation. Lastly, onto the balance sheet. During the fourth quarter, we expanded the existing $225 million term loan and originated a new $350 million term loan, which matures in 2020 and is priced at LIBOR plus 95 basis points. We have swapped $150 million of this term loan to a fixed rate of 2.2%. Major debt maturities in 2017 primarily consist of a $300 million unsecured bond maturing in mid-March. Our current preference is to finance this debt with five to 10-year unsecured bonds depending on the treasury rate and underlying spread, but we will be opportunistic as we have several options to refinance this debt. With a low level of unfunded commitments for 2017 of $215 million, which represents only 1% of total market cap, our $1 billion line of credit, expandable to 2020, and a light maturity schedule over the next couple of years, we continue to be well positioned to weather any potential capital market dislocation. That concludes my remarks. I will now turn the call back to the operator for questions.

Hi, it's Jordan here. I was wondering if you could share more details about your Southern California outlook of 3.5% to 4%. How does that break down across the different submarkets? You mentioned that Orange County will have significant supply this year, so any additional insights on the various submarkets would be appreciated.

Sure, this is John. The submarkets that we're seeing going forward are Irvine and downtown San Diego, which are going to get hit with significantly more supply than they had this year. So those areas will likely be weaker. As we look at the job side, the LA market slowed down quite a bit in employment overall, but yet supply is kind of in the zone. The big hits on supply will be in the Irvine area, where we don't have too many assets that will be impacted by that, and then downtown San Diego. Does this give a little more clarity on what you need, or are you looking for more?

No, no that's helpful. And then just Northern California, I was curious. It sounds like it's going to be a little bit volatile at the beginning of the year with the deliveries more heavily weighted. How do you expect sort of the quarter-by-quarter trends to spread throughout the year across Northern California? I mean do you expect it to snap back in the second half of the year once concessions begin to abate, or more just stabilize?

Yeah, I would call it more stabilization. But one of the good things last year, I used the word 'choppy' in terms of the market, and it seems we're using it now. A lot of the impact of the lease-ups is reflected in market rent. Last year was a transition year, so things were somewhat volatile. I think going forward it will be softer in the first half as we continue to absorb the supply. As we get into the second half, I think ultimately some of the concessions will evaporate. It won't be a pure snap back, but if you think about it, a property giving two months of concession, if that goes away as they finish lease-up, that’s effectively a 15% rate increase. Ultimately, as we move through the year, I think the market will improve a few percent. Some of the new lease-ups will inevitably reduce the concessions, and we will see better rental strength, but that doesn't necessarily mean pushing rents up, per se, coupon rents. As we roll into 2018, we should be in a solid position for a good year.

Great. Thanks for taking the questions.

Hi, good morning. I was still just wondering if you can give a little bit of color on, you talked a little bit about loss-to-lease, kind of what you are expecting on new leases, maybe across three regions and the spread to renewals you are forecasting. It sounds like you are saying Northern California new lease growth could be negative, but if you could just give us a little on that that would be fantastic.

This is Mike, thanking you for joining the call. Our January to March renewals are going out at around 4%, and within that, Seattle and Southern California are in the 5% range, and Northern California is in the 2.5% range. So that should give you some idea. To follow up on what John just said, we expect the supply hangover, as John called it, to clear over the next six months. From that point on, the market should recover. The issue we have is that for market rents to recover, it takes time before it really impacts the bottom line. I think this year is one where the first couple of quarters will be quite challenging, especially in Northern California, but in several others Southern California submarkets as well. As we enter the second half of the year, we're feeling much better about regaining pricing power. There's a unique dynamic where the 1% leasing apartments are effectively setting prices for the 99% stable owners. So when that clears the market, we think it will create a much different environment. Unfortunately, we'll likely be at that point around July or August, and there simply aren't enough months left to report the rent changes.

Okay, great. And for concessions, how are you guys viewing that? I guess in Northern California specifically, is the level going to be pretty similar year-over-year in 2017? Any color there in terms of how 2017 positions itself, just because supply is still elevated on a year-over-year basis and how you guys have approached that?

This is Mike again. It varies dramatically by market. Right now, for example, in Sunnyvale, which is just north of San Jose, there are eight lease-ups in the marketplace. And therefore, as you would expect because they're all trying to get 25 to 30 units a month, it's not surprising that there are six to eight weeks of concessions in the marketplace. That isn't true for all of Northern California; that's specific to that submarket. It's derived from the number of lease-ups competing against one another. Fortunately, I believe the trend for concessions is getting better, though slowly. In the fourth quarter, you had two phenomena affecting prices: the normal seasonality where demand drops off in the fourth quarter and the continuation of delivery and supply in the market. Those two combined are what caused a weak Q4 relative to other Q4s. I think Sunnyvale is the key example there, with many lease-ups in the marketplace. The Salta market is probably near that range of six lease-ups, one to two months free. Some other submarkets in Northern California continue to improve. With demand resuming as we approach our peak leasing season, I believe the level of concessions will start to decrease as new deliveries come online. By the time we reach summer, I believe we will be looking at a much better scenario regarding concessions and pricing power.

Thanks. A couple of questions on investment activity. I was wondering if you could provide more color on the expected development stuff in 2017 and how are the yield expectations for new starts compared to the last couple of years?

Well, Mr. Eudy is here, so I'll let him handle that one.

We have as many as three starts planned for this year, all of which are land yields that we negotiated two, three, or four years ago and titled prior to the current requirements being asked for on new deals being transacted with various cities. Relative to the amount of exposure compared to say two years ago, our peak will be stabilized out at about a third of where we were at at the peak, if I heard your question right.

That's helpful. And then as a follow-up, you talked about disposition JV as a form of expected funding in 2017. So I was wondering if the $400 million to $700 million guidance you have for dispositions includes assets currently going into JV, or is that only for wholly owned dispositions?

The guidance is a net number, so it includes dispositions. Is that what you are asking?

Yes, sorry I didn’t clarify. It includes both dispositions as well as the assets that you will contribute to a JV.

Right. So, it’s $400 million to $600 million in our guidance range of acquisitions.

Yes, $400 million to $700 million in dispositions. Dispositions likely will include some disposition JV activity, but it will also include the continuation of calling the portfolio. So there are a couple of different disposition strategies. One of them is calling the portfolio, which entails selling properties that don’t perform up to our expectations and we anticipate underperformance will continue. We will sell those assets outright. There are properties that have decent growth rates and decent operations, which will become disposition JV possibilities. One of the benefits of a disposition JV is that we can, through management fees and promotes and some savings opportunities, achieve a higher yield. But we will only do that obviously for properties that we want to own for the long term. Occasionally, there is an opportunity to sell an asset and reinvest at a higher total return expectation. We will pursue all three disposition strategies and it’s difficult to tell you right now how much will fall into each bucket.

Hey everyone. I guess first off, I know you guys mentioned preferred equity investments that you originated a couple or converted in Q4. As you look out to 2017, especially given the development market right now, how do you view the size of that market and how will it trend through 2017? Is there a fairly significant opportunity there or is it just kind of one-off opportunities?

Hi Tom, it's Mike. I would say that it is a market where we see a fair amount of opportunity. We have a goal of around $100 million, most of that related to apartment development transactions. These are properties in our core market that we would otherwise like to own, but they don't generally hit the yield thresholds we would be willing to invest in as a common equity owner. We see $100 million as being an achievable goal, but there are many transactions that, candidly, fall below the yield thresholds required, making it difficult. As time goes on, we’re seeing more and more transactions where the going-in cap rates are so low that we can't layer in a preferred equity piece with a 10% to 12% coupon and make the numbers work. So, I would say that we have a decent pipeline with a good reputation in the marketplace, but I don’t think we would be able to, for example, double the $100 million goal. I think we will get four or five deals done, and it will be around $100 million, and that's probably what is likely to happen this year.

That's very helpful. And then I guess bigger picture, how are you guys expecting, I don’t know if you guys have done any studies on how immigration policy might impact your major markets over the next four years. Do you have some sense of the number of H-1B visa residents in your portfolio?

We have a substantial number of H-1B residents in our portfolio. The statistics highlight that issue similar to discussing the job openings within these large tech companies. The H-1B program allows for 85,000 visas granted annually, I think that happens on April 1st. There are somewhere between 500,000 to 600,000 people in the U.S. on H-1B visas. I don't know where they are located because that information is not disclosed. But it's an important factor and I don't think we know what will happen with respect to policy coming out of the new administration on this and many other issues. Thus, I really can't go there on predictions. From our perspective, we are advocates for allowing the best and brightest of the world into the U.S., and I think that’s crucial.

All right. Thanks. I appreciate the color.

Thanks. Just want to clarify your expectations for the same-store revenue growth in 2017. Do you expect consumer deceleration on a quarterly year-over-year basis throughout the year, or does it assume a stabilization in the back half?

We are assuming a stabilization in the second half as the supply pressure abates a little more and also we work through the concessions that both Mike and John commented on earlier.

Okay. So, I know it's a little early for 2018, but would it be fair to state that based on your comments about economic growth and what supply that you might see a re-acceleration into 2018?

This is Mike, Nick. You know how we are, we are typically more conservative. But I certainly think that 2018 is shaping up to be a very good year. The challenge we have this year is that we begin with relatively high loss-to-lease in Northern California; scheduled rents are above market rents by 1.9%, and overall in the portfolio by 25%. Given our expectations regarding job growth in our markets, we are effectively building a loss-to-lease scenario in our portfolio. Market rent growth needs to occur for this to change; if it were to happen now, we would still be faced with the loss-to-lease as we're rebuilding. Thus, we think of 2017 as a rebuilding year for our portfolio, and as we shift to summer, we expect things to look much better, though this may not substantially impact our results for 2017. However, it should bode well for 2018, and we look forward to it.

Thanks. I appreciate that. And finally, what was the gain on the sale of marketable securities in the quarter?

From time to time, we have marketable securities that we sell, and that’s all that is.

We have a captive insurance entity that has generated a lot of cash, and so we have reinvested that cash, leading to these securities sales.

Thanks.

Thank you. Mike, I appreciate your comments and your color on immigration reform concerns. I know it’s very difficult to answer these kind of questions, but I was wondering if the 21,000 job openings by major tech companies are a recent high or one of the highest figures you can remember. And also, is your concern at all embedded in your rental projection for Northern California in addition to that gain?

Yes, I believe the 21,000 is the biggest number we’ve tracked since we—since we began. Again, it is up from 17,000 last summer. This indicates a surge, as we know the unemployment rate for college-educated people is under 3%, 2.5% to 3%. Thus, we clearly find a shortage of skilled workers, which is causing some issues in the tech sector, as demand for those workers is high. For instance, we saw Apple open a campus in Austin. However, we view that less favorably than keeping those jobs here, as tech companies may build facilities where the right types of workers are located. Thus, this could be in the U.S., but we fear it may potentially be outside the U.S. This matter is crucial, and we follow it closely. To answer your question, yes, it's embedded in the Northern California actual job growth figures. As you know, we strive to create forecasts based on historical job growth relationships. LA tracking close to U.S. growth is one example. We also pushed it higher in 2016; we believed the job growth would rebound, but we were wrong.

Okay, great. And if I could ask just a quick balance sheet question, what is the net debt-to-EBITDA including joint venture debt? And also, where do you think you could price 10-year unsecured notes?

The net debt-to-EBITDA including joint venture won't differ significantly, as our joint venture leverage is only around 28%, so it's very similar to the parent entity. With respect to where rates would be, if we issued today, a 10-year unsecured bond would be in the high 3s to low 4% range.

Good afternoon. Mike, why sell 50% of the four older assets into a disposition JV? Why not sell 90% or something like that if you’re really a disposition JV?

Yes, there are some pretty good reasons for that, actually. But the main ones are we're focused on continued income generation; we generate fees; we have a promoted interest. And as we’ve seen, promoted interests can be quite substantial over time. Additionally, from a structuring standpoint, we would like to prevent a reassessment, generally speaking, under property taxes. Thus, there are some important reasons for structuring in this way.

Okay. So, the latter was really the driver. You sold another - you sold Downtown minority shares; will you revisit this?

We look at the whole equation.

Okay, all right. And then, given the comments before about starting three developments, I don’t know if any of that’s the next phases of Station Park Green or whatever. But it looks like, at least from your listing on development pipeline, you guys are starting to run short of land. How aggressive are you guys at this point in backfilling either through ownership or through options on future development parcels?

This is John Eudy. First off, you are correct that Station Park Green is one of the three deals we believe will commence this year. As far as being aggressive, yes, we're on the sidelines; we are looking at many opportunities; we are trying to be opportunistic. However, we are not going to undertake development deals with cap rates at the four to four and a quarter range just to do a deal. That's easier to talk about than execute. That said, we believe this is a year where we may have opportunities to strike opportunistically in a few occasions, but we aren't seeking them in retail.

Just a quick one again on investment activities. How are you guys thinking about redevelopment opportunities in your portfolio? And could your redevelopment pipeline grow from current levels?

Sure, this is John. We assess our entire portfolio every year in detail. We sit down and evaluate each asset and possible opportunities for returns, whether it be unit returns, adding laundry, backyard extensions, or complete renovations. At this point, I would say we're pretty much at a stabilized number. If you look at our unit turns compared to the total portfolio, we’re somewhere in the 5% to 6% range typically, which implies a 20-year life for kitchens and baths. For larger assets, we’re putting a few, two to three to four through major renovations at any one time. We’re at a sustainable level for continued operations. To accelerate from here, there are few things we're looking at, some opportunities relating to technology and others, but not a lot of acceleration regarding major assets or unit turns. We’re likely to slow unit turns down a bit in 2017 due to market conditions, but not huge.

I'll add one more thing to that—when you have new lease-ups offering concessions at the levels we’re experiencing, it compresses the rehab return. Thus, it becomes more difficult to make those projects economically viable. We’ve seen some pullback regarding unit turns that we’re able to execute, which is a drag until concessions start to decline in the marketplace.

I just wanted to return to the issue of the market’s forecast on rents you've provided for this year at 3.6% and your same-store revenue growth midpoint below that. I think you gave some reasons, but I wanted to understand more about why that is happening?

This is John. From a broader perspective, if you assess the economic rent forecast, you come to 3.6%. Right now, we have a gain-to-lease in our portfolio of about 0.5%. If you do the math, you end up just a little over 3%, and the difference reaching the midpoint of 3.25% relates to other value-add factors. In practical terms, the rents appear throughout the year at varying times related to lease expirations. Some of those leases are scheduled to expire at a gain-to-lease, so they are going down while at the same time, the market is moving up. Thus, it never abides perfectly, which causes a timing issue.

To reiterate what John said, using slightly different terms: if supply abates as we expect in Northern California post-second quarter, we anticipate market rents will appreciate. But again, that positive impact on same-store revenue won't materialize until well into the mid-2018 timeframe. Market rents can increase, but it will take time to see that reflected in the reported numbers that we use.

So it appears this is more of a timing issue in the first half of the year where you face pressure and then things improve in the second half. Is that the way to think about it?

I think that is part of it, as we have all this delivery of new supply coming into the market in the first half of Northern California, which is the main concessionary market. The second half will look much better than the first half. But more fundamentally, in terms of looking at loss to lease, I mentioned on the last quarter's call that, at September 30, 2015, we had about 7% loss to lease. By September 30, 2016, we had about 2% loss to lease. So, of the reported revenue over that period, 5% of the difference between 7% and 2% came from that loss to lease. When rents are increasing, you're effectively building loss to lease that is not reported as rental revenue. Conversely, if that trend flips and rents are declining, it starts to eat into your loss to lease, making your results appear better than they truly are. When you assess market rents, it’s clear that supply in the first half with concessions is a critical issue, and so the conditions are likely to fade post the summer.

I guess the question is whether—though I see it is helpful to receive all the market-level forecasts you guys mention. However, reflecting on the last couple of years, you’ve outperformed market forecasts on rent growth. Now, this year you seem to be falling short, and you started with market rent projections before undershooting a bit. Are you considering changing that messaging moving forward?

Had we to do it over again, yes, I believe we would alter the messaging. We strive to ensure the market isn't surprised by our actions. But candidly, Q4 was a tougher quarter than we anticipated, leading to lower results than initially expected. As seasonality coupled with significant concessions impacted market prices. Q4 ended up being a weak period, and unfortunately, we're likely going to miss expectations throughout the first half predominantly due to supply hits in the Northern California regions. Our guidance looks better in the second half as demand resumes and our concessions return to trending downward.

I'll still say good morning out there; I think we've got another few minutes. Mike, on the JV capital front, has there been any change from the JV partners regarding their appetite to invest in your market? If so, could you provide details on where they might be more interested or less interested in investing?

I'm going to let Angela handle that one because she's probably the point person in touch with most of the institutions on this.

Thanks, Mike. Hey, Alex. Regarding institutional investors in our markets, demand has been steadily increasing. The change is related to the type of products and the profile of expected returns. For instance, three to four years ago, there was a much stronger demand in development with corresponding higher return thresholds. More recently, there has been more focus on core, core-plus investments, resulting in decreasing IRR and return hurdles. However, net dollar interest in our properties remains high.

Okay. But Angela, are they still willing to invest in Northern California as much as Seattle and Southern California, or are they focused more on one specific geography versus the others?

They're glad to invest in all of those markets, given that they’re very long-term in terms of investment—as these funds last between 7 to 10 years. They're not focused on a one-year supply concern regarding Northern California. They truly believe in the technology trade as the growth engine, not just for the West Coast but for the U.S. economy as a whole. Additionally, the interest in transactions available in the West Coast remains strong, matching that of Northern California, Southern California, and Seattle.

Okay. And then just a second question. Again, when looking at Seattle, that market continues to impress, and you guys have similar growth as observed in Southern California. Despite all of the supply and things like union contracts, do you have any concerns about that market? Or do you view the recent decoupling between San Francisco and Seattle continuing for another year or two?

This is John, Alex. As you noted, we do respect the level of supply coming into the marketplace, though the market has performed excellently. There is significant job growth; however, the supply is certainly a factor to monitor, as we're noting some pressure coming from the east side in terms of supply. I can affirm that our east side portfolio performed very well in the fourth quarter in terms of revenue, as I previously mentioned. Simultaneously, there has been a notable slow-down in achieving economic rents. That's typical for the seasonal cycle, but was exacerbated more than normal. We will want to observe how the market behaves after Super Bowl Sunday when leasing tends to increase and see if that market upholds. I believe we can achieve our numbers, but the trend is softening a bit from where we’ve been.

Good afternoon. First of all, thanks for all the details on the call; that's really appreciated. I just wanted to focus on some of the acquisitions and disposition activity. I think the schedule on S-16 gives some basic pricing information. But I was hoping you could discuss in terms of cap rates, where some of these Q4 and Q1 transactions were done, especially the JV, and generally what kind of cap rates you are seeing in most of your major markets?

Yes, Tayo, it’s Mike. They are consistent with what was indicated in the prepared remarks. The JVs and non-core assets were in the 4.5 cap rate range, representing older assets. The Jefferson Hollywood deal closed at around the 4 cap rate. So, again, quite consistent with what we projected. I think in every case, we’ve met our internal NAV estimate for these assets. We haven't witnessed much movement in cap rates; certainly noise exists. We had two or three buyers on the Jefferson deal, but some dropped out. But, ultimately, as long as one buyer commits to a transaction, that suffices for completion. There remains significant interest in our West Coast apartment products.

Got you. Okay, that's helpful. Lastly, apart from the situation with immigration reform, everyone's bemused about it. I wanted to understand your perspectives on tax reform under the Trump administration. Could you discuss how you foresee any material impact regarding dividends or anything of that nature?

That's a fantastic question, Tayo. I'm uncertain how to precisely respond, as these proposals are quite dramatic. Are 1031 exchanges being abolished? Will we be able to write off all non-land purchase prices for buildings we buy? The ramifications concerning dividends are indeed important. Yet, it's too unclear for us to draw any conclusions from this currently. We have many other pressing issues to address right now. However, I acknowledge this could be significant; I suspect it won't be as extreme as it might seem in the discussions. Still, I am uncertain of how it will pan out.

Hello everyone. Looking at Seattle, do you think it could be the next San Francisco, or is there just enough job demand to absorb the supply?

Hey, Wes; it's Mike. That’s a thoughtful question. As you know, we've remained cautious regarding Seattle over the last couple of years, largely due to supply concerns. However, the upside for Seattle is that it’s much more affordable; its rents are lower while incomes remain high. I suspect this has redirected some job growth that would have otherwise been in Northern California to Seattle. Thus, what we are witnessing is the market reacting to affordability conditions, moving some of that job growth to Seattle. For us, it remains a market with excess supply, and it doesn’t seem worth doubling down on. It remains concerning that the industry, as it shifts to a broader economic cycle, hasn't entirely stabilized the market. You haven't observed any expansion of our portfolio in Seattle lately, which is precisely why.

And what’s the developer behavior been like? Are they still acting rationally at this point?

No, the developers maintain differing views from the stabilized owners. This composes our main issue. Though I'm not labeling the industry as irrational, the developer incentives conflict with those of fixed owners.

In the last year, if you assess the inventory that we hope will burn off quickly, we think it will continue reducing in the direction it is going through 2017. It’s a challenge to execute on development projects, as obtaining financing remains extremely tough, and lenders are offering only about 50% lending compared to 80% just three years ago.

Most of my questions were already answered, but I guess I just had two quick ones, regarding general development activity, and how have you seen the landscape change over the last six months? What do you expect from starts, and have you seen any projects actually get put on hold here?

Okay, Steve, thank you. Angela can address the second part. John Eudy and I talk every week about deals ongoing. I hear him communicate is that obtaining construction lending is becoming much tougher, while costs have slightly moderated but are still significantly high. Cities are becoming increasingly proactive on the approval front, leading to complications in the execution of projects. There are some deals that continue to be attractive, particularly those with lower land basis from a few years ago. These properties will likely close, while we observe opportunities in our preferred equity program. However, the increasing construction rates, city regulations, and land costs are presenting challenges.

As for the stock buyback program, as you may recall, we have a $250 million buyback program, and we did buy back a small amount of stock earlier in the quarter. However, it was immaterial, and we didn’t need to report it. When we sell an asset, we look to maximize returns essentially on how we sell it, including cap rates and the associated acquisition opportunities compared to the stock price at the time. It’s a relative decision, but we are willing to act if the opportunity arises that makes sense.

Thank you. Good afternoon. Could you please comment on the measures in Los Angeles? The one that passed in November, and the one that's coming up in March that would limit supply growth? What do you think the potential impact that could be, and then how that plays into your outlook for LA over the long term?

Yes, Conor, it's Mike. What was the proposition? Was it...?

Measure S and then I think JJJ was in November and S is in March.

Well, these proposals have appeared not just in LA but in variances across many states. In many instances, those proposals—though they authorize something—also layer on many additional requests leading to a slowdown in housing supply. California has built only about a third of the housing needed based on job growth. The political process is thus leading to added restrictions and further tasks on housing initiatives. Consequently, the expectation is a reduction in total built housing and ultimately could lead to increased rental prices. It's a conundrum that one would not expect, but this is the state of California.

And since Measure JJJ was passed in November, have you guys observed any changes in land pricing or developer activity within Los Angeles for unentitled land?

We haven't witnessed any yet, but we expect to.

Hey, guys. Thanks for taking my question. Two questions real quick. First, given the elevated supply environment in your markets, are there any markets in particular that you view as particularly opportunistic or that you think you have a better chance to acquire into to gain more exposure? Any thoughts would be helpful.

That is a great question. As rents have moderated here, our focus is continuing primarily on Northern California rather than Southern California. The job growth and relationship with supply changes in the marketplace make the potential for better suited acquisitions appear strong in Northern California. Prices have dropped significantly there, which aligns with the opportunities we see to invest more in acquisitions there.

Okay. And then, lastly, I think everybody is focusing on immigration and the visas and job openings, but given that job openings are no concern, people who take those jobs, just wondering if you have any sense, and I don’t know if you have any numbers, but for people in your residence who may be on H-1Bs, are they more from Asia or more from the Middle East? I suspect if it is more Asia, there’s really no risk regarding immigration, while it would be a bigger question mark if it came from one of the seven countries primarily on the list?

Yes, that's a pertinent inquiry. I haven’t seen a breakdown of exactly where the H-1Bs are sourced, and Anna, you raise an interesting point related to that. I know the volume is quite high, and I understand the 85,000 visas issued annually on April 1st—over the last few years, 500,000 to 600,000 have been on H-1B visas. But actual residency locations remain unclear. Though, I believe this factor is significant, and we may not precisely forecast its implications on our markets right now.

Thank you very much. In closing, I want to note that we appreciate your participation on the call. We look forward to seeing many of you at the Citi Conference in March. Have a great day. Thank you.