Essex Property Trust Inc (ESS) — Q1 2017 Earnings Call Transcript

Thank you for joining us today and welcome to our first quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments, and John Eudy is here for Q&A. This morning, I will comment on first quarter results, market conditions, regulatory matters, and investment activity. Our results for the first quarter were better than expected, as a recovery from a challenging fourth quarter occurred more quickly than we expected, contributing to core FFO growth that was $0.09 per share, above the midpoint of the guidance range. While our sequential revenue growth was modest at 40 basis points, market rents grew 3.1% from year-end to the end of the first quarter 2017. While this sounds great, it needs to be evaluated against the challenges we had in Q4 ‘16, where market rents dropped 2% from the end of Q3 to the end of the fourth quarter of 2016. Looking at market rent growth from September 2016 to March 2017, Northern California was the strongest part of our portfolio, followed by Seattle. The results for the quarter do not significantly change our expectations for the remainder of the year and are consistent with our thesis that rental growth rates will approximate long-term averages in the West Coast metro areas. Angela will discuss the projections in a moment. Our operations team did a good job of identifying opportunities to make incremental improvements in a variety of areas, saving money and generating additional income, which added a few cents to the core FFO even with wage pressures, weather-related challenges, and significant utility cost increases in California. I greatly appreciate the skill and effort of our operations team and thank them for their effort. An important part of our expectations is that tight labor markets in California will push incomes higher, providing some relief to affordability issues. For the Essex markets, 2017 personal incomes are expected to grow an average of 5%, led by San Francisco at 6.2% and compared to the US average of 3.9%. Further, over the past year, the ratio of rent to income declined in both San Francisco and San Jose, two areas most affected by the affordability issue. Median home prices are generally growing faster than rents, averaging 7.2% for California versus 5.2% for the nation over the past year, and four of the seven Essex markets outperformed California's median increase in home prices. My next topic is an update on regulatory matters. State and local governments in California have proposed legislation that potentially impacts apartment owners, which I'll briefly summarize. First, the State of California recently dropped a bill that would have repealed the Costa-Hawkins Rental Housing Act, which generally limits the scope of rent control ordinances enacted by cities. Even though rent growth in Northern California has decelerated, tenant rights groups that are well organized and well-funded continue to advocate for rent control and related issues in cities and at the state level, demonstrated recently by a new rent control ordinance in the Northern California City of Pacifica. As noted in previous calls, rent control has a variety of unintended consequences, which include prolonging and intensifying the shortage of housing by reducing turnover and thus availability of the purpose for those seeking rental housing. Bottom line, we expect rent control advocacy to continue in California, while industry organizations highlight the unintended consequences of rent control in an effort to defeat or soften any proposed legislation. A second bill in California would require apartment owners to use licensed inspectors to certify the structural integrity of balconies and decks more than six feet above ground level every five years. While the requirements for these inspections as outlined in the bill may still change, it would add operating cost pressures for apartment owners. At the federal level, we're watching two topics closely. The first is the impact of tax reform on REITs. Unfortunately, the path ahead is unknowable and therefore any comments would be speculative, given the lack of details and therefore, we will wait for greater clarity. Second, we're tracking the ongoing discussion about reforming the H1B Visa Program. This is an important issue for Essex because the top ten tech companies have close to 22,000 open positions in California and Washington, and these open positions have steadily increased in the past year. In addition, the national unemployment rate for college graduates hovers around 2.5%, which suggests a critical shortage of skilled labor, both generally and within the technology industries. Earlier this year, there was widespread concern that the new administration was going to dramatically change or eliminate the H1B program. More recently, the focus of the discussion has been to address specific issues and alleged abuses regarding the program. A recent executive order directs various agencies to recommend changes to the program. One discussed change would be to replace the existing lottery system with a process that prioritizes higher income jobs like those typically provided by tech companies. As for H1B extension applications, we have heard anecdotal stories about delays or shortened renewal periods, although we could not find data to support this. Bottom line, some of the proposals being discussed should help the high-tech sector and reduce the reliance on intermediaries that arrange H1B visas, and so we're optimistic about the changes being discussed. The next topic is investments. As noted in the press release, we've been active in the transaction markets, as we continue with a self-funding model that does not rely on stock issuance or increased indebtedness. These transactions support our view that multi-family cap rates have not changed significantly. We completed a second preferred equity conversion transaction in which we acquired a common ownership position in Sage apartments. We will continue to look for opportunities to convert preferred equity investments into common ownership positions, while also pursuing the buyout of co-investment entities with promoted interests. In our preferred equity program, which also includes a few subordinated loans, our outstanding investments declined about $10 million in the quarter, related to the conversion of the investment in Sage apartments and stood at nearly $240 million at March 31. Generally, we're seeing more demand for this capital, as banks continue with conservative lending standards for construction loans and construction costs increasing faster than property net operating income. These forces create the need for more equity, which we are willing to provide if our standards are met. At this point, I believe that we will achieve our $100 million target for preferred equity and subordinated debt in 2017. It's important to note that many apartment development deals don't have sufficiently high yields to support an expensive preferred equity component and therefore apartment development projects are often being delayed. As noted last quarter, we continue to see headwinds related to development deals and believe that the trend for apartment supply is downward in 2018. Cap rates remained stable during the quarter with A quality property and locations trading around a 4% to 4.25% cap rate using the Essex methodology, and from time to time, more aggressive buyers will pay significantly lower cap rates. B quality property and locations typically have cap rates 25 to 50 basis points higher than A quality property. With the REITs mostly on the sideline, there are fewer motivated apartment investors in the market as compared to a year ago. That concludes my comments. Thank you for joining the call today. Now, I’ll turn the call over to John Burkart.

Thank you, Mike. I also want to thank the operations team for another great quarter. Their hard work and persistent focus on our corporate objective has helped us produce year-over-year same-store revenue growth of 5% and NOI growth of 5.6%. Although our quarterly revenue growth was 5% over the prior year’s quarter, our scheduled rent growth was 4.3% in January over the prior year’s month and decreased to 3.9% in March over the prior year’s month as we expected. The difference was due to 50 basis points of increased occupancy over the prior year’s quarter as well as increases in other income and utility reimbursements. Some of the income was related to one-time items such as increased cancellation fees and collection of delinquent utility reimbursements, and the rest was related to sustainable increases in various categories, as we continue to focus on the nickels and dimes of the business. We expect the year-over-year earnings comparison to continue to decline through the third quarter due to tougher comps as well as the supply entering the marketplace, moderating the seasonal increase in rents. Although we plan to continue to emphasize occupancy based on the current market conditions, the impact from occupancy on year-over-year revenue growth will be zero in the third quarter since it was the third quarter of 2016 that we had modified our strategy and achieved higher occupancy. The gain to lease of 50 basis points at the end of the fourth quarter, meaning that market rents were below the average rent in the portfolio at that time, led to the relatively low sequential growth of 40 basis points for the portfolio in the first quarter. The good news is that although the market was weaker than expected in the fourth quarter of 2016, it came back stronger than expected in the first quarter of 2017. Currently, we have a loss to lease of 1.8%, a 230 basis point increase from the 50 basis points gain to lease in December of 2016. We are cautiously optimistic about the market and our performance in 2017. Turning to expenses, we continue to see wage pressure driven by both the increases in minimum wage in both California and Washington and the tight labor market on the West Coast. The minimum wage will increase at an average rate of between 7% and 9% for the next few years. Our administrative and maintenance staff costs were up about 5% year-over-year. Additionally, utilities were up 7% over the prior year’s quarter as we had anticipated. The increase in utilities is driven by increases in gas, water, and trash collection. Many of our utility companies have pushed through significant increases. For example, PG&E, our Northern California gas and electric provider increased gas rates over 15% to create funds aimed at improving infrastructure as well as the need to meet certain global warming regulations by buying renewable energy at higher rates than other options. We have several workflows related to reducing administrative, maintenance, and utility expenses and we expect to continue to make incremental progress in controlling expenses. Finally, our unit renovations slowed down significantly in the first quarter from 917 in the prior year’s quarter down to 594 in the first quarter of 2017, because of both rental market conditions and labor shortages. Now, I’ll provide an update on our markets. The Seattle MSA's expansion continues, as job growth remains healthy at 3.1% for the first quarter of 2017 over the prior year’s quarter. This marks the eighth quarter in a row of 3% job growth or higher and has helped keep the unemployment rate low at an estimated 3.2%. Boeing plans to reduce its Puget Sound area manufacturing workforce by more than 1,800 people in 2017; however, that is not expected to have a material impact, considering the strength of the economy. There were roughly 9,600 Amazon job openings in Washington as of the first quarter of 2017, a 28% increase compared to the same period last year. The high quality of life and sustained economic growth has managed to bolster net migration by adding roughly 50,000 people in 2016, while elevated supply continues to be a constant threat throughout the MSA, with 48% focused in the CBD. Fortunately, approximately 83% of the Essex portfolio is located outside the Seattle CBD market in the east, north, and south markets. Office absorption was 2% with 5.7 million square feet under construction, 47% of which is pre-leased. Our same-store Seattle revenues grew 7.9% year-over-year with the CBD at 7.5% and the remaining east, north, and south submarkets achieving between 7.7% and 9.7% revenue growth. In Northern California, the Bay Area averaged 2.3% year-over-year job growth in the first quarter, outpaced in the US by 70 basis points with roughly 77,000 jobs added over the prior year’s quarter. San Francisco led the way, posting year-over-year job growth of 2.6%, while San Jose and Oakland were up 2.1% and 2.5% respectively. The Bay Area’s VC funding in the first quarter totaled $4.1 billion, up nearly $1 billion from the fourth quarter of 2016 and about equal to the first quarter of 2016. Office absorption in the Bay Area was relatively flat in the first quarter; however, the market has absorbed over 3 million square feet or 1.4% of total office space over the last 12 months. In San Francisco, Google leased another 166,000 square feet, expanding their footprint in the city to nearly 900,000 square feet. Across the Bay in Fremont, the ramp-up for the new Model 3 continues with Tesla expected to increase employment at its plant by 50%. Finally, in Silicon Valley, Amazon continues its expansion, announcing leases for more than 560,000 square feet at two newly constructed locations. During the quarter, the under construction pipeline grew more than 1.2 million square feet, totaling 16 million square feet of active construction projects, of which 43% is pre-leased. In March, Google received approval for their new 600,000 square foot Charleston east campus in Mountain View, which should break ground later this year. Moving down to Southern California, in Los Angeles, the first quarter job growth was 1.7% year-over-year, in line with the US at 1.6%. Even with the slower job growth, the MSA achieved 3.6% revenue growth year-over-year in the quarter with the tri-cities at the top growing 5.4%, the LA CBD performing consistent with the MSA, growth revenues at 3.6%, and the west LA sub-market at the bottom with 3% revenue growth over the prior year’s quarter. The growth of online television in recent years has spurred the wave of large real estate deals in recent quarters from tech companies, such as Netflix and Amazon. In fact, the entertainment industry now occupies roughly 25.5 million square feet in Los Angeles County, up nearly 3 million square feet from five years ago. Netflix, which will produce around $6 billion worth of original content this year, recently committed to increasing its production infrastructure in California, rather than chasing filming tax credits in other states. Orange County’s job growth came in below our expectation at 1.2% year-over-year for the first quarter compared to our estimate of 2.3% for the year. We will be monitoring this market closely, especially considering the level of supply anticipated in 2017. Our north and south Orange submarkets achieved 6% and 4.8% revenue growth year-over-year respectively. Last but not least, in San Diego, job growth was strong at 2% for the first quarter over the comparable quarter. The North City submarket, where we have over 70% of our San Diego portfolio, achieved revenue growth of 5.8% over the prior year's quarter. San Diego is about to roll out the largest city-based Internet of Things platform in the world. The city is partnering with GE to upgrade 1,400 traffic lights to LED and integrate the traffic light system into a connected digital network. Deployment of 3,200 smart sensors will enable the network to optimize parking and traffic, enhance public safety, and track air quality. Currently, our portfolio is at 96.6% occupied and our availability 30 days out is at 4.5%. With a loss to lease of 1.8%, we are positioned well for the leasing season. Thank you, and I will now turn the call over to our CFO, Angela Kleiman.

Thank you, John. I’ll start with a review of our first quarter results, then discuss guidance revision and conclude with an update on capital markets activity and the balance sheet. For the quarter, our core FFO exceeded the midpoint of our guidance by $0.09 per share. The components of the outperformance are outlined in our press release on page 4. Also in the first quarter, we declared a quarterly common dividend of $1.75 per share, which is a 9.4% year-over-year increase and represents 23 years of consecutive dividend growth. Moving on to the full year guidance, we are raising same property revenue growth guidance by 25 basis points to 3.5% at the midpoint. The increase is attributed to favorable first quarter results and an increase in projected other income for the rest of the year. While we are raising our growth outlook for the year, we still expect our revenue growth to decelerate from 5% reported in the first quarter to around 2% by the third quarter. As previously noted, we expected a more difficult second half of the year, largely due to a tough year-over-year occupancy comp and a lower level of turnover. In conjunction with the same property growth increase, we're raising core FFO guidance by $0.08 per share to $11.76 at the midpoint. This guidance increase primarily reflects the revised revenue growth outlook, partially offset by the timing of expenses. Overall, we are now projecting core FFO to grow at 6.5% for the full year, which is a 70 basis points increase compared to our initial guidance. As for the second quarter, we are forecasting core FFO to be $2.87 at the midpoint, which is $0.07 lower than the first quarter results. There are three key factors contributing to this outcome. First, we benefit from a one-time commercial lease termination fee in the first quarter. This has a $0.02 impact. Second, we expect higher interest expense in the second quarter due to capital markets activities. This has a $0.03 impact. As you may recall, in March, we repaid a $300 million bond with a cash rate of 5.5% and an effective rate of 1.8%. In April, we issued a $350 million bond at a rate of 3.625%. This bond offering was consistent with our original guidance provided last quarter and does not impact our full year core FFO projection. Third is the timing of expenses. Our guidance assumes expense growth will be around 4.5% in the second quarter. Nonetheless, for the full year, we still expect our operating expenses to be consistent with our original guidance range of 3% at the midpoint. With the April bond offering, we have substantially completed our debt refinancing for the year. Our remaining maturities in 2017 total approximately $100 million, which has been mostly funded by the April bond offering. At the end of the quarter, our net debt to EBITDA was 5.7 times, which is a reduction from 5.9 times at year-end and consistent with our expectations that this ratio would trend down from growth in EBITDA. With full availability on our billion dollar line of credit and a similar maturity schedule, our balance sheet remains strong. That concludes my remarks and I will now turn the call over to the operator for questions.

Thanks. Just want to start on the preferred equity deal. So what’s the opportunity to grow that book today and how large could that book eventually be?

Hi, Nick. It’s Mike Schall here. I think it could be a lot larger than we want it to be and so we're seeing a lot of demand for that product and again, for the reasons that I cited in our script. So I think that our limitation is sort of a self-imposed limitation. We're trying to pick the best deals out of the group and the ones that both underwrite the best and are most consistent in terms of higher quality locations and properties. The main reason for that is because the term of these deals is somewhere in the three to four year range and they have a high coupon somewhere between 10% and 12% typically on them. When that reverses, if we can't replace them, then we have an FFO decline issue. And so we're trying to be very thoughtful about how we execute that business. We think it's a great opportunity in the marketplace today and we want to take advantage of it. We just want to do it within boundaries. So I think a long time ago, we talked about somewhere around a 5% cap relative to the total market capitalization of the company, and we're well under that and we expect to remain well under that.

Thanks. And then appreciate the uncertainty around immigration and H1B visas, but just curious if you've seen any change in traffic of non-US residents in any of your properties or across the portfolio?

Yeah. Nick, this is John. The answer is no. I can't say that we've perfectly tracked that, but we really haven't had any anecdotal or other information indicating any changes in traffic. I mean, frankly traffic overall is about the same as it was last year and specific traffic as it relates to any particular person.

Hi. Good morning and thanks for taking the questions. Just want to touch on guidance really quickly. You still talked about there being heavy supply in the first half of the year and we've seen job growth moderate a bit across some of your markets. So I guess just what gave you the confidence to raise the same store this early in the season or before entering the peak leasing season or with the higher earn in, I guess, do you have some conservatism baked in now through the rest of the year?

Hi, Austin. It’s Mike Schall. Let me start here, and then Angela may have some additional thoughts. As we began this year, we recognized a wider range of potential outcomes, primarily due to the negative loss to lease. At the end of December, our market rents were below the scheduled rents in our portfolio, which make up a significant portion of our revenue. This created some uncertainty. We also faced questions regarding the timing of lease-ups and how aggressive property owners would be with concessions. These two factors contributed to our uncertainty in projecting this year in general. In our last quarterly call, we mentioned that due to the negative loss to lease, we would see a buildup of loss to lease this year. Consequently, as we accumulate loss to lease, the reported results will reflect this increase significantly. These were the underlying dynamics affecting our projections. Angela, would you like to elaborate on how the numbers are shaking out?

Sure. Thanks. And so the way the numbers were allowed is that the rent growth midpoint of 25 basis points raised essentially reflects the first quarter achieved results and we added to that other income that we are expecting, which John Burkart alluded to earlier about focusing on the nickels and dimes of our business. So it's primarily driven by those two components and that flows through FFO. And then the additional couple of pennies on the FFO side relates to our preferred business and other small items. So that’s why we're comfortable with our guidance range.

Thanks for the detail there. And then just the one follow-up, what would you need to see or what would get you more comfortable with increasing the unit renovation?

Yeah, this is John. I'll take that. As I mentioned, there are really two things that have been slowing us down a bit. One is related to the market and the other to labor shortages. We're facing some difficulties in getting contractors, which is a challenge that needs to be resolved and is not as simple as it seems. Additionally, the markets are getting stronger and are now aligning with our seasonal expectations. At the same time, the first quarter is just the start. We have yet to fully enter the second quarter to assess how things are progressing, but the marketplace is generally performing as we anticipated, which is encouraging. We plan to increase renovations as much as possible, but we still face some limitations due to labor shortages.

Increases above what you would have anticipated I guess on the fourth quarter call?

No. We're in line with our overall plan. We were a little bit behind in the first quarter from what we had anticipated and will be in line overall for the year or just slightly below that.

Great. Thanks. So in your press release you mentioned that Northern California saw lower apartment supply deliveries, and I think on the last call, you mentioned that the bulk of supply in Northern California is expected in the first half of 2017. So I was wondering when you say lower apartment deliveries, is that compared to your expectations going into the year or compared with last year?

This is Mike, and maybe John will want to follow up with this. In general, we said that supply is declining in Northern California, and we think that that's going to continue into and through 2018. In fact, from ’17 to ’18, we're forecasting about a 36% reduction in supply, ’18 over ’17. And within ’17, it drops off quarter-to-quarter. The first half remains pretty strong and then the supply should drop off in the second half of the year, although I think there's been some leakage in terms of pushing back some of our expected first and second quarter deliveries in Northern California maybe into the third quarter and beyond. So those are the dynamics there. So again, as I mentioned earlier, the ability to figure out exactly what's going to deliver and how those owners are going to price concessions, we've seen some increase in concessions in Q2. It's one of the variables, one of the difficulties in trying to estimate what's going to happen. But the statement that you made, we agree with basically that Northern California supply is being reduced, we expect that in ’18, it will be relatively flat in Southern California and declined about 13% in Seattle.

And this is John. I would just add that we go into the field and assess the situation twice a year. Additionally, we conduct spot-checks, and during a recent check in the first quarter, we discovered that several assets we expected to be delivered were not. I'm guessing they are experiencing similar challenges to us on the rental side, specifically a shortage of skilled labor for finishing. I believe the entire industry is feeling that pressure.

Okay. And as a follow-up, I think in your remarks, you mentioned an opportunity to convert from preferred equity investments to owning those assets. I was wondering when you are evaluating the preferred equity investments, are you underwriting them the same way as you would for your wholly-owned acquisition platform?

In general, yes. I mean, this would be a supplemental source of potential acquisitions and investments. It would not be something that we're trying to give a preference to one of the owners of one of these preferred equity deals. So no, it’s strictly an acquisition strategy.

Good morning. Just hoping to follow up on Gaurav’s supply question. Could you be a little bit more specific in terms of the individual markets within Northern California that are contributing to that 30 plus percent year-over-year decline, ’18 versus ’17 that you’re expecting?

Sure, this is Mike again. Approximately 50% in San Francisco, which extends down the peninsula into San Bernardino County. About 25% is in Oakland and 26% in San Jose. So, this year in San Jose, we're looking at roughly 3,200 multifamily units decreasing to about 2,400 units. We are observing a widespread decline in Northern California, less so in Southern California, and a slight decline in Seattle next year in 2018.

And are you concerned at all because I mean you obviously are talking about some slippage due to labor that that massive decline year-over-year won't materialize and kind of may cause 2017 to play out differently than you’d expected in your fiscal year guidance?

Well, generically, Juan, I’d say we’re obviously concerned. This is a business where you're constantly humble because what you think is going to happen doesn't always happen, but this is a discipline of trying to understand the market and understand what's happening, what the dynamics are, what the forces are, so that we can get the capital allocation of the portfolio right. I suspect that we won't be 100% right about the projections for 2018, but I also will suggest it will be more right than wrong and this is the information that gives us a little bit better knowledge and strategic advantage in terms of making good investment decisions and capital allocation.

Okay. And just one quick follow-up on the lease term fee at commercial. Could you just give us a little bit more color on a quantum dollar-wise and where that was booked?

I will go back to what it was and let Angela explain where it was booked. This relates to an asset we purchased that had a paying tenant, but the space was actually vacant. We worked to negotiate a resolution to that situation so we can renovate that center, and we're quite excited about that. Regarding its booking in the financials, I’ll let Angela take over.

Oh, sure. Yeah. And so in terms of the dollar amount, it was about $1.2 million and it’s booked in other income on same-store.

Hey all. Thanks for taking my questions. As far as I noticed on the development page, looks like land ticked up about $30 million. Am I reading that correctly, and if so, can you tell me what that's related to?

Mr. Eudy is here. I hope he’s had his outline.

Sure. It's the Hollywood deal that I think you may be aware of that we put into pre-development if you will. All these things were achieved at the end of the fourth quarter and we will be starting, we get the demo, move the tenant out, and break ground in December. We’ll be starting construction we expect late Q2, early Q3.

Okay. Great. And then just circling back to the preferred, can you give us a sense of, I know you have a good amount of those, but one of those going to be maturing, for example, five more are going to be maturing this year compared to maybe last year or in ’18 and then are you seeing or do you anticipate most of those converting into common because your partner has way less liquidity than you do, so they’re probably unable to pay you back on that.

Hi. This is Mike. We have no contractual right to convert anything. So just to make that clear, however, we have exceeded the table with respect to the outcome on some of the preferred equity deals, and therefore it's just good. It gives us another bite of the apple, let’s say. And so from that perspective, I think it works well in terms of the maturity schedule. I think as we've ramped up the business, we don't have that many maturities. We did have one other conversion earlier this year, and I think we also had several maturities that have come through. So what you're seeing and building from, I think it was about $100 million last year to $100 to $150 million last year to $250 million, you see in a net booking of transactions relative to repayments. I think the repayments will start hitting a little bit more substantially a year or two from now, but I don't think it's going to affect next year in any material way.

A quick question for Angela on the debt maturity. I have a little over $300 million of secured debt maturing in ’18 with a weighted average rate of 5.3. I was hoping you could comment on what the effective rate on that is and whether there's an arbitrage opportunity to potentially prepay that at this point this year.

The effective rate was shown here; it’s 5.3.

So there is a possible average rate?

Yeah, there should be right at this point. And as far as the general planning, we would prefer to refinance our secured debt with unsecured debt in our ten-year maturity and continue with laddering our maturity.

So the season's costs become economical?

With secured debt, the prepayment penalty is pretty severe, and so unless it's built into the agreement itself, and some tend to be more prepay, pay six months in advance but there are quite a few differences, but we won’t incur those kinds of costs because it just doesn't make enough economic sense at this point.

So it sounds like there is no impact from anything dealing with those maturities in this year’s guidance.

We're not planning for that. And then a question on your operation front, you mentioned rents, I believe it was San Francisco but correct me if I’m wrong, rebounded 3.1% during the first quarter after being down in the fourth quarter. So could you break that down? Was that San Francisco specific and what do those kinds of swings in rent growth look like in some of the other submarkets around the Bay Area? Is kind of the stabilization that happening from inside out? Does San Francisco kind of snapping back, but other markets maybe not rebounding or how to quantify that?

Yeah, this is John, if you want me to give, let me kind of a broad answer here. So what we're seeing is generally good action in the Bay Area consistent, actually the whole portfolio is consistent with historical seasonality. We're seeing a little bit more strength in areas like San Jose and San Francisco that were hit hardest and in a couple of areas like for example in the East Bay where people had moved from the higher-priced zones of San Francisco and San Jose, they moved into those areas probably due to affordability. We're seeing a reversal of that which would make sense. So the East Bay is struggling a little bit related to people moving back to San Francisco, San Jose is what the belief is. As it relates to Seattle, we're seeing again strength there. And in LA, a little bit less. LA is a little bit flatter but still positive, LA being also a little bit less than San Francisco. LA itself is a little flatter, San Diego stronger but Orange County is fine, and that’s kind of an overview. Does that answer your question?

Hey Drew, just one comment. The 3.1% was the portfolio average, so Northern California looking at economic rent growth for the quarter for December 31 of March 31 was 3.8%.

Okay, I appreciate the clarification. Just one more on the Bay Area, you talked about some supply potentially getting delayed away from the first half of the year this year into the second half. Anyway to quantify what percentage of your overall deliveries you expect in ’17 that’s already delivered versus what's become delayed?

Yeah. This is Mike; we do have it by quarter. And again, these change from quarter to quarter because we go out and drive the properties as John said and try to gauge when they're going to deliver. So in Northern California we have Q1 deliveries for ’17 at 35%, dropping to 29% in Q2, 20% in Q3 and 16% in Q4. The biggest deliveries were in San Jose so far this year according to the schedule.

Just sticking with the Bay Area on concessions you mentioned earlier in the call you saw an uptick in Q2. Just wondering if you can give a little more color on which submarkets you're seeing the uptick in?

Sure this is Mike. Concessions, I say in general are up maybe two weeks from Q1 to Q2 so far. San Francisco, actually the typical concession is still 4 to 8 weeks that applies to San Francisco downtown San Jose. There are some areas that are closer to two months free, Dublin Pleasanton for example and Sunnyvale which has just a bunch of active lease-ups underway right now. So, and the other areas are a little bit less than that so the San Francisco peninsula has got better; it's about one month free. But again this is a fluid process and they can decline or increase over time almost, and they’re constantly changing and we do the same thing on our lease-ups as well. We're pricing the smaller units different from the bigger units based on supply and demand for each unit type. So the concession numbers are a fluid process, and they will continue to change throughout the year.

And then just on the portfolio generally, I was just wondering if you can give an update on move-outs to purchase a home?

Sure. Yes, move-outs to purchase a home are roughly about 10% right now. But materially the same as it's been for a long time, no surprises there.

And actually, I'll make one other comment and that is partially because the supply of for sale housing is still muted in the West Coast. So we're not building a lot of for sale homes and therefore the ability to transition from an apartment to a home is more challenging out here.

Firstly just on LA. You touched on the market a little bit throughout, but looking at the revision you made just to the market-wide stats, hoping you could maybe elaborate a little bit on whether that was a heavier supply or demand component contracting that down a little bit.

This is Mike; maybe John will want to throw in a comment here. I think part of it is the concessionary nature of different parts of Southern California. Obviously, Southern California is a big place. But we saw a pretty big ramp-up in supply in Orange County for example this year and the continuation of supply in downtown LA. So six to eight weeks typically downtown LA, so you know I think it's more of the same but dealing with supply relative to the amount of job growth. Obviously, the Southern California area doesn't produce the same amount of jobs that Northern California and Seattle have, and I think that that is probably the key difference between the two at this point in time because stronger job growth means more demand in the tech markets relative to Southern California.

And then sorry to add on to the regulatory theme from earlier too, but one thing you didn't mention was AB 199, and I'm not sure if it necessarily impacts you, but something we’ve monitored from the homebuilder side. It sounds like it's more just related to redevelopment now, and I'm sure if that has any impact on your redevelopment business out there.

Yeah, actually, I had AB 199 in my script yesterday afternoon. So we decided to drop it. John Eudy is here; he does a lot of this political stuff for us. Our belief is that AB 199 is not likely to survive. This would impose a prevailing wage requirement for any new construction that has an agreement with the city and would probably end up further restricting the amount of supply that gets built both for sale and rental. So that is that proposal or that law, and we didn't mention it because we thought that was likely not to survive.

And the chance it does, is there any impact on the redevelopment side or as you understand it, strictly on new construction?

This is John Eudy; I’ll further add on to what Mike said. Basically, we believe it's going to affect only those developers to get public funds and/or come through the successor agencies and redevelopment agencies, the way it's been modified. So in both cases, it would not affect us.

And that would be, that’s the system we’re with now, right? So that’s effectively no change. I believe the way it’s going to be if it gets passed is it will clarify what already is the case.

And if I could just squeeze a quick question on property taxes. The 1% or so rate in the first quarter, how are you, what’s embedded in the guidance for the full-year for property tax increases?

We are guiding around 4% for the year. In Q1 we had some refunds which benefited Q1. However, we still have not gotten property tax on Seattle, and that tends to be the wildcard.

So just two questions here. First Mike, you've mentioned that you guys were seeing a lot of opportunity on the mezz finance side. But just curious, as far as it relates to investing and development, my understanding is with the new tighter bank regulation, the developer has to come up with that 35% percent of equity being all equity they can't use preferred or anything of that sort of debt yielding. So are you guys not doing development or are the banks not as strict as, of course, what the regulators have laid out?

Well, Mr. Eudy is here and he loves to talk about development work. We're active but we're not as active as we could be primarily because we don't see a lot of development deals that generate the types of yields we need to achieve to take the risk of that business. So that has been a choice. But having said that, we will always be active in development and we have enough deals over the next couple of years that are you know the next phase of several transactions that are underway now. The Hollywood deal, etc., that we're not going to be completely out of the development world at all. Having said that, as we look at new deals and again keep in mind what's happened here, you have construction costs growing much faster than property NOI, and obviously that causes cap rates to compress measured today. If you have compressing cap rates, we haven't changed our objectives or goals with respect to development. We're still in the 5% to 5.5% unleveraged yields or cap rates measured today, not with trended rents measured. Because we're competing against an acquisition measured today. We're just not seeing a lot of those deals that cross that threshold. So I think Mr. Eudy's job is…

Mike, I was actually talking when you guys are doing the mezz, like investing in another’s people deals, not your own accounts but when you’re doing like preferred equity investments.

I’m getting to that Alex. The mezz deals, we have relationships with some lenders, and so I don’t think that‘s entirely right with respect to the mezz deals and the yield on the preferred; although the yield on preferred generally doesn't apply to the construction period anyway. So I think that’s probably the key there. It's accrued.

Okay, that's helpful and I'm sorry about that. The second question is, on the guidance you guys did $5.6 million in NOI in the first quarter, but the range is $28 to $46. So is it more year-over-year comp related than the back half adjusted customer or is that, as you're cautious just given you know you want to see how the summer goes and if the supply continues to pull back and the concessions hopefully start to maybe lessen over the year that you're just not sure how the summer is going to go and therefore that's why the range is where it is versus how you got did the first quarter.

Alex, this is Mike. We need to revisit the previous topic; currently, we are facing a loss-to-lease situation in San Francisco that amounts to $100 today. This loss won’t impact our bottom line until we either turn a unit or a lease. We are witnessing a gradual decline in scheduled rent, which is what really affects our income statement. To provide some context, scheduled rent was up 4.3% in January, but it dropped to 3.9% by March and is preliminary at 3.7% in April. This trend of decreasing scheduled rents and increasing loss-to-lease is expected to persist throughout the year, likely until about the third quarter when we anticipate a turnaround.

Yeah, and Alex, that is why we view that we’re going from a 5% revenue growth down to 2% in the third quarter. What that means is, in the second quarter we think that revenue will come in that low to mid 2 range.

Alex, this is John. I’m going to add one more piece here, just so we get the context. As Mike said we went from 4.3 to 3.7 year-over-year in April on scheduled rents, and we already said that the loss to lease was 1.8% or 180 basis points in March. In April, it went up to 2.6% in April. So the market's doing as we expected it's moving up, but because of this delay our scheduled rent continues to go down again as expected. So this is all according to plan; things are good, but it's just the way the numbers roll out. And then I mentioned before the occupancy adjustment that will be a net neutral in the third quarter.

I guess my question really is when I think about what you're seeing fundamentally in 4Q versus 1Q, there's been a big thing in the Northern California market and things keep swinging around all the time. Could you just talk a little bit about kind of fundamentally what you kind of doing week in week out to kind of make sure you're fully capturing the kind of crazy inflection point? Again, you know you guys are meeting a budget and things of that like. Have you kind of think anything procedurally to kind of just make sure that all this volatility you don't kind of get caught on the wrong side of it?

Tayo, I’ve been in this business a long time and honestly, there's not a whole lot you can do on a week-to-week basis. Certainly with respect to you can monitor the lease-ups and you can react based on what they're doing now, and again we do the same thing; we have our own leaseups that are in the marketplace right now, and we have weekly pricing calls and we try to monitor what's everyone is doing in the marketplace so that we're not out of step with respect to everyone else. But you know that's about as much as we can do. This business is really driven by the long-term trends both with respect to demand and supply. And so we try to make good decisions as to those longer-term trends and then just execute well when we're on the ground, you know the decision a year ago for example in the third quarter last year to build occupancy by 50 basis points was a strategic decision because we thought, okay, if we're not going to have rent growth, let's try to build occupancy and play a little bit of an occupancy game, and I think we did that pretty well. So with that said, John, do you have any additional comments?

Yeah, I would just add, I mean clearly in the big picture, it’s the supply-demand game as Mike said. But on a daily basis, our people are working extremely hard, they're trying to understand the market obviously that it is, they just need to understand it and react properly to it. And so we have great communication amongst teams, making decisions. The team is empowered to make decisions; we don't make them from corporate. They're empowered to make the good decisions, and the communication is often, and that's what enables us to thrive in that pretty challenging market. It does, as you point out, change pretty significantly week to week, month to month, but they're doing an awesome job.

Again, could you just talk a little bit about fundamentally what you're seeing in regard to how Class A versus Class B assets that are performing within your market?

Sure. Interestingly, as the market came back, we are seeing better activity higher growth in some of the Class-A assets for certain and will again watch cautiously how the supply enters the market and the competition comes because they'll be the first to feel a more significant impact. But as we came back in the first quarter, the As did a little bit better than the Bs overall, really across the market.

John, I apologize if I missed this earlier; did you give new lease growth in renewals for 1Q and then where things are trending thus far into 2Q?

I didn’t, and I'm glad to give you some of that input. So new lease growth for Q1 in total was roughly 2.4% and pretty consistent in the different markets across SoCal. As we get to NorCal it was actually negative new lease and that does get part of our numbers all kind of tied together, we were negative about 1.6%. And then as we get to Seattle, we were again positive about 2.5%. On the renewal side for Q1, SoCal was about 4.5%, the Bay Area was about 2%, and Seattle was a little bit closer to 5%. And going forward very, very preliminary input numbers, NorCal has now switched to positive. We've moved from negative to positive again, we're moving up as Mike has mentioned, and so NorCal is a little bit over 1% up year-over-year and Seattle's is over 5%, it’s taken off. SoCal is fairly flat, it is around 2.5 still on new leases, but the movement is all in the right direction. Does that answer the question you were looking for?

Yeah. Maybe give me a further portfolio as a whole in 1Q and then as a whole for renewals thus far?

Sure. As a whole, around 90 basis points in 1Q for new and about 3.5% for renewals and looking out, I guess, the last piece for you, looking out the renewals we’re sending out, overall, are about 4.5%. Moving us incrementally for each of the different terms.

Okay. And then you will have some bleed off of that, the 4.5?

It's interesting. It depends because in some cases, people do want to negotiate, but often with renewals, we send them out and typically quote a 12-month lease. We offer various lease terms, and it's not uncommon for people to opt for a shorter lease term and pay a premium. It really varies; sometimes we actually perform better because more people choose the shorter term over the 12-month term, if that makes sense.

Okay. And then on the other income items, it looks like in the same-store portfolio that grew around 10% or 11%, the non-rent items and you highlighted some of those, just want to make sure I understand what’s going on there and the extent that that is going to persist throughout the year. You mentioned utility reimbursement and some break fees, is there anything else there that we need to understand? And then, just so I get it correctly on the utility reimbursement, does that have a matching item on the expense line where your expenses should be higher, but then it gets washed out?

Yes. Big picture for sure. I think Angela's covered the adjustments in the updated guidance. Again, some of the utility was really related to one-time items, collecting some past delinquencies. As we mentioned last quarter, we pushed very hard and we continue to push all the nickels and dimes, so some of that just carried over into the first quarter. So that's what some of that was. The lease breaks, those really are one-time items and they've actually started to trend down as we would expect. So that one-time, there are a few additional ongoing items and that's what Angela has picked up in the guidance.

Kind of just to add on the expense side, the 7% increase in utility expense is what we actually expected. So it’s built into our guidance. That was not a surprise to us.

Okay. But the level of reimbursement, right, but I mean just, as we think about it right, like if there was a surprise on utility expenses, you're getting paid back to that by your resident. So this is more of the catch up as John mentioned?

Yeah. It was a catch-up, and again going forward, yeah, it is roughly 60% to 70% of utilities get reimbursed. So if there was a negative increase on utilities that was unexpected, we're going to collect roughly two-thirds of that coming back.

Okay. And then as we’re thinking about the same-store growth just going forward, should we expect that non-rent component to grow closer to the overall level of rent in the future?

I don't think it’s that direct correlation. I mean, we did factor that into our guidance. That’s part of the 25 basis point increase, but it’s not correlation.

Okay. Very good. Well, all of us thank you for your participation on the call and we look forward to seeing many of you in NAREIT and do the conversation. Have a good day and a good weekend.