Essex Property Trust Inc (ESS) — Q2 2017 Earnings Call Transcript

Thank you for joining us today and welcome to our second quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments and John Eudy is here for Q&A. This morning, I will comment on our quarterly results, market conditions, changes to our market outlook and investment activity. On to the first topic. We are pleased with our second quarter results which benefited from outperformance in Seattle along with continued improvement in Northern California. Results in Southern California were mixed, impacted to varying degrees by supply-related disruption and slowing job growth. John Burkart will comment on each Essex market in a moment. Overall, the West Coast continues to outpace the slow-growth national economy, although the level of outperformance has narrowed. As noted previously, pricing power is disrupted when large rental concessions are introduced to the market, usually occurring when several lease-up communities compete directly with aggressive absorption targets. In our experience, six to eight weeks of free rent, equivalent to 12% to 16% of annual rents, provides sufficient incentive to draw residents out of stabilized communities. Fortunately, these large concessions generally represent only a short-term disruption to pricing power, while long-term fundamentals remain intact and California's persistent housing shortage continues. This year’s strong recovery in Northern California confirms that the pricing destruction we experienced in 2016 was directly attributable to levels of rental concessions. As soon as these concessions abated in early 2017, market rents recovered and pricing firmed. Accordingly, we have experienced recent concession-related pricing power erosion at certain of our properties in Downtown Los Angeles, West L.A. and the Tri-Cities. We expect pricing power to rebound when concessions abate. I would like to recognize the operations team for reacting quickly and thoughtfully to changing market conditions. Noted on our last call, an important part of our expectations is that tight labor markets in California push incomes higher, attracting net workers from other parts of the U.S. and the world. The Essex markets, 2017 personal incomes are expected to grow 4.9% led by San Francisco at 5.9% and compared to the U.S. average of 3.2%. Further, over the past year the ratio of rental income has declined in both San Francisco and San Jose, two areas most affected by affordability constraints. Median home prices are also growing faster than rent, Seattle leading the way at 14.8% year-over-year, and California up 7.2%, both outpacing rent growth over the past year. This is important for two reasons; first, higher home prices make the transition from a renter to a homeowner more difficult; and second, a significant part of the Essex portfolio is convertible into condos. On to our revised 2017 outlook. We made a number of changes to our MSA level forecast. First, we've reduced our job growth forecast for several metros including Orange County, San Jose, and San Diego. Across the Essex portfolio, job growth peaked in 2015 and has slowed since. Tech markets continue to report strong yet decelerating job growth that has consistently outperformed the U.S. average. Southern California, however, is a more diversified economy and therefore performing more in line with the broader U.S. average. Additionally, several factors have impacted our forecast; first, and most notably is the shortage of skilled workers and low unemployment rate, which are more acute on the West Coast. Unemployment rates in the Essex markets are now at or below the U.S. average of 4.5%, with San Francisco the lowest at 2.6%. Overall, the unemployment rate in the Essex portfolio has declined 50 basis points over the past year with nearly 20,000 open positions at the large companies in California and Washington. Second, demographic factors are also contributing to slower job growth. According to one study, there are now 8,000 baby boomers turning 65 each day and that rate will continue to accelerate. At the same time, the number of millennials entering the workforce is now declining. Growth should continue to slow as the number of baby boomers reaching retirement age is expected to exceed the number of millennials entering the workforce. Fortunately, longer lifespans and healthier senior workers will slow this impact because they often remain in the workforce past the typical retirement age. Third, the housing or location preference of retirees. It is estimated that more than 70% of retirees want to “age in place,” referring to the fact that they strongly prefer to remain in the same house and/or community, surrounded by friends and family. Given longer life spans and the preference to age in place, many look to consume homes without requiring a job, thus creating housing demand that is not appropriately represented in the normal relationship where two jobs are needed to create one household. Finally, the limited supply of skilled construction labor also appears to be an influence. The demanding physical requirements of construction result in earlier retirement compared to other industries and studies indicate that many more construction workers are nearing the end of their career than newcomers entering the trade. This leads us to believe the construction labor pool will remain in short supply, which will help keep construction costs near current levels without significant increases in housing prices. These forces should remain in place as we head into 2018—tight labor and market conditions pushing incomes higher and hopefully attracting people from other areas. While higher wages will impact operating expenses, they also make apartments more affordable and are necessary to drive rents higher. In summary, as long as the economy continues to expand, we see apartment rents growing at near their long-term averages for the foreseeable future. Turning to investment activities, we modified our investment strategy during the quarter driven by lower capital costs for both long-term debt and equity as well as improved expectations for rent growth in some areas. Previously, our 2017 plan relied primarily on dispositions to fund new investment. We now anticipate fewer dispositions, relying instead on stock issuance and long-term debt. Regarding dispositions, our strategy will focus on portfolio culling activities, whereas previously we targeted partial sales of wholly-owned properties to an institutional co-investment entity. Thus, we are now targeting a range of $300 million to $350 million for property sales in 2017, down from a range of $400 million to $700 million previously, of which one transaction totaling $132 million has been completed year-to-date. With respect to acquisitions, investment conditions remain highly competitive with strong investor demand relative to a limited number of quality properties hitting the market. Thus prices are being driven above our expectations and we are often outbid. We have closed $270 million year-to-date and currently have two properties in contract for approximately $230 million. If these transactions close, cumulative 2017 acquisitions should be approximately $500 million, which is within our targeted $400 million to $600 million range. Please note that the foregoing comments about acquisitions and dispositions should refer to total property values as many of these transactions will involve institutional co-investment. Angela will discuss the net impact on Essex's balance sheet in a moment. Additionally, given the strong investor interest in apartments, especially for value-added opportunities and high-quality properties in the best locations, we have lowered our internal cap rate assumption for the Essex portfolio by 10 basis points. Across our market, A-quality property in the best locations are trading around 4% cap rate using the Essex methodology, and sometimes more aggressive buyers will pay sub 4% cap rates. Cap rates for B-quality property and locations are generally 40 to 60 basis points higher than A-quality property, with upgrade costs and related rents assumed for value-add opportunities. Switching over to our preferred equity and subordinated debt program, we've made good progress during the quarter. Significant transactions were detailed in the press release, and at quarter's end we had a total outstanding of approximately $276 million, up about $26 million from last quarter. Through Q2, we have funded approximately $34 million in new deals in 2017 against our guidance for the year of $100 million. On the repayment side, we received $13 million in repayments during the quarter and converted one preferred equity investment into a common ownership position earlier this year. We have also approved five additional preferred equity deals involving around $100 million, most of which are expected to close by year-end. Going forward, we remain on track to equal or exceed our original guidance. Finally, on the development front, we remain on schedule to commence construction on two new projects and the next phase of our Station Park Green project in 2017. In general, we continue to see headwinds to new development deals, and we believe that the overall trend for apartment supply is downward in 2018. That concludes my comments. Thank you for joining the call today. I’ll now turn the call over to John Burkart.

Thank you, Mike. Q2 was another solid quarter for Essex with year-over-year same-store revenue growth of 3.9% and NOI growth of 4.7%. Overall, the market performed at or slightly above our expectations. However, the market was stronger in April and May and a little weaker in June. Typically in L.A. and Orange County, net effective rents were flat and/or declined in June. L.A. is negatively impacted by a very competitive lease-up environment and Orange County is impacted by the combination of lower employment growth and increased supply. The Bay Area and Seattle saw significant market rent growth during the quarter; however, occupancy declined in those markets. The decline in occupancy in the Bay Area and Seattle was mostly due to higher turnover, which is consistent with seasonal norms. However, in Seattle, we also saw a slight slowdown in the market in June. We adjusted rental rates to meet the market in July and we picked up 20 basis points of physical occupancy during the month of July, bringing occupancy this week to 96.4% and decreasing availability 30 days out from 5.3% at the end of June to 4.9% this week. Lower rents appear to have peaked in June, a month earlier than the historical seasonal pattern, with strong leasing activity that we experienced in July giving us confidence that the markets are healthy. It is our expectation that the markets will follow a normal seasonal pattern in the second half of the year. Our loss to lease for the portfolio in June 2017 declined to 3.4% compared to 3.8% in May 2017. In our market, rent for the portfolio increased in June over May. Scheduled rent increased more than 57 basis points, which is a good thing due to leases being renewed or units being released at their rents, leading to loss to lease declining. We are spinning out renewals for the third quarter at an average of 4.8% for the portfolio. However, renewal rates may be negotiated down as rents appear to have peaked for the portfolio. In the third quarter, we expect that our occupancy will be roughly the same as the prior year’s quarter or about 96.5%. Thus, we will not receive the benefit of increased year-over-year revenue growth related to the increased occupancy that we have had in each of the last four quarters. It is our continued expectation that the third quarter will be the low point for the year-over-year revenue growth, between 2.5% and 3% over the prior year’s quarter, in part due to a tougher occupancy comparison from last year. Turning to expenses, we continue to face strong headwinds from both utilities and wage pressures that I have noted on prior calls. However, we have been successful in partially offsetting the increases by strategically bidding out asset collections to service vendors. For example, our pool and landscape contract expenses are down 1% from the prior year’s period despite the 10% increase in minimum wage, which directly impacts both services. Moving on to update our market. In Seattle, job growth has slowed relative to prior quarters, but remains the strongest job market within the Essex portfolio with year-over-year growth of 2.6% for the second quarter. Amazon continues to expand with their purchase of Austin-based Whole Foods for $13.7 billion, and currently, in the State of Washington, Amazon has 8,600 openings. Microsoft announced a reorganization earlier this month that will result in thousands of worldwide company job cuts. However, only 400 to 500 layoffs are expected in the Seattle region. Multi-family supply remains high at the market and concessions are generally one-month free for properties in lease-up. Interestingly, some of the lease-ups in the Seattle CBD have little to no concession. We have seen move-outs to buy homes remain elevated in the Seattle market at approximately 20% compared to the historical average of around 14% to 16% for this market. In office activity, Seattle has recorded the strongest year-to-date office absorption of any major metro in the U.S. at 2.9% of existing stock. Additionally, CMD has nearly 6 million square feet of office under construction, almost half of which is pre-leased by Amazon, Facebook, and Google. On the east side, Vulcan has developed a substantial amount of office space for Amazon in Downtown Seattle and purchased two development sites in Downtown Bellevue, both of which are zoned for 450-foot tall towers. Our same-store revenues in the Seattle market grew by 6.6% year-over-year for this quarter, with the CBD at 6.7%, the east submarket achieving around 6.3% and the north submarket achieving 7.8%. In Northern California, job growth in the Bay Area averaged 1.8% year-over-year in the second quarter of 2017, with roughly 63,000 jobs added over the prior year’s quarter. San Francisco continued to lead the way, posting year-over-year job growth of 2.3%, while Oakland and San Jose were up 1.9% and 1.5% respectively. There was almost 19 million square feet of office space under construction in the Bay Area, roughly 44% of which is pre-leased. In San Francisco, Salesforce and Amazon expanded their combined footprint by an additional 330,000 square feet. Across the Bay, we plan to open our first office of 75,000 square feet in the open CBD by the end of the year, and in Pleasanton, construction has begun on Workday’s 400,000 square foot office building. Finally, in Downtown San Jose, Adobe is in contract to purchase the site adjacent to their headquarters where they are planning on an expansion that could house an additional 3,000 employees. Additionally, Google has started negotiations with the city of San Jose on the formation of a new campus in Downtown, which could ultimately house up to 20,000 employees. During the quarter, we continued our lease-up of Century Towers in Downtown San Jose and Galloway located at Pleasanton using four to six weeks of concessions on selected units for both lease-ups, averaging over 30 leases per month at each site. Shifting to Southern California, in Los Angeles County, job growth averaged 1.4% year-over-year for the second quarter of 2017 and is generally in line with the U.S. at 1.5%. Essex continues to perform well in this market led by Long Beach and the Tri-Cities submarkets with year-over-year growth of 6.9% and 6.2% respectively in the second quarter, followed by the Woodland Hills submarket at 3.9% and the West L.A. and L.A. CBD submarket at 2% and 0.4% respectively. The revenue in our L.A. region was negatively impacted in the second quarter by a dispute with a corporate tenant, which was resolved after the close of the quarter. Concessions are still high in Downtown L.A., often offering two months free at new assets and lease-ups, which encourages prospects to break their existing leases and move into the new building. Commonly in California, leases allow tenants to move out prior to the end of the term by paying a one-month lease break fee. As a result of these aggressive Downtown lease-ups, we are now starting to see some stabilized assets offering $500 to one month free on new leases, similar to our experience last year in the Bay Area. Additionally, new lease-ups in Glendale and Hollywood are now commonly offering two months free. Looking at office activity in the market, the television and entertainment industry continues to drive office demand in the West L.A. submarket, as Amazon Studios, HBO, and Netflix expanded their footprints with a combined total of over 170,000 square feet of new leases. In Orange County, job growth continues to show signs of weakness with 0.7% year-over-year growth for the second quarter of 2017. We achieved solid results in this market despite the weak job growth and supply. The South and North Orange submarkets grew at 5.2% and 4.6% year-over-year respectively in the second quarter of 2017. We are watching Orange County closely as market rents are being negatively impacted by the supply-demand imbalance at this time. Finally, in San Diego, job growth was 1.6% year-over-year for the quarter. Our North City and Oceanside submarkets achieved 4.5% and 4.1% year-over-year growth in the second quarter of 2017, while our Chula Vista submarket achieved 2.5% over the same period. Despite the lower job growth, the rental market in San Diego has remained strong. Currently, our entire same-store portfolio is 96.4% occupied and our availability 30 days out is 4.9%. Thank you. And I will now turn the call over to our CFO, Angela Kleiman.

Thank you, John. I will start with a review of our second quarter results, followed by the full-year guidance revision and conclude with an update on the balance sheet. In the second quarter, core FFO grew 8.4% and exceeded the midpoint of guidance by $0.10, of which $0.03 is related to the timing of expenses and expected to occur in the second half of the year. The remaining $0.07 outperformance was driven by the following: $0.02 from revenue exceeding expectations, $0.02 from operating expense savings, and $0.03 from lower property taxes as we received final bills from several legacy BRE properties, which primarily relates to the prior year period. Therefore, this is a non-same store item. As a result of the second-quarter performance, we have tightened the range of our same property revenue growth, thereby raising the midpoint to 3.6%. Year-to-date, we have raised this midpoint by a total of 35 basis points compared to our original guidance of 3.25%. Moving on to expenses, we are pleased to be able to decrease the midpoint of our same property expense growth guidance by 30 basis points to 2.7%. This reduction is due to a combination of property tax refunds and savings realized from various initiatives implemented in operations, as described earlier by John Burkart. The resulting impact to same-property NOI growth is a 30 basis points increase to 4% at the midpoint. Year-to-date, the midpoint of our same property NOI growth has been increased by a total of 62 basis points, as our original guidance was 3.38%. On to FFO guidance, we’ve raised our full-year core FFO per share by $0.07 to $11.83 at the midpoint, reflecting a 7.2% year-over-year increase. We continue to drive our operating results to the bottom line as our core FFO per share growth is 315 basis points above the same property NOI growth rate at the midpoint. As for the third quarter, we are projecting core FFO per share of $2.93 at the midpoint. The $0.04 sequential decline is primarily due to the one-time property tax benefit mentioned earlier. Lastly, on the balance sheet, at the end of the quarter, our net debt-to-EBITDA improved to 5.6 times from 5.7 times since the last quarter. This is consistent with our expectations for this ratio to decrease from growth in EBITDA. The continued downward trend in this metric over the past several years has enabled us to reduce the low end of our target range from 6 times down to 5.5 times. During the second quarter, we issued $81 million of common stock through our ATM program, which substantially meets our equity needs to match fund our investment activities. Since much of our acquisitions and dispositions will involve the co-investment program, the net effect is minimal on our funding plan as it relates to future equity issuance. We remain disciplined and well-positioned to be opportunistic relative to our cost of capital in order to optimize opportunities in the marketplace. With full availability on our $1 billion line of credit, a variety of capital sources, and zero debt maturities for the remainder of the year, our balance sheet remains flexible and strong. That concludes my comment, and I will now turn the call back to the operator for questions.

I was just hoping you could speak to the new and renewal trends achieved in the second quarter by the major markets. If you would.

Sure. This is John. So new in Southern California was about 3.1%, renewals were about 4.6%, in Northern California new was about 1.8% in the second quarter and renewals were about 2.7%, and then in Seattle, new was about 8.7% and renewals were about 5.9%. So overall for the portfolio, new coming in about 3.6% and renewals at about 4.1%. And to be clear, the way we're looking at that is versus comparable terms, so roughly 12-month lease compared to a 12-month lease because as soon as you start changing the terms due to revenue management pricing it'll shift the numbers around a little.

And then I was just hoping you could talk about Southern California and you kind of mentioned some supply pressures. How do you see that playing out in the second half of the year, and if supply is skewed to the second half of the year in Southern California? What are your thoughts into 2018, and how should we think about the duration of this supply pressure, maybe comparing it to what we saw in Northern California last year? Have you seen any improvement in the jobs, or should we expect the same level to continue?

Hey Juan, it’s Mike. I'm going to try and address that question and maybe John may want to add on to that. We see supply continuing in L.A. actually increasing a little bit in 2018 relative to 2017. Orange County, however, seems to drop off pretty significantly in 2018 relative to 2017, but we’ll remain consistent for the rest of the year. We actually expect a pretty large increase in San Diego for 2018 over 2017, so that's how that plays out and that compares to significant reductions, around 40%, in Northern California in 2018 and around 10% in the Seattle marketplace. So that is one factor. And then as you noted, the other factor is what's going on with jobs, and we've brought those numbers down significantly from the last quarter to this quarter in regards to Southern California job growth. But do a couple of months make the year or the quarter fundamentally change? I’m not sure we can answer that question. We try to highlight some of the factors that we think are influencing or reducing job growth, which includes the shortage of skilled workers and the overall low unemployment rate, so the availability of workers is just not there. I believe that's probably the key factor that is limiting job growth. The answer to that would probably be that wages will go up, and people in other parts of the country will relocate to the West Coast to take those open jobs. I'm not sure how we track that, but I think that is key, and those forces will put pressure on wages and hopefully increase rates of mobility, making it more attractive to move from the East Coast or the Midwest to the West Coast. We think that's ultimately the answer.

I'm going to add just a few comments. As Mike said, for jobs overall, our April and May really reflected the nation's level of weakness, and then June came back stronger, just like the U.S., so it's a little bit of mixed messages. Additionally, just a little bit more commentary on the marketplace. In Northern California, I referenced earlier what we’re seeing in L.A. with the concessions, and how now some of the stabilized assets are giving concessions because of eight weeks free or two months free at the lease-ups. That is the main difference. In Northern California and Seattle, the markets are more seasonal, where in the second half of the year they drop off pretty significantly. Whereas in Southern California, that tends to not happen, it comes down a little bit but not very much. So how this plays out? I suspect it will trend a little bit stronger than Northern California did last year.

Thank you very much. It’s very helpful.

Thanks. In terms of the preferred equity and nice debt opportunities, what sort of competition are you seeing in the market today?

This is Mike, I’ll take that one again, Nick. We're seeing more competition generally speaking, and at the same time we’re seeing somewhat lower deal flow. So we're seeing both of those occurring, and that's pretty consistent with what we see on the development side. John Eudy might want to add to this, but overall we think fewer development deals are penciling primarily because construction costs are rising faster than NOI, which is putting pressure on development deals. So I think generally speaking, the number of deals that make sense are fewer than they were a year ago, let's say, and that cuts into the preferred equity and debt program as well.

Thanks. And just in terms of rent control initiatives, do you have any update on those? Recognizing the market has been in a stop-and-start pattern in terms of rent growth, but any update there would be great.

Yes, it's Mike again. There are over 100 bills that are in the state legislature right now, and many of them deal with housing. I was going to note that there's a really good summary of a lot of the activity in the L.A. Times article dated June 1st of this year. I guess the big question is what, if anything, hits the ballot in 2018. There have been discussions about Costa-Hawkins, which is a statewide rent control measure that basically limits the extent to which local governments can enact rent control. That's the big discussion here. But there's a lot of activity out there, and I don't think we can conclude much at this point in time based on all this activity. But I can give you some of the areas that some of these bills are dealing with—certainly affordable housing production is one of the key areas. For example, allowing smaller units, such as 150 square feet per unit, could lead to more housing of all types. Another bill would expand the area around a BART station that can be developed for housing from a half-mile radius to a mile radius, raising money for housing of all different types from bonds and other types, transaction fees on real estate, eliminating the mortgage interest reduction on second homes, and doubling the tax credit for low and mid-income renters. So there's lots of activity, both at the state level and at the local level. There's a lot going on in California, and a lot of discussion, but it's probably not the right time to conclude anything from all of this.

Thanks.

Yes, hi. Thank you. Earlier in the call, you talked about median home prices going up in Seattle and Northern California, and you also mentioned that a significant portion of your portfolio is convertible into condos. Can you provide a little more color on that? Is that something on your radar?

Yes, this is definitely on our radar. We have somewhere around 8,000 or 9,000 apartments that can be converted into condominiums. Some require additional work to complete that process. Virtually everything we build has some kind of condo map at some stage. This includes a couple of the deals that we have recently started or can start in the near future. I know John Eudy has spent a fair amount of time looking at that. But just to remind you of our overall metric, we need to see a substantial premium of condo values or the value of our property as a condo considering all the costs involved relative to its value as an apartment building. Apartment values have performed really well over the last several years, and so we are starting to see some of those premiums for sale housing relative to apartments. I think we have a ways to go, but we are definitely monitoring and focusing on this.

Okay, great. And as a follow-up, I think you talked about how difficult it's getting to develop more assets due to higher costs. I was wondering when you think about your pipeline over the next few years: should we expect you to do any more development outside of the starts that you mentioned earlier in the call?

Yes, this is John Eudy. I think we've mentioned in our previous call, we’ve got up to three deals that we anticipate starting between now and year-end. All three have legacy land costs and don't have some of the exactions that are being asked for and approvals that are being granted today. So you could expect those three to occur late Q3 to early Q4. Beyond that, our pipeline is very, very skinny. We are looking at a couple more opportunities as we can, but clearly, a year from now if you look at our pipeline in process, it will be significantly less than it is now.

Okay, thank you. That's all from me.

Thank you.

This is Trent Trujillo on with Nick, and thanks for the color and for taking a question. I just wanted to follow up in detail on your guidance range. You tightened and increased the same-store revenue guidance for the year. Can you talk about your forecasted second half San Francisco rent growth expectations? And along similar lines, earlier in the year, you provided some additional detail on the same-store revenue expectations by region. Do you happen to have an update on those underlying ranges and if you amended the aggregate range?

I would point you to the regional detail. As for the port, I would point you to our F-16 which outlines our expectations for the year specifically. And for the year, for the total portfolio, the second half of the year, our range would imply low end for the second half at about 2% and on the high end, if we achieve the high end, it's closer to 4% to get us to the average of the 3.6% average.

Okay, that’s helpful. And just maybe to get into the same-store expense side, you provided a lot of color in your prepared comments. I just wanted to go back to something that you had mentioned earlier in the year about second quarter expenses projecting to about 4.5% and they ended up well below those expectations. So just a little bit more color on what you did to improve expenses and if there is anything that we can expect going forward as additional expense savings.

Sure, happy to. As far as our first-quarter call, we announced the 4.5% expense growth, and at that time, we hadn't contemplated the property tax benefit. But also, we had expected that in Q1, due to storm activities, we would incur the normal painting, tree trimming, etc. Those activities occurred in the second quarter, but it only made sense to delay that during peak leasing season. That's the $0.03 that will still incur in the second half of the year. And then of course, the combination of various operational initiatives that John Burkart mentioned earlier led us to gain confidence in lowering the overall expense guidance. So we're not expecting more than we had talked about earlier.

Okay, very helpful. Thank you very much.

Thank you.

Hi, good morning. Thanks for taking the question. Just a quick one; you talked about lowering your internal cap rate about 10 basis points. I was just curious if you could talk about what you're seeing in the transaction market in terms of volume as well as the number of bidders and who the bidders are?

Yes, Austin, it’s Mike. Thanks for the call. Yes, we lowered our portfolio NAV as noted by about 10 basis points, and really that was the culmination of looking at all the transactions that we've done over the last let's say six months or so and realizing that we basically outperformed what we expected per NAV model. In terms of the properties that are most attractive and the types of bidders: generally, the REITs are not in the market. You saw the Monogram take-private transaction and a name co-JV buyout and that type of thing, but for the most part, we're not seeing a big rebound. We are seeing many institutions that are interested in apartments and want to invest in apartments. I’d say the institutional side has been very, very strong. They are focused on very well-located and high-quality properties, generally within the top areas, high-quality properties, and then the value-add component with a partner who can execute that. Those two specific types of transactions are seeing multiple bidders. They are going through several rounds of best and finals that typically accompany those. Overall, we're seeing prices that are generally exceeding our expectations, and hence my comment in my prepared remarks that we are often outbid.

Thanks for the detail there. And then just curious, when you think about same-store revenue growth expected to bottom in the third quarter, and occupancy will again be flattish in the second half of the year. Should we expect that blended lease rates for the portfolio to turn positive on a year-over-year basis sometime in the back half of the year? Or does any of that change given some of the supply dynamics getting pushed out?

Yes, so you're saying blended new lease rates, we do expect that our rates right now are above the year-ago figures and we expect that to continue. Last year we did see quite a falloff in the second half. Our expectations this year are to be more consistent with a normal year, and so that will ultimately create a greater spread. So at the end of the year, if you look at year-over-year lease rates, the December over prior year's December, that would mean a closer rate of about 4% year-over-year that we would end on.

Great. And then just last one for me, just with all the moving pieces within the Northern California portfolio in terms of jobs being out in San Jose. You talked about Adobe and Google. Any plans or thoughts on changing any sub-market exposure within the Northern California region?

Hi, this is Mike. I think that within the Northern California region, we still like San Jose a lot. It has some of the best fundamentals. The rent-to-income ratio makes more sense. It seems that area is receiving the most activity. It’s also about locating apartments near the jobs, so it seems logical for us to focus there. That said, we’re not ruling out properties in other parts of the Bay Area; this is part of the function of cap rate and the value we believe we can add. So I'd say we're not going to rule out different parts of the Bay Area, but San Jose is certainly an area we like a lot.

Thanks for taking the questions.

Thank you.

Hey guys, thanks for taking the phone call. You've discussed this in various parts throughout the call. I want to take a step back and think about guidance in terms of supply versus demand. You’re taking guidance up at midpoint. From a high-level standpoint, what is driving that higher guidance at midpoint? Is it supply getting pushed out in some of your markets, or is it maybe stronger demand than you would have thought? How are you thinking about the supply-demand balance?

Yes, this is Mike. Honestly, we don't know exactly what it is. I mean the enemy here is six weeks to two months free rent, which draws people out of stabilized communities and softens pricing power throughout the portfolio wherever it occurs. The essence of what you're asking is where are we going to see six weeks to two months of concessions within the markets from Seattle to San Diego because that will impact pricing to the greatest extent. Typically in California, we offer a lease break fee given how the laws work out here, so that’s equal to one-month free; if you get two months free, then the lease-up will pay the lease break fee and pocket the other month. Therefore, that is a significant incentive to move out of the building. So when we say some supplies being pushed out, what we mean is that when we start seeing six to eight weeks free, this means that there are two or three or more lease-ups competing directly against one another, and that causes pricing disruption within that location. Generally, that will always clear the market at some point in time, and when it clears, we will start seeing greater pricing power again. It's exactly what happened in Northern California, and we suspect it'll happen in other parts. There isn't like we can go out and count every quarter the number of lease-ups coming into the market; honestly, we can't see within a 200-unit building how many units are going to come to market when they're completed. So we have to use the anecdotal process of what lease concessions appear on the market and how they affect price within the local market. We look to the overall supply and demand for a good indication of where we think the biggest risks are and wherever there are significant supplies. So in Seattle, we’re concerned about the Downtown L.A. area, particularly with the rise in supply. In Downtown San Diego, supply is going up, but pretty much everywhere else, supply is expected to go down. And let me correct Seattle: in 2018, the supply is expected to decrease, but it will still remain relatively high.

Got it. And then just one more question quickly about San Francisco—there have been a few different data points asked regarding whether or not supply is getting pushed out. What do you see in San Francisco? Is it supply going down in the near-term? How do you think about that?

Yes, San Francisco's interesting; we have San Francisco at five weeks free right now, but that's down from six weeks free recently. So again, back to my anecdotal evidence, it's concerning but remains at a somewhat stable range in the four to five weeks for it to be an acceptable environment. It doesn't provide enough incentive to draw people from, for example, stabilized communities to live in San Francisco. You get up to eight weeks free, and people living in, say, San Mateo are more likely to move into San Francisco. The other point I would make relates to the Bay Area; at one time, there were about 25 active lease-ups, and several of these in San Francisco, 10 of those 25 are in the final lease-up phase. So when they are gone, I think it will become tighter. We see the projection for the Bay Area to become a tighter market with a left lease-up philosophy, which should help us with pricing.

Got it. And then just one last thing, if I can—sorry for being redundant here—how do you think supply versus demand affects your overall view of the market?

Yes, demand is generally not the problem; it's a matter of price, and that's why I focus on the concessions that have been the critical key element of this.

Thanks, good morning. It sounds like in Seattle, despite the increase in vacancy this quarter for you, the characteristics are overwhelmingly positive. Where do you think we are in the cycle in Seattle, and has that changed at all in the last few months?

Yes, it’s Mike. Seattle's a little bit of an enigma for us. We expect it to be a little more muted over the last couple of years, and we’ve been wrong; it turned out to lead the portfolio. The thing that obviously concerns us is the supply. When you point to Amazon here and look at what they've done in Seattle, it’s worth noting that this entity has a dramatic impact. We view Seattle, given the amount of supply coming online, as a little bit riskier market. This would mean we’d seek a little bit higher cap rate if we were investing there. We don’t necessarily want to continue to add to the portfolio in Northern and Southern California without adjusting that pro-rata share. We will look at acquisitions in Seattle, but we’d want to be pretty cautious about buying in that market. Going forward, I guess we’re more or less jumping on board with the Seattle train, saying it looks pretty darn good and appears to be viable in the near future, so I think that as we go into 2018, we're going to view it as one of our best markets.

Yes, I would just add, I recall these calls years ago when people would ask us about Boeing. Look at the changes that have gone on in Seattle; really fundamental changes, and they continue to this day, yet Seattle still has a rent-to-median-income ratio of about 25% compared to many of our markets. So there’s still room to go. It’s a market that’s undergoing very positive change, and I think it still has legs.

But as far as weighting your company, it's still going to remain around 18% or so?

We target 20%, but that can ebb and flow again; cap rates and deal flow and opportunity become part of that equation. We're not developing in Seattle right now, because we don't want to be the one that is half completed when the cycle ends. Again, we like Seattle; we're more optimistic about it today than we were a year ago, but it is a cautious area across the board.

Okay, and then on your balance sheet, marketable securities went up $30 million this quarter, totaling $152 million. Can you just remind us what this is primarily comprised of and if you own any shares in any public company?

Let's see. Marketable securities are primarily our insurance captive activities, so there is not a meaningful change in investment activities there. We don’t have any meaningful ownership of any of our peers.

Okay, thank you.

Hi, good day out there. Just two questions here. The first one is on Downtown L.A.; that market has been transforming for over a decade, and there's always a lot of supply there. Do you have a concern that that market, just because it seems like there is a lot of development push to have development there, remains in a situation of persistent imbalance where developers will never pull back just because of the political push to develop, or do you think that it will hold back and finally allow landlords to regain pricing power there?

Alex, it’s Mike. That’s a good question, and obviously we don't have a perfect answer to this one. We entered Downtown L.A. in the late 90s and we had two scenarios; one was it continues to be the place that everyone leaves at six o'clock at night, and the other was that it becomes more like a 24-hour city. I think we now know where that's going. The California Global Warming Solutions Act of 2006 has helped with it, where California is trying to get people out of suburban sprawl and into high-density residential in urban areas. If there's a shining example of that, it’s probably Downtown Los Angeles. The amount of transit dollars going into that area and the amount of development occurring has transformed Downtown L.A. We think this will be choppy over time, but remember financial constraints will impact new development. If developer rents disconnect from construction costs and construction costs rise, we systematically witness development slow down. Applying this logic to Downtown LA shows that there cannot be unfettered development forever. So we’re believers in Downtown LA. We're not going all in, but we think it's a market that can take some time to achieve its potential. Remember, all the jobs are already there; it has a substantial downtown, so it will come down to at what point will people choose Downtown L.A. over commuting from Glendale, Burbank, or Westside LA. Another issue driving California is the limited investment in cars and highways, relative to demand; this creates traffic congestion and pressure on commutes which incentivizes residents out of their cars; once again, we interpret this to be a positive for Downtown L.A.

Okay. And then the second question is just going to John. John, you mentioned that there was some softness in June versus earlier in the year. Was that comment regarding portfolio wide or was that more focused on Orange County and L.A.?

Sure. I mean over the whole portfolio, our occupancy dipped a little bit in June. If we go back to last year, we had a really strong January through May; we were not going to miss the market, so we pushed pretty hard on rent. So I think we found the top, but that's why I went into a bit more depth in the comment to say that in July we then turned around and gained occupancy by making a few adjustments with rent. I don’t see there being a market problem; it’s more pronounced in Seattle. And as I mentioned, part of it relates to turnover and more contact; we were also really trying to see if we were reaching the peak of the market. We're now implementing the adjustments, and we expect it to finish with solid occupancy in Seattle looking into Q4. So that’s our management plan there; I hope that helps.

Okay. That’s helpful. Thanks, John.

Thank you.

Hi, everyone. Looking at the supply next year in Seattle, are you more concerned about the CBD where you don’t have exposure or more of the submarkets such as Bellevue which is going to have an uptick?

Hi Wes, it’s Mike. Well, I have a chart that has the breakdown. I think we still see more supply in the Downtown area, and our portfolio is largely on the East side. We believe we have a little protection relative to that. But it looks like next year’s breakdown shows a slight increase in supply in Downtown; around 4,500 units, the East side remains similar this year at around 2,700 units, and the North and South show about 1,500 units. So overall, Downtown is increasing a bit and the East side will remain similar with North and South seeing less overall supply than we had last year.

Okay. And then looking at your cap rate that you cited, is that nominal or economic?

Well, that's why I say that it’s using the Essex definition, and let me summarize; I can't translate it immediately in my head. Our definition of a cap rate is using market rents today in the marketplace with a market management fee or management cost and marking property taxes to market, while assuming a 95% financial occupancy rate.

Okay, thanks a lot.

Thank you.

Hey, good afternoon. Just on the macro comments Mike you made in the prepared remarks about less millennials entering into the workforce. While that may be the case, are you seeing more millennials fitting into a range maybe closer to where your average tenant is? I see your average tenant is not 22 or 23 years old; any comments on that?

Well, I think the markets we're talking about in general may not necessarily reflect our performance because A product versus B product: you know, you have millennials who are more likely to rent the Bs. However, it puts pressure on the pool of moving people around within the pools. I’m not sure that our actual performance is reflective of exactly the market. But we’re starting to look at demographics as part of the overall supply and demand relationship, and I look back and think that I had a relatively easy time over the last 30 years because this business came down to a few factors: supply, demand, affordability between apartments and for-sale housing, and maybe commute patterns. Now we have to deal with rent income demographics and maybe regulatory issues, so it's a bit more complicated. But I'll go back to John—John, within our portfolio do we see any notable changes in who our renters are?

No, I think it’s a surprise to some people. They tend to think that our portfolio is going to be full of millennials, but we really have a diverse group of people across our portfolio. Some people remain as long-term renters, and they're phenomenal tenants; others kind of come and go, which is more typical of the millennial group.

Okay, that’s helpful. And John, one last question, could you provide loss to lease by region?

Sure. In Southern California, our last release for June was 2.3%, in Northern California 2.8%, in Seattle 7.2%, and then as I said in the opening, that brings the average to 3.4%.

All right, great. That’s very helpful. Thank you.

Yes, thanks for taking my questions. Just a follow-up on Drew’s question for Seattle. What was that trending at on the loss to lease? What’s that trending that for the past few quarters that elevated from some point to?

Sure, if we look back a year-ago, it's probably the easiest. If you go back to June '16, it was 9.5%, and if we go to December '16, it goes down to 1.6%. So a very big reversal; the market is very seasonal. Then we come back to May '17, it was 7.4%, and now in June '17, as I said, it’s 7.2%. So Seattle has a huge level of seasonality in the market; it's our most seasonal market, compared to the Bay Area and Southern California, which sees much less variability.

Great. That’s very helpful. And then most of my questions have been answered, but just one more general one. In terms of move outs, are you hearing any more about move out due to single-family rentals by any change? And how do you all incorporate that into your supply outlook? Do you include the single-family rental market in there at all?

Yes, actually we do, but indirectly. We do supply and demand as a whole, so if someone goes from renting the house to renting a family unit, we track that; we use that to look at the entire housing stock. So what’s the net change in the housing stock? What’s that net change in demand represented by job growth and maybe demographic factors? Supply and demand shows us what appears stronger or weaker, so our view is based on those principles. So in terms of what people actually choose to do, this remains a question of affordability versus demand. And we actively consider this interconnected system when evaluating our portfolio. An example of this dynamic can be seen in multifamily permits not being lower in our markets, but not too concerning because multi-family permits remain pretty high relative to other permitting.

Yes, maybe just a little bit more anecdotally. Are you hearing about more move-out due to the single-family rental pool becoming a bit institutionalized? Are you seeing a trend that way?

No, not at all. The single-family rentals, as it relates to institutional ownership, they’re really outside our market. They may have literally one house in our Bay Area market, and they just don't have penetration in our market; they’re outside and located where housing demands are lower.

Okay, that’s all from me. Thanks, guys.

Sure.

Hey guys. How are you?

Doing well.

Thanks for joining.

Just wondering about Seattle here. If I look at your June deck, you guys were doing 7% in Seattle in April and May, and you've reported 6.6% for the quarter, which kind of tells me that June was a lot weaker, around the 5.86% range. Is there something specific that happened in Seattle in June? I know you mentioned seasonal, but what's pricing like there today versus earlier in the quarter?

Sure. This is John. So yes, June for Seattle was about 5.5%. That decline in June is really a combination of, as I mentioned earlier, the occupancy decline. Occupancy in Seattle declined 90 basis points from where it was at the start of the month; that’s a result of turnover and just pushing rents very hard. I wouldn’t say it's reflective of the market having trouble; as we've said from the end of last year, we're expecting declines to continue. But we've since picked up some occupancy in Seattle again, as expected, based on our management plan, so we’ll finish up the quarter with solid occupancy heading into Q4. Does that help?

Sure. Perfect, that's all for me.

Thank you.

Good afternoon.

Hey, Conor.

John, what was new lease growth for July up to now?

Yes, so new lease growth for July is—I don't have it directly in front of me—but it’s trending less year-over-year, about say 2.5% versus the 3.6% in June because we’ve pulled rents down and gained occupancy. So overall, we moved rents down in July about 1%, and then decreased availability by about 40 basis points, which is significant; so we’re sitting now at 95.1%. Where I'm going with that is we pulled it down a little more to be more strategic with our management. We filled up the portfolio, and now we’re pushing the numbers back up. So does that help?

Okay, yes, just to be clear, you said 96.1% or is it 96.5% for the quarter you're expecting?

Right now, where we sit, occupancy is 96.4% and our availability 30 days out is actually 4.9%.

Great, thank you. And then what's the opportunity on the BRE portfolio and continued redevelopment there, even not on full scale but lighter CapEx, to get that up to speed with the rest of the portfolio? How has that played out this year, and is there further opportunity next year?

We don't even separate out the assets like that anymore. I would say across the board in our portfolio, it's like all of us in this room here: every year we get a year older, so we are on a steady path right now, so if you look at renovation say if we renovate 5% of our unit, that would imply a 20-year life for say the kitchen and bath. That’s kind of where we tend to be. I think that will continue that way, and the BRE portfolio is largely getting rolled in or it has been rolled in as it relates to most of those things. Also, as I mentioned in the call earlier, we are now paying attention to some strategic locations—finding some opportunities on expenses in other areas.

Great. Thank you. The last one, San Francisco showed a slight acceleration versus last year. I mean, it’s obviously very small for you guys, but it’s big in terms of how it impacts the East Bay. When do you expect— I mean, you said earlier that people aren't being drawn back into the city from the East Bay yet, but at what point do you think San Francisco starts to push people back out into Alameda?

It’s Mike; this has been an ebb and flow. When San Francisco has six to eight weeks of concessions again, people start flowing from the East Bay back into San Francisco; and then when those concessions abate, it actually goes the other way, because people are very price sensitive. Remember, that’s somewhere between 12% to 16% of annual rents; that provides a strong incentive. I think the key point for what we’re trying to express is that supply has to be carefully monitored. We observe close interactions between Oakland rents and San Francisco rents. Oakland and similar markets have underperformed last year but are doing better this year, and we expect that back and forth activity to continue based on the concessionary environment.

But just again with the direction of San Francisco, as the concession stays low, that should begin to reflect more in your Oakland portfolio in the second half of the year or early next year?

That's what I think is happening; yes, I think people can afford San Francisco, therefore they are staying in the East Bay. Yes. Thank you, operator. We greatly appreciate your participation in the call. We hope to see many of you at the BofA Merrill Lynch conference next month. Have a good day. Thank you.