Essex Property Trust Inc (ESS) — Q3 2018 Earnings Call Transcript

Thank you, Dana. I would like to welcome everyone to our third quarter earnings conference call. John Burkart and Angela Kleiman will follow me with comments, and John Eudy is here for Q&A. I will discuss three topics on the call today: Our third quarter results and preliminary 2019 market outlook; investment market conditions; and an update on the apartment industry’s campaign to oppose California Prop 10. First topic. Our third quarter results were mostly as expected, reflecting a solid economy and severe shortages of housing on the West Coast. We continue to experience strong demand for multifamily housing across the West Coast metros, with periodic disruptions to pricing when multiple apartment lease-ups occur within a submarket, often leading to large leasing concessions and often impacting pricing at nearby stabilized communities. Job growth has continued to outperform our initial 2018 expectations across the Essex portfolio. Job growth is slightly lagging in Southern California and strong in the tech market as demonstrated by greater than 3% job growth in both Seattle and San Jose. With tight labor market conditions, income growth continues to outpace rent growth, which is improving rental affordability. Per capita personal income growth in Essex metros is expected to average 5.7% in 2018, almost 1% from year-ago and compared to 4% for the nation. As John Burkart will discuss in a moment, we have experienced normal seasonal patterns in 2018, significantly different from 2017. Same-store revenue growth for 2018 troughed in the third quarter, mostly due to revenue strategy and year-over-year seasonal variation. Overall, market conditions are much better now compared to year-ago, and our portfolio remains well-positioned. Consistent with the strong job growth in the tech markets, job openings for the top 10 public tech companies, all of which are headquartered in California and Washington, increased 26% year-over-year to nearly 22,000 open positions as of September. With the dearth of skilled workers, employers continue to face shortages of qualified personnel, pushing wages upward to attract employees from other areas. Turning to our market outlook for 2019. Today, we have better visibility into the year ahead compared to last year. And thus, we have included our preliminary outlook for 2019 on page S-16 of the supplemental. We also provide the primary supply and demand drivers that shape our rent growth expectation. S-16 is intended to be a scenario based on the strength of the U.S. economy. We begin with the U.S. GDP and job growth estimate from third-party sources. And based on these key assumptions, we estimate job growth and housing demand in the Essex metros. As to housing supply, we drive each market to gain insight on apartment delivery timing to create quarterly estimates. Using historical relationships between housing supply, demand, and rent growth, we established our 2019 market rent growth expectations. For 2019, the U.S. economy is expected to continue growing at a healthy pace with U.S. GDP and job growth of 2.5% and 1.3%, respectively. The unemployment rate for the Essex markets declined by 50 basis points from the past year to 3.5%. Over the past several years, falling unemployment contributed to job growth, although this positive impact will likely diminish going forward. We expect the West Coast economies to outperform the nation regarding job growth, which we estimate at 1.8% for the Essex metros in 2019. This was about 30 basis points below the September actual job growth of 2.1%, again reflecting the impact of tight labor market conditions. For 2019, we expect 3.1% market rent growth in the Essex markets, with California slightly outperforming Washington and the best results in San Jose and San Diego. Oakland is expected to lag due to increasing apartment deliveries. Reflecting the importance of economic growth in our 2019 assumptions, we produced a new graphic on page S-16.1 of the supplemental to demonstrate the outperformance of the Essex metros in terms of cumulative nominal GDP growth. Bottom-line, the Essex metros have outperformed the U.S. average and other major metros in the past five years and are well-positioned for continued leadership going forward. Turning to Supply in 2019. Our preliminary forecast assumes that multifamily supply will be relatively flat in 2019 versus 2018 in the Essex markets, with significant variances in some markets. Most notably, we expect a substantial increase in apartment supply in Los Angeles and Oakland, and significant reductions in Orange County, San Diego, and San Francisco. Construction labor shortages continued to be a major factor affecting apartment delivery timing, and this issue continues unabated. Thus, in 2019, we made a notable change to our supply methodology on page S-16 of the supplemental by factoring delays into the estimated delivery timing of newly constructed apartments. Thus, our multifamily supply, shown on S-16 of the supplemental, has pushed roughly 8% of apartment units, or around 3,000 units, from 2018 into 2019 and from 2019 into 2020. For the next couple of years, we see little change in the number of apartments being built and the overall construction labor force. Therefore, there's no reason to believe that the delays will abate. With housing demand continuing to exceed supply, we believe the housing shortages on the West Coast will continue. Now, turning to my second topic, investment market conditions. 2019 is likely to be another year where escalating construction costs, driven by labor shortages and entitlement cost increase at a faster pace compared to rental revenue and net operating income. Therefore, developer yields are being compressed, creating a significant headwind to apartment construction starts. This is a challenging scenario for our direct development activities, and thus, we have not materially added to our development pipeline. Instead, we are focused primarily on providing preferred equity to third-party apartment developers in the Essex markets. At the start of 2018, we had a strong preferred equity pipeline and hoped to significantly exceed our $100 million target. As it stands now, we will struggle to hit our target in 2018. Angela will comment on guidance in a moment. As it relates to acquisitions, we continue to see plenty of capital looking to buy apartments, keeping cap rates relatively flat. Recent increases in interest rates have erased most of the positive leverage tailwind that we have enjoyed since 2007, as long-term apartment financing rates are now comparable to cap rates. A-property and locations continue to trade around 4% to 4.25% cap rate and sometimes sub-4 for exceptional property, with B-quality property and locations generally trading 25 to 50 basis points higher. We will continue to monitor the transaction market closely. And now onto my third topic, an update on California Prop 10. As we have highlighted on prior calls, we are part of a broad coalition to close California Prop 10, which seeks to repeal the Costa-Hawkins Rental Housing Act on November 6. We are joined by other apartment companies, trade organizations, unions, veterans, and a variety of pro-business groups. I think it's appropriate to recognize the extraordinary effort of those involved in the No-On-10 campaign, especially the executive committee and co-chairs, John Eudy, and Barry Altshuler. They have successfully united the industry around a worthy cause. We believe that passing Prop 10 will intensify housing shortages, making a bad problem worse. It will likely lead to the expansion of price controls for all types of housing, resulting in less housing being built. Price controls produce longer tenancies, which in turn reduce the number of available rental units for those seeking housing, and those with limited means will be at an increasing disadvantage competing to pay for housing amid greater scarcity. Finally, apartment, condo, and single-family owners will have a strong economic incentive to convert rentals subject to price controls to owner-occupied housing, thereby shrinking the rental stock. Important to note that Prop 10 contains no funding for affordable housing and no requirements for additional housing to be built. The state of California directs a process called the Regional Housing Needs Assessment to plan for sufficient housing supply. However, many cities don't want to create housing because of the related costs of services, including schools, police, etc. Gavin Newsom, a leading gubernatorial candidate, captured this issue on his website with the following comment: 'Cities have a perverse incentive not to build housing because retail generates more lucrative sales tax revenue. The bigger the box, the better, because cities can use the sales tax for core public services.' As a better approach, the state has recently passed many laws that support the Regional Housing Needs Assessment, which we believe are critical to increasing housing production, the only viable solution to the crisis today. We also believe that more funding is needed, targeted to affordable housing. And thus, we support California Prop 1. That concludes my comments. And now I'll turn the call over to John Burkart.

Thank you, Mike. The third quarter was solid and aligned with our expectations, following typical seasonal trends with the rental market reaching its peak in July. Our operations team adjusted our strategy from maximizing occupancy to securing higher rental rates typical of the season. Consequently, we saw a slight dip in occupancy across our portfolio, down by 30 basis points, while rents for new rentals increased by about 3.5% compared to the same quarter last year. For 2018, the third quarter represents the lowest point for same-store revenue growth due to lower occupancy and a special payment made in the third quarter of 2017 tied to delinquency collections from a corporate housing operator, which distorted comparisons. If we adjust for occupancy changes and this one-time item, same-store revenue growth for the third quarter of 2018 would have been 2.6%, or 40 basis points higher than what we reported. Overall, our concessions for the same-store portfolio in Q3 2018 decreased by roughly 20% compared to the previous year. Renewals in the third quarter increased by about 4.2%, and we anticipate sending out renewals at around 4.5% for the fourth quarter. Our loss to lease in September was 1.7%, compared to 20 basis points in September 2017, reflecting a stronger rental market this year, positioning us favorably for 2019. We project that same-store revenue growth for the fourth quarter will be roughly 2.9%. While we are not offering specific guidance at this juncture, we observe that the market appears to be a bit stronger than in 2018, and our portfolio benefits from the 1.7% loss to lease in September. We expect some revenue challenges due to increased occupancy costs in 2018 and ongoing wage pressures in our markets, which are consistent with trends over the past several years. Now, regarding our markets, the Seattle area continues to thrive, supported by strong job growth, posting a year-over-year increase of 3.7% in Q3 2018, the highest job growth recorded in Seattle in over 17 years. In the job market, Amazon has over 7,000 job openings as of Q3 2018, more than double since last year. The tech sector remains a significant contributor to market dynamics. Amazon, Google, and T-Mobile have leased over half a million square feet of office space in Bellevue, and Facebook lists around 150 open positions in Redmond, signaling expansion. With the light rail expansion to the east side set to commence service in 2023, we anticipate a rise in office leasing in that submarket. Same-store concessions in Seattle rose from 80,000 in Q3 2017 to 197,000 this quarter, with concessions spread across numerous assets in different submarkets mainly used for closing deals. Revenue growth in the east side and Seattle CBD submarkets was relatively flat at 1.6% and 40 basis points, respectively, while the North and South submarkets grew by 2% and 3.5% respectively in Q3 2018. Overall market loss to lease at the end of the quarter was 1.2%. Now, in Northern California, job growth in the San Francisco Bay Area for Q3 averaged 2.4% year-over-year, adding over 76,000 jobs. San Jose saw strong growth at 3.2%, while Oakland and San Francisco experienced increases of 1.8%. Significant office leases this quarter included a combined expansion of 350,000 square feet by Amazon and PwC in downtown San Francisco; in the Peninsula, Facebook leased 800,000 square feet for ongoing projects in Burlington; and Roku added 250,000 square feet in the Bay Area, while Splunk signed a lease for 300,000 square feet at Santana Row, planning to hire 2,000 additional employees. Overall office leasing exceeded 11 million square feet in 2018, surpassing combined leasing activity for the previous two years. VC funding in San Francisco and Silicon Valley reached a peak of $41.6 billion over the trailing four quarters through Q3. However, same-store concessions fell by over 50% in Q3 2018 compared to the prior year. The year-over-year same-store revenue growth for Q3 2018 was led by the San Mateo submarket at 3.4%, with Oakland and San Jose each showing growth at 2.4%, while Fremont grew at 1.8%, and San Francisco remained flat during this period. Rents in the Bay Area were approximately 3.3% higher, with a loss to lease of 1.1% in September. In Southern California, job growth in Los Angeles averaged 1.3% year-over-year in Q3 2018. Netflix is enhancing its presence in the market, preleasing an additional 330,000 square feet in Hollywood. Similarly, co-working companies SpaceX and WeWork expanded their presence by nearly 200,000 square feet during this timeframe. Year-over-year revenue growth in Q3 2018 was driven by our Long Beach and Woodland Hills submarkets, with growth rates of 5.4% and 4% respectively, followed by West LA at 2.8% and Tri-Cities at 2.4%. The loss to lease in LA County was 2.4%. In Orange County, job growth in Q3 was up by 60 basis points year-over-year. This mirrors 2017 trends when job growth rose from 30 basis points to 2.2% upon revisions. We will keep monitoring job growth in this area. Orange County's loss to lease stood at 1.7% in September. Lastly, in San Diego, job growth year-over-year remained steady at 1.7% in Q3 2018. Amazon expanded its tech hub in San Diego by 85,000 square feet and plans to hire 300 tech workers. Notably, high-paying industries accounted for over 50% of job growth in San Diego. Year-over-year revenue growth for Q3 2018 in northern San Diego submarkets was 3.4%, with Chula Vista at 4.1%. The loss to lease in the market was 2.2% in September. Overall, same-store concessions in Southern California have decreased by about 30% compared to the previous year's period, with 65% of the concessions related to downtown LA and areas in South Orange County affected by supply. Currently, our portfolio's occupancy stands at 96.5%, and our availability 30 days out is at 5.1%. Thank you. I will now pass the call to our CFO, Angela Kleiman.

Thank you, John. I’ll start with a brief review of our third quarter results, then discuss the full year guidance, and conclude with an update on capital markets and the balance sheet. In the third quarter, core FFO grew 5.7%, exceeding the midpoint of guidance by $0.03 per share. Details of the reconciliation to our original guidance are included on page four of the earnings release. Our favorable third quarter results enabled us to raise our core FFO per share guidance by $0.03 at the point to $12.56 for the full year. This represents a 5.4% year-over-year growth, which is 90 basis points higher than our original guidance of 4.5%. Turning to our third quarter investments and funding plan. We closed $104 million in acquisitions in the Wesco V joint venture and originated an $18.6 million preferred equity investment, which brings our total structured finance commitments to approximately $385 million. We plan to fund the new investments with two dispositions that are on track to close at the end of the fourth quarter. As for guidance on investment activities for the full year, on acquisitions, we expect to achieve the low end of our range. On our $100 million preferred equity target, we currently have $45 million closed through October and believe that the majority of the remaining balance could close by early 2019 with funding up to six months thereafter. This is consistent with Mike's earlier comments and the headwinds regarding apartment construction starts. On dispositions, we have several properties in various stages of the sale process in anticipation of funding needs for 2019. Depending on the timing of the sale, some properties will transact by year-end. Therefore, we are increasing the high end of our dispositions range from $300 million to $400 million. The use of proceeds may include potential buyout, joint venture partner interest, development funding, stock buyback, and debt repayment, depending on market conditions. As we have done in the past, we will seek to redeploy the proceeds into the most attractive investments in order to maximize the total insurance. Consistent with our original guidance this year, we do not start any new development. As it relates to our existing $940 million development pipeline, our share of unfunded obligation is $384 million, most of which will be funded in 2019, which means over 85% of our development pipeline will be completed and in lease-up by next year. Keep in mind that lease-ups are FFO dilutive until we approach stabilization. Consequently, our preliminary forecast anticipates a potential FFO per share impact of up to $0.10 for the next year. Lastly, on capital markets and the balance sheet. Our capital needs for 2018 remain de minimis. We look to 2019 as we’re trying to repay approximately $590 million of secured debt, which was assumed from the BRE transaction and has an effective rate of 3.4%, but the cash rate is 5.6%. Therefore, this refinancing will be an economic benefit to the Company, but will create an FFO headwind of between $0.05 to $0.10 per share, depending on timing and market conditions. The current rate on our 10-year unsecured bond offering will be in the mid-4% range. However, we have a good amount of flexibility with access to multiple refinancing alternatives. Our balance sheet remains strong at 25% leverage with 5.5 times debt to EBITDA, and virtually full availability on our $1.2 billion loan of credit. That concludes my comments, and I'll turn the call back to the operator for Q&A.

Hi. Good afternoon. Just wanted to follow up on the supply data where you mentioned you changed up your methodology. Could you just give us a little bit more details around that? What would the numbers have been had you not assumed delivery delays, which have been pretty consistent, like you said, ‘18 into ‘19, and ‘19 into ‘20, just to get a sense of comparing that to third-party providers?

Hey, Juan. It’s Mike. Thanks for joining the call. I appreciate it. It's challenging for me to reconcile these figures precisely because the supply estimates from the vendors have varied significantly. There may also be some procedural issues. We are trying to take a longer view of supply, so we looked back to 2017 and projected forward to 2020. Our analysis showed that the total number of units produced in the Essex metros ranged from 34,000 to 36,000 each year across all our metros. Essentially, we conclude that construction labor is the primary constraint. This labor can differ from one submarket to another, meaning it can be somewhat mobile, with workers transitioning between places like LA and other metros. What we believe is happening is that there's a limit on the amount of construction that can occur. We're observing a fairly consistent number of apartment units delivered each year. This led us to make our best estimate of how much would shift from one year to the next. As mentioned in the prepared remarks, we estimate it to be around 3,000 units moving from 2018 to 2019 and from 2019 to 2020. In that context, it results in approximately 36,000 units, give or take, in each of the four years leading up to 2020.

I was hoping you could provide some insight into the expense side. I know it's a bit unclear who should address this, but Angela shared some points about how to consider the impacts on FFO from occupancy and developments. Any additional information you can offer regarding expenses, especially concerning larger items like real estate taxes, as we look into 2019?

Sure. On the real estate taxes, I think with California, that piece is pretty straightforward. CRO continues to be more of a wildcard. So, for example, we had expected 2018 CRO capital to come in around, say, between 10 to 13%; it came in at 16%. For next year, we’re still working through that process right now. But it’s probably going to be consistent and that it’ll be high and it’ll be more than 10%, but probably below, say, 16%, if you will. So that’s our current thing. We expect utility costs to continue to add around that 4% or 5% range. And I think those were some of the largest non-controllable items.

Mike, you talked about cap rates haven’t moved, but you mentioned that positive leverage has started to be eliminated. Historically, you’ve mentioned that it’s being kind of one of the supportive metrics of sustaining low cap rates. So, I'm just curious, when you look back historically, what does your research tell you about the lag between perhaps when cap rates could begin to move higher as a result of the eliminating the positive leverage?

Sure, Austin. I think in our experience, cap rates are pretty sticky; they don’t change quickly overnight. Buyers and sellers need time to adjust to a new environment. There is an enormous amount of money out there looking for investments and looking for yield, and that is one of the forces keeping cap rates at relatively low levels. I wouldn't expect any significant change in cap rates in the near term. I think what happens is you will see buyers and sellers not agreeing, and that will essentially cause a freeze in the transaction markets for some period of time before cap rates would change. Again, we haven't seen that now because there's so much money in the market, chasing deals. We will see what happens going forward. It’s going to take several quarters for this to play out.

I appreciate the thoughts there. And then, can you just give us a sense of how 2019 supply delivery stacks up? Is it more heavily weighted in the first half of the year or back half of the year?

Overall, we believe 2019 will be similar to 2018, with some regional differences. For instance, supply has significantly varied in areas like LA and Oakland, impacting our overall numbers. It's been tough to accurately predict the timing as we look ahead. Currently, we expect the third and fourth quarters of 2019 to remain fairly consistent, although they are somewhat higher in northern California compared to Seattle and Southern California. Thus, supply appears to be relatively even across the quarters throughout 2019.

How do you think about capital allocation and nonorganic growth, given the current stock price? You’ve been active in the past, either issuing equity through the ATM to fund growth or repurchasing shares when you’re trading at a large discount. But right now, you’re somewhat in between those two scenarios. So, how do you think about adding value in this environment?

This is Mike, and that’s a very good question, and we think it's pretty darn difficult to add value in this market. We’ve tried to focus on preferred equity investment, and I think that will continue to be something that we focus on going forward. We also, at this point in time, in prior cycles, have leaned more toward joint venture or co-investment type transactions. However, with interest rates up, they’re becoming more challenging to make work as well. And then, finally, on the development side, we’re just seeing a lot of low to mid-4 cap rate measure today, untrended, so measured on rents in place today, throughout our portfolio. We just don't think that’s enough cap rate to get us excited about development. John, do you have anything to add to that?

Only that we’re keeping our powder dry for when the time comes, and that will change.

Yes, it will be interesting. And so, I will conclude by saying, I’ve learned in this business that you shouldn't try to make something work that just fundamentally doesn't work. Essentially, focusing on the balance sheet, making sure it’s in pristine shape and being ready for opportunities when they arise, we don't know when or where they are going to be, but when that happens, we want to be ready. I think that's our focus now.

And then, you mentioned the headwind too and compression in market development yields. Do you think that will have an impact on rent concessions during lease-ups due to the product that is underway now?

I think that we're expecting pretty consistent concessionary activity going forward. John, do you want to handle that one, concessions going forward, given development?

Yes, absolutely. In Q4, we see a little bit more supply coming at us for the year. So, there would be the normal Q4 softer market. I'm sure we're going to have some more concessions. But overall, our expectations are concessions are in check across each of the market. Again, as Mike has mentioned, LA, downtown LA is going to have more products. There will be isolated cases with more concessions. But overall, as a company, our concessions are down in the same-store portfolio, and we see things generally in pretty good order, 4 to 6 weeks, limited situations with 8 weeks, and oftentimes concessions are going back down to three weeks.

On Proposition 10, some of the polls are going to be working in your favor as far as it not passing. I'm just wondering, how confident do you feel about this vote going in your favor versus a few months ago? And is there a particular poll that you pay attention to more than the others?

I’ll try. This is John Eudy. We are cautiously optimistic that we have made a good start and are at the point we expected to be at this time. However, past polls have been inaccurate. Regarding the PPIC public poll released a week ago, it shows 60% against and 25% in favor, with the rest undecided. Our internal polling reflects this as well. Nevertheless, the situation can change in the last eight days. Currently, we believe we are in a favorable position to win or push back against the deal.

I'm going to add one thing to that, and that is Mr. Eudy does not give up and he is very focused on really pushing hard right through election day to make sure that the campaign is very focused on the ultimate result. Again, we have watched John do this for the last couple of months. He has been incredibly focused and incredibly effective.

Best of luck. On your repairs and maintenance, the costs were down 1% year-over-year. I’m wondering how much of this is due to low turnover versus capitalizing more or maybe some other factors.

It's not really capitalizing more; the turnover is a factor for sure. There are also some timing issues there as well. I think it will kick up in Q4 but all according to the original plan for the year. So, we are finding opportunities to create efficiencies and lower our cost to offset some of the wage pressures that we face and are coming in again with another good year as it relates to controllables.

Angela, I was noticing in your guidance, and this may be old news but just clarify it for me. Insurance reimbursement, legal settlements, etc., you've recognized the negative $2 million year-to-date but you've got a budget or you have $6.2 million for the year negative. Is there a one-time charge you are expecting to get in the fourth quarter?

Yes. That’s all related to our Prop 10 campaign efforts. And so, that is a one-time charge. It will occur in the fourth quarter.

Okay. So, $4.2 million would get to FFO in the fourth quarter, and that’s in your guidance or not?

It is in our guidance.

I have a quick question about occupancy. Could you clarify what the occupancy rate was at the end of the third quarter and what it is now? Also, should we expect to see it return to year-over-year levels in the fourth quarter, especially considering we’re entering a less favorable season with potentially increased supply arriving at inopportune times? I'm just wondering how to approach the modeling for that.

Our current occupancy stands at 96.5%, which is slightly below last year's level by about 30 basis points. This year, we are expected to remain under last year's occupancy rates. Initially, we started with a higher occupancy, but as market conditions changed, we adjusted our strategy to prioritize achieving market rent over maintaining occupancy. We anticipate facing some challenges in Q3, which will carry over into Q4 and likely into the first half of 2019. It's difficult to predict our occupancy going forward, as we are observing increased supply, particularly impacting Q4 during the low demand period. However, I expect our occupancy to remain relatively stable, potentially increasing by around 10 basis points.

And then, quickly, on Seattle, kind of the characteristics for supply for next year. It looks like you are expecting less multifamily supply growth in Seattle next year versus this year. Is that construction delay impact noticeable there? And I guess, as you go on the next year, is the supply just kind of downtown concentrated or this year, is it a little more spread out?

Hey Drew, it’s Mike. We think it will decline a little bit, maybe around 10%. Seattle will still have plenty of supply in 2019 relative to 2018. But yes, to your second question, which is it will be more spread out; and the more spread out it is, the less we see that phenomenon of multiple lease-ups competing against one another and offering very large concessions. The fact that it’s spreading out should help us in 2019 relative to 2018.

That’s a very good question. Yes, it does include a component. So, the $590 million of the debt assumed from the BRE acquisition consists of $300 million due this year and $290 million due in 2020, as we can’t prepay it without incurring any penalty; that’s the right economic decision and that’s the reason. In total, we actually can and are planning to pay about $900 million of debt, of which $290 million is optional.

I appreciate the commentary in your prepared remarks about this, but what are your latest thoughts on voter support for Prop 10 and how it is or how has been impacting the transaction market? You mentioned cap rates are broadly unchanged. There’s still healthy liquidity and capital chasing multi-family product, but what kind of depths in buyer pools have you seen? We’ve heard that there’s been less in institutional interest in California multi-family recently.

It’s another good question. I'm not sure I have the perfect answer for it. I think that the greatest sensitivities are the transactions are hitting the market in some of the cities with the most extreme forms of rent control. I know that there was a transaction, for example, in Berkeley that had very extreme forms of rent control. I think that the market is reacting to those by pushing the bids for them past November 6th. You’ll know the answer before people commit to it. So, I think there’s been somewhat of a showing the fact in the marketplace as people wait for Prop 10’s ultimate outcome. But I don’t get the sense that it’s had an overall impact; in other words, some parts of the market areas that have less severe forms of rent control. I think it has a smaller impact on the market.

And you alluded to having a handful of assets on the market as a source of fund. Can you perhaps speak to the type of product you’re looking to recycle, and if these are perhaps in those submarkets that are being subject to the most extreme versions of rent control potentially?

No, not necessarily. This is Mike. We use the same basic methodology for both sides of our portfolio. We rank our submarkets based on long-term rent growth, which is influenced by job growth and supply growth, and we identify the areas that are the weakest in that regard to adjust our portfolio accordingly. The domain disposition earlier this year is a good example of this approach. Additionally, we seem to be receiving more unsolicited offers. We evaluate these offers on a case-by-case basis and may act on them if the value is right. These are the two main driving forces behind our disposition program.

So, most of my questions have been answered already. But quickly, with respect to fourth quarter expenses, I think the guidance implies maybe high 3s, upwards of 4% of same-store growth in the fourth quarter. Is that driven by the uptick in repairs and maintenance? I think John did this. Is there something else going on there that we should be aware of?

No. I think it’s what you’re anticipating. On the expense side, we’re expecting to land for full year at 2.6%, and it’s not atypical for us to run high in expenses in the fourth quarter. There’s definitely timing element with that in conjunction with what John Burkart said earlier as it relates to repair and maintenance.

Yes, you are exactly right. The most significant impact occurs in the first and second quarters, where we saw much higher occupancy rates. In Q1, our occupancy numbers were very high, around 97.1 to 97.2. I do not expect to reach those numbers again. Moving into Q2, occupancy rates will be lower, and as we approach Q3, we will likely be on target again, with Q4 also expected to align closely. The main challenge we face is primarily tied to occupancy rates in Q1 and Q2. We are still in the process of planning our budget, but I wanted to provide you with a broader overview. If we identify more opportunities or reasons to be more proactive, we will certainly consider that. For now, these are the most apparent challenges we are facing.

How significant is your current redevelopment opportunity across the portfolio, and how comfortable are you that you can achieve targeted returns for new projects at this point in the cycle, given market and supply conditions?

We are renovating approximately 2,500 units each year, which corresponds to a lifecycle of over 20 years based on the size of our portfolio. We feel confident that this process can continue, although it may fluctuate depending on the rental market's strength. We consistently monitor our progress to ensure we meet our expectations, and there's no indication that our unit turn program will slow down in the upcoming years. Regarding larger projects, we have several underway that are performing well, including four specific properties in our pipeline, which we expect to continue. As for asset age, we seek opportunities to implement more substantial upgrades to asset systems to enhance value. Therefore, I anticipate that our renovation program will remain consistent over the next couple of years.

And then, what’s the current expected stabilized yield on the six properties in your development pipeline?

In the mid-five range.

I have two questions. First, Angela, regarding your comments on the outlook for next year, there is a potential lease-up drag of $0.10 from the deliveries and an additional $0.05 to $0.10 from refinancing. However, you have a good track record of growing earnings. Altogether, it appears there could be a drag of over $0.20 for next year. Is that the right way to interpret it, or did I misunderstand?

I think you are thinking of it correctly. What you're thinking is the same way I’m thinking of it. And so, although, the team’s common operating fundamentals are coming in as we expect, there are other sectors impacting FFO. Financing and dilution as it relates to timing of development and lease-up are two important factors.

Okay. Mike, regarding the supplemental page with your 2019 outlook, I'm uncertain if it pertains to general market trends or specifically to Essex's revenue or rent projections. However, it appears you're anticipating around 3% rent growth for next year based on that information. This year, rents have increased by 2.3%, and revenues have risen by 2.8%. It seems that the revenue environment next year may not differ significantly from this year, considering occupancy is likely to remain flat overall. Is it reasonable to assume that revenue next year will be around that 3% mark, or is there potential for occupancy improvements that could lead to exceeding that 3% growth?

Alex, this is Mike, and we're not going to morph into a guidance conversation here. But let me just clarify what we mean and our market forecast. So, S-16, our economic rent growth represents in these submarkets, not for Essex but for the broader submarket, what we think market rents will do in each of these areas. Our portfolio can vary from that by some amount, depending upon where it is, depending upon its competitiveness within the marketplace, et cetera. Our actual revenue results can be different. Again, this is for the entire year. How it breaks down the rent growth curve, it’s not a flat line straight up during the year. It tends to be strong in the earlier part of the year and weaker in the end of the year. So, there could be variations in these numbers. I’ll leave it at that. I’ll be giving guidance at some point in time in late January, early February, and we’ll talk about it in much more detail at that time.

And I would just add, Alex, I think you said that occupancy would be flat. That's not what I'm saying. I'm saying occupancy will be a headwind. The greatest headwind will be Q1 and Q2 with Q3 and Q4 basically flat. But for the year, it will be a headwind overall. Does that make sense?

Just a quick question for me. I understand that you prefer not to provide guidance. However, could you consider whether the impacts of higher anticipated supply or slower than expected job growth are the biggest risks to your market forecast for economic rent growth, and how they might affect both the upside and downside?

I think we have the supply pretty well locked down. We could be wrong from quarter to quarter, like everyone. I know everyone has been frustrated with the supply forecast over the past couple of years. I think that now we're looking at a broader period of time, and it seems to make reasonable sense to us. The greater risk is on the job side. Our forecast on S-16 is a scenario. It begins with what's going in the U.S., and we have a lot of history with respect to the U.S., the 2.5% GDP and 1.3% job growth. This is what typically happens in the Essex markets. We try to make the jump from what the U.S. does and to what our markets do. Given all the geopolitical issues, interest rates rising, and other things, the U.S. assumptions can change pretty significantly over time, and they can change at any time really. It tends to be a scenario that begins with the strength of the U.S. economy and it rolls down into what that means for the Essex metros. Does that make sense?

It does. That's helpful. Are there any markets where you think you might have greater variability than others, either to the upside or the downside?

Well, I think that Seattle has always been challenging. I think that we have beat up Seattle historically over the last several years much greater, outperformed what our expectations have been. But it is more challenging just because if you look at the amount of supply that it produces, 1.8% versus about 1% in northern California and 0.7% in Southern California, there is a greater degree of variability there. We could be wrong. The higher the supply number typically, the more wrong you could be. I would point to Seattle.

In your supply outlook, you guys noted that you are adjusting for delays this time. Could you give us some insight into your process, just bottom-up, what it was before and how it's changed, and how you are actually accounting for those delays in supply?

Sure. This is John. On a process perspective, we drive every single site, and we have been short where it's at, what we think is going to happen, and we do this on a regular basis. We’re looking at all the other information out there as well. We feel we have a great database of the various sites and where they are at. What’s been a challenge is really trying to understand where they are at, when they are going to actually finish, when they are going to come to completion. If you look at any building from the outside, you can't tell exactly where things are, how far along the building is. We are relying to some extent on conversations we have with developers or other people to gather information to really focusing on that side. What we’ve done in the sense of our adjustments is we looked at how often we were right and how long the delays actually have been on an asset-by-asset basis and came up with the track record. We think that each of those monthly measures will adjust our outlook for 2019 and will provide value as we proceed.

Let me add one more thing to that. I think what has typically happened, we’ve seen out there and some of the data providers is when some doesn’t get delivered in Q1, it gets pushed to Q2 and Q2 to Q3, and you end up with a lump of supply that is going to ultimately get done in Q4. If that doesn’t happen again, it gets pushed to the next year. So, that's been sort of the process that started what John just talked about. You end up with a very large number in Q4 which doesn’t get delivered, which pushes down next year's start out with a very large number, and it confuses the entire picture. We are trying to create something that is hopefully more sustainable and more accurate.

That’s really helpful. We can certainly appreciate the challenges. Just one follow-up to that. What is your radius like? I hope, John, you’re not having to drive around all of Southern California and Northern California. How do you decide this asset is within our comparability set?

So, although I do a lot of driving, there’s a whole team of people in the research department that do the specifics, and they have actually a mobile database that they log into, check things out. They’re driving the entire MD to understand exactly what’s going on. Again, we don’t look at it and say, here’s an asset that we’re going to go within 3 miles. Different people have different ways of doing this. We look at the whole supply-demand picture and make an assessment according to that. We’re looking at all assets that are 50 units and up, driving those assets, seeing where they’re at and factoring that in. From an operational perspective, we have individual operational asset reports created by our research department to better understand what supply is going to impact which assets and therefore adjust pricing strategies. But from a big picture from the economic perspective, we’re looking at the whole MD, each of the MDs, and seeing the scope of work in this area.

Hey, Mike, have you given any thoughts or plan B, say, if Costa-Hawkins gets repealed, or are you not even going there right now? What do you do?

We always have a backup plan. However, it's important to note that we operate in 70 different cities across California, which makes us more diversified than it might seem. The greatest risks typically arise in urban locations, and we have a mix of urban and suburban properties, with about 10% situated in the urban core. We believe our portfolio offers a certain level of safety. I've mentioned before that there are only four cities where we manage more than 2,000 units, which demonstrates our diversity. We're not significantly affected under any scenario, although we do have a contingency plan focused on a few cities that concern us the most. While I wouldn't say we’re completely inactive, I believe we are overall well positioned. We also track other metros because we want to ensure that the West Coast is competitive with some of the eastern metros for sure, reflecting job growth in certain of those eastern metros of late. It's ultimately to confirm whether our existing property profile is appropriate given the broader U.S. landscape. It’s sort of confirmatory. Based on that, looking at supply and demand dynamics, we feel good about the West Coast.

I was looking for an update in San Jose, more in particular that large lease at Santa Clara Square. Has that impacted the market and how do you model that delivery and job growth over the next few years?

This is John Eudy. We open that right after the first of the year, as you’re probably aware. It’s a pretty deep market; a lot of Sunnyvale product burned off on inventory this year. We think it's well positioned to have a pretty good start come late Q1. We have maps on, like Mike said, roughly 8,600 units; most of which are urban core units we have been developing over the last 15 years. We’re always looking at the metrics between NAV value, condo conversion versus apartments. So, that optionality is there. We’ll make the right decision at the right time.

Mike, I understand your comments about the transaction market, only seeing a slowdown in volume, no impact on pricing and high-risk cities of rent control. There’s a very real chance this comes on Costa-Hawkins on a 2020 ballot as well. Any conversations you and John are having that suggest that the transaction market slowdown could be more multiyear in nature and not exactly everything continues on after November 6?

John, it’s Mike. It’s a good question. Honestly, we don't know the answer. There is a lot of money in private hands looking for yield, and it’s there, it’s not going away probably anytime soon. How much we will transact given the amount of money searching for quality apartment deals remains to be seen. I guess, I wouldn’t be as dire as you’re suggesting as it relates to the transaction market. Conditions can go on a lot longer than we might think before pricing changes or you see that for you. It would be a guess and I would be speculating. I think I will probably just leave it at that. There is no reason to believe that things will change overnight; they generally take a significant amount of time to change. I would guess that it would be at the very earliest, sometime a year from now or something like that.

Okay. On Seattle, and I know this market rent forecast. The acceleration you're calling for in terms of economic rent growth from 2% to 2.9%, are you seeing any leading indicators within your portfolio in Seattle that suggest market rent growth is stabilizing? The pace of deceleration you and your peers report has been pretty persistent deceleration. So, wondering what really causes the conviction and the 100 bps acceleration in market rent growth next year?

What we're observing on the supply side is that the fourth quarter is expected to be quite challenging for us. The first and second quarters are also significant but to a lesser extent, and then we anticipate a notable reduction in the third and fourth quarters in Seattle. Currently, job growth stands at 3.7%, representing strong growth this year in the third quarter compared to last year’s low point. Last year, we experienced a decline of about 50 basis points in job growth, which affected our numbers for this year. However, the increase in job growth this year will positively impact the rental market in 2019. There tends to be a lag between job growth and rental market performance. The combination of improved employment this year and declining supply is likely to enhance our rent growth figures, although we expect some difficulties in the middle. The fourth quarter will certainly be tough and noteworthy.

Thank you, Dana. Thank you for your participation on the call today. We look forward to seeing many of you next week in San Francisco at the NAREIT Convention. Have a good day. Thanks for joining the call.