Essex Property Trust Inc (ESS) — Q4 2019 Earnings Call Transcript

Thank you everyone for joining our fourth quarter 2019 call. John Burkart and Angela Kleiman will follow me with comments, and Adam Berry is here for Q&A. Today, I will review our 2019 results, summarize our expectations for 2020 and provide an update on the West Coast investment markets. Beginning with our results. 2019 was a successful year for Essex as we generated 6.4% core FFO per share growth, representing over 50% better growth than contemplated in our original guidance. Same-property NOI grew 3.9% in 2019, which was at the high end of our original guidance, reflecting stronger job growth than we had assumed. For example, Q4 2019 job growth averaged 2.3%, 50 basis points above our initial 2019 estimate. Once again, the tech dominant markets in Seattle and Northern California are leading the way with recent job growth of 3.3% and 2.6%, respectively. Southern California, where economic growth generally resembles the United States, recently added jobs at a rate of 1.5% on a trailing three-month basis. In addition, continued apartment construction delays resulted in less competition in 2019. We estimate that approximately 33,000 apartments were completed in 2019, about 7% less than expected. We continue to believe that tight construction labor market conditions will prevent significant acceleration of supply deliveries. John will provide more color on fundamentals in a moment. Our initial outlook for 2019 did not assume a significant improvement in the cost of debt and equity capital. In early 2019, we eagerly bought back our stock at a significant discount to consensus net asset value. As volatility in capital markets abated and our cost of capital improved, we altered our business plan and began actively pursuing investment opportunities. As a result, we are pleased to report that we exceeded the high end of our acquisition and preferred equity guidance ranges from the focused effort of our investment team. In 2019, we added ownership interest in eight properties for $856 million, as further detailed on Page S-15 of the supplemental. These communities are mostly located in the tech centers along the West Coast and submarkets we know well and expect to be added to the portfolio’s growth profile. We also committed to over $140 million to new preferred equity or subordinated debt investments, significantly better than our production in 2018. In summary, 2019 demonstrated how we attempt to add value throughout the economic cycle. 2019 was also an important milestone for Essex as we celebrated 25 years as a public company with some notable achievements, a 17% compounded annual rate of return for our shareholders since the IPO through the end of 2019. In other words, $100 invested in our IPO would be worth over $5,000 today, with dividends reinvested. Through several economic cycles, our business model has generated an 8.4% compounded growth rate in FFO per share and a 6.4% rate of growth in our cash dividend, which has increased every single year. We were very pleased to learn that Essex was recently added to the S&P 500 Dividend Aristocrat index. I'd like to thank all of the longstanding partners, the Essex team and shareholders who’ve contributed to the Company's achievements over the last quarter-century. Turning to our outlook for 2020. We continue to see healthy demand for rental housing. Recent job growth for our West Coast markets continues to exceed the 1.7% forecast for 2020, on page S-16 of the supplemental. However, we continue to believe the job growth will likely decelerate in 2020, given tight labor market conditions and a low unemployment rate, which was 2.7% in the Essex markets as of November, down 50 basis points from a year ago. Turning to slide S-16.1 in our supplemental. We highlight a central theme of our West Coast focus. The chart on the right of this slide demonstrates that job growth has remained strong on the West Coast, and reaccelerated in 2019, diverging from the rest of the nation. On the left side of the chart, we note that multifamily permit activity in our metros peaked in 2018 and has declined about 14% from that peak, again, a divergence from the recent trends outside our markets. Rising construction costs and a challenging regulatory environment continue to compress development yields in most of our markets, which should lead to fewer supply deliveries in the future. Our delay-adjusted supply estimates for 2020 have not changed from our original estimates last quarter. Notable changes year-over-year indicate about a 30% reduction in Seattle apartment supply in 2020 and about a 45% increase in Northern California. Tight labor market conditions on the West Coast continue to push incomes higher. Per capita personal incomes are estimated to have increased 6% in our markets in 2019, significantly higher than the U.S., average of 3.9%. Personal income growth has outpaced rent growth in most of our markets since 2016, which is leading to improved rental affordability. Consistent with this trend, the percentage of customers who moved out for financial reasons or a rent increase was almost 16% in 2015. In the fourth quarter of 2019, this factor accounted for less than 8% of those moving out. Despite last year's outsized media coverage of the failed IPO of WeWork, or the disappointing stock performance of other unicorns, the outlook for economic growth and new jobs in our markets remains favorable in 2020. Having closely followed Silicon Valley for the past four decades, we're not surprised to see volatility with respect to VC-backed companies. The venture capital model assumes many failures, which are more than offset by the hyper-growth of the most successful investments. Bay Area venture capital investments dipped in the second half of 2019, but remained at healthy levels, well above this cycle’s average pace of investment. We continue to track over 26,000 job openings listed in our markets by the top 10 largest tech firms, a 12% increase compared to a year ago. The largest tech companies continue to add commercial square footage at a rapid pace, which John will comment on in a moment. Overall, we are tracking over 38 million square feet of office construction in our core market, which is almost 70% pre-leased and underlies the need for more housing. Turning to the investment markets. Cap rates remain stable, with A quality properties and locations trading in the high 3% to low 4% range, while Bs traded 25 to 35 basis points higher. In this environment, we are looking primarily for A minus to B minus quality communities in markets with the best long-term growth prospects. Six communities we acquired from our co-investment partner earlier this month are consistent with this strategy. We are pleased to increase our stake in these high-quality communities, while earning a $6.4 million promote from significant value creation from our partners and shareholders. The majority of our development pipeline will be leasing up in 2020. We have experienced our share of development delays due to a challenging construction labor market. However, we remain pleased with the initial customer response at our development communities and the current leasing pace. We continue to pursue development opportunities but often see a better risk-reward relationship within preferred equity and other structured investments. That concludes my prepared comments. I'll now turn the call over to John.

Thank you, Mike. For the full year, we achieved 3.4% year-over-year same-store revenue growth, which was an increase of 60 basis points over the prior year's growth rate. Huge thank you to our E-Team for their outstanding work in improving the customer experience while delivering top results. Our fourth quarter 2019 results were fantastic, with 4% revenue growth over the prior year's comparable quarter. This was driven by strong market and bolstered by our shift in strategy to increase occupancy in preparation for both the seasonally slower demand period and expected elevated supply in the fourth quarter of 2019 and the first quarter of 2020. This resulted in 30 basis points growth from the increased occupancy. We additionally had 40 basis points growth from other income, which included some one-time items such lease breaks. Overall, our markets continue to show strength, driven by year-over-year job growth, 2.3% in the fourth quarter of 2019, which exceeded our expectations by 40 basis points. Income growth continues to outpace rent growth, improving affordability in our markets. Turning to 2020. Our guidance of 3.1% revenue growth at the midpoint contemplates rent growth for our portfolio of 3%, consistent with long-term CAGRs in our market and what is outlined on the S-16 in our earnings package. Additionally, we have factored in a slight reduction in occupancy of 10 basis points, as well as the negative impact of rent rollbacks related to the recently passed California assembly bill AB 1482, which is a 10 basis point headwind for our California communities. Regarding expenses in 2020, we continue to see pressure on utilities, taxes and wages with offsets in controllable, resulting in our midpoint guidance of 3% for our year-over-year operating expense growth. In terms of supply, the bulk of the new apartment deliveries continues to be in downtown locations. We project that 2020 deliveries will be about 65% lower in our suburban sub-markets compared to the downtown urban sub-markets, consistent with 2019. Only 12% of Essex’s portfolio is concentrated in downtown urban sub-markets. We estimate the demand/supply ratio in our markets, assuming it takes two new jobs to absorb each new home, to be 1.7 times, meaning demand is continuing to exceed supply across our West Coast markets. Lastly, we continue to drive our vision of optimizing our portfolio’s performance through our strategic tech investments, various platform initiatives, and asset optimization through data science and analytics. Recently, we implemented a new lead management system in our call center and plan to roll it out to the communities this year. Also in the pipeline is our plan to upgrade 20,000 units for smart home technology and rollout our mobile maintenance platform 2.0 across the company. Shifting now to an update on our market. In Seattle, our same store revenues in the fourth quarter were led by Seattle CBD with 5.4% year-over-year growth, while other Seattle sub-markets grew between 4.4% and 5%. On jobs, Seattle remains the strongest major U.S. market for job growth in the fourth quarter, growing 3.3% year-over-year. This growth was mainly due to an additional 32,000 jobs in the top four paying industries, a 57% increase from the prior year. Regarding major tax activity in the market in recent years, Amazon has committed to a sizable footprint of nearly 3 million square feet in Bellevue area while recently putting up 770,000 square feet for sublease in Seattle. Although we are seeing some local geographic movement, several other major tech companies such as Apple, Google and Facebook have recently expanded their footprints in Seattle. As mentioned on a prior call, Apple announced it would expand its Seattle workforce by more than 2,000 employees by 2022, a significant increase from its current census of 450 employees. Other activity in Seattle includes, Airbnb expanding by 60,000 square feet and Bank of America committing to 116,000 square feet of Amazon sublease. On the other side of Lake Washington in Bellevue, Facebook preleased an additional 325,000 square while of Alibaba expanded their footprint by 50,000 square feet. Office supply and demand is strong in the market with over 9 million square feet of office space under construction, 79% of which is preleased. Multifamily supply in Seattle was down substantially in the fourth quarter and we expect it to decline about 30% in 2020 from 2019. Combination of strong income and job growth as well as declining supply is leading to tight market rental condition. Moving to Northern California. Year-over-year same-store revenues in the fourth quarter were led by San Francisco achieving 5.4% growth, followed closely by San Mateo 5.2%, Santa Clara at 4.6% and Alameda at 4%. Job growth from the Bay Area averaged 2.6% year-over-year for the fourth quarter. San Francisco, San Jose and Oakland grew at 3%, 2.9% and 1.8% respectively. The Bay Area continues to maintain higher job growth in top paying industries compared to the bottom paying industries. Office expansion in the Bay Area remained robust in the fourth quarter. This includes biotech expansion activity, about 540,000 square feet made up of Amgen’s new lease in downtown San Francisco and Zymergen’s new lease in Emeryville. In the South Bay, Google expanded by over 800,000 square feet adding a new lease in Sunnyvale, in addition to acquiring a trio of Cisco buildings in San Jose. Airbnb grew their South Bay footprint by signing a 300,000 square foot lease in Santa Clara. There is currently over 15 million square feet of office space under construction in the Bay Area, over 70% of which is preleased. Looking at 2020 multifamily deliveries in the Bay Area, San Francisco deliveries are expected to be slightly higher than in 2019, most of which is concentrated in downtown San Francisco and San Mateo. San Jose is expected to see twice as many deliveries in 2020 than in 2019. And in Oakland supply deliveries will remain elevated in the broader market throughout 2020 with significant supply continuing to be delivered into downtown Oakland, while Fremont will get an influx, half of which will be for sale condo. Heading further south to Southern California. Year-over-year, same-store L.A. County revenues for the fourth quarter were up 3.5%, led by Woodland Hills with 5.5%, West L.A. with 3.7%, and the Tri-City submarket with 3.7%. The L.A. CBD submarket continues to decline with revenues down 1.6%. L.A. job growth in the fourth quarter was 1.5%, 10 basis points above the U.S. average. On supply, we estimate consistently high deliveries throughout 2020 in L.A. County. Deliveries in the L.A. CBD submarket are expected to remain high at 4% of stock, but down materially year-over-year. Our West L.A. and Woodland Hills submarkets will see more new supply in 2020. Moving down to Orange County. Year-over-year fourth quarter revenues were up 4.2% in the South Orange submarket and 3.1% in the North Orange submarket. Total 2020 supply in Orange County and San Diego remain consistent with 2019. However, deliveries in both counties are expected to decelerate through the year. Lastly, in San Diego, our year-over-year fourth quarter revenues were up 2.8%, led by the Oceanside submarket with 4.9%, followed by Chula Vista with 4% and North City with 3.3%. Job growth for the period was a healthy 2.3% year-over-year, led by professional business services, which made up almost a quarter of the growth. Apple made progress on their plans to grow the footprint in the San Diego market by pre-leasing 200,000 square feet of office space in the Sorrento Valley. Our Q1 renewals have been sent out at about 4.4% and our portfolio is currently at 97.2% physical occupancy with our availability 30 days out at 3.9%. Thank you. And I will now turn the call over to our CFO, Angela Kleiman.

Thank you, John. I will start by providing some color on our 2020 guidance, followed by an update on capital markets and the balance sheet. The key assumptions for our 2020 guidance are available on page five of our earnings release and S-14 of the supplemental. We're guiding to a midpoint of 3.1% for same-property revenue and NOI growth this year. Overall, operating fundamentals in our markets remain healthy, as we continue to assume steady market rent growth, near the long-term averages and for our West Coast market to continue to outperform the U.S. average. Compared to 2019, we're expressing a modest acceleration in Seattle and a slight deceleration in California, largely attributed to demand and supply trends commented earlier. Moving on to the core FFO guidance. We are expecting a growth rate of 4.2% at the midpoint in 2020. As discussed in our previous call, we have a short-term headwind from the repayment of a highly accretive mortgage-backed security, which generated a 17% internal rate of return for Essex shareholders. The lost income from this investment accounts for approximately $0.18 of headwind in 2020 or 1.3% of our 2020 FFO growth, and mostly explains the sequential decline in core FFO between our fourth quarter results and the first quarter forecast. Our 2020 guidance also includes the recent acquisition of a 45% joint venture partner's interest in a $1 billion portfolio. We expect to recognize a $6.4 million promote from this transaction as well as a remeasurement gain in excess of $225 million, which incorporates small impairments of $18 million recognized in the fourth quarter. This gain and promote will be recognized in the first quarter of 2020 and both are excluded from core FFO. We remain committed to our co-investment platform as it provides for an alternative source of capital and an attractive risk-adjusted return for investors. Over the past three years, we have generated incremental earnings for our shareholders from promote income totaling approximately $66 million. Lastly, on capital markets activities. In the fourth quarter, we issued $150 million 10-year unsecured bond at an effective 2.8% interest rate, prepaid several mortgages with 2020 maturities. Consequently, we only have $280 million of maturities to refinance this year. We continue to maintain our discipline to optimize our cost of capital and will remain thoughtful and opportunistic. Our balance sheet metrics remain strong with over $800 million of available liquidity. That concludes my prepared comments. And I will now turn the call back to the operator for questions.

Hi. Good morning, everyone. With the move to a high occupancy strategy, what are you guys assuming for blended lease rate spreads for 2020? And then, could you also tell us what the spreads look like for the fourth quarter of 2019?

Sure. This is John speaking. Going forward, our guidance is set at 3.1%, which consists of about 3% rent growth as indicated in our S-16, along with some additional income. When we refer to the blended rate, it aligns with that. We generally do not increase our renewal rates beyond the market levels; we keep them consistent with the market to ensure simplicity and maintain focus on the customer experience, which is extremely important.

And so, what is that blended number versus what it was in '19?

Sure. So, in 2019, all in, obviously our revenue came in at about 4% for the fourth quarter, 3.4% for the year. And that was really about 3.2% scheduled rent, which would be the blended number and the remaining amount relates to other income items.

Got it. Thanks for that. I’m curious about what prompted CPPIB to decide to dissolve the venture, and what opportunities you see across those six communities.

Hi. It's Angela here. We have an excellent relationship with our JV partners. And the exit really relates to the timing of the investment. These properties were formed as individual joint ventures, and most of them were formed back around 2010. So, at this point, we're near that 10-year term. And so, it made sense to have a discussion for the exit. And so, going forward, we actually have continued to have active conversations about future opportunities as they come up. But, as you know, we decide to put an asset or investment in joint venture, it's really driven by a function of trying to optimize the cost of capital. So, it depends on where the stock is trading, where the asset sales are coming in, et cetera.

Did you consider I guess, selling outright, or was the plan all along really to buy out their interest?

Well, you see that we actually sold one of the assets in joint venture in the fourth quarter as well, and that was Masso. And that was a very attractive sub-4 cap rate sale. And so, we do evaluate whether it makes sense to bring it on this wholly owned, or really what's the best return for our shareholders.

So, just following up on Austin's question on the CPPIB. Can you just provide a little bit more color on funding? Was there anything transacted or was it sort of an even trade? And then, two Angela, what the benefit is for 2020? Obviously, you guys are working hard to backfill that CMO. So, just curious how much this played a role in providing an FFO assist for 2020?

I will discuss the funding first, and then Mike will provide insights on our overall strategy. Regarding funding, we utilized our line of credit to bridge the closing, but our goal is to refinance with long-term debt. Since the portfolio is currently unlevered, we won't need to raise as much equity to maintain leverage neutrality. This situation will enable us to be flexible with our equity issuance, and we may consider selling assets based on market conditions.

Yes. And Alex, I'll just add real quickly. Keep in mind that we had a promote, which is noted in the press release. And we also have the different tax base than what the tax base would be at market. And therefore, our yield is a little bit higher. And that helps make these transactions attractive to us.

Okay. Maybe I missed it. Did you provide what benefit this is on an FFO?

It's incorporated into our guidance. If you look at our line on accretion from external activities, it includes the CPP transaction among others.

And then, second question is, Mike, your favorite topic, regulation and taxation. So, with all the fun of Prop 10 2.0, Prop 13 split roll. Maybe you can just address your thoughts on what you guys see the Governor in Sacramento as far as increased taxation, if they do the split roll? And then, how you think the Prop 10 2.0 is shaking out at this point?

Yes. Alex, I think it's a good question, and it came up very early in the call today, so all good. So, as I probably reported recently or actually late last year, there were 18 bills that were signed by Governor, some dealing with housing. The biggest one was 1482, which is a statewide rent control initiative. Following up on that, there's been some pretty big allocations of funding for housing, $1.75 billion last year and $500 million that has been discussed as part of the ‘20 to 2021 budget. And so, I think that the political environment here is to try to wait and see what happens with these large investments and with 1482 as opposed to go to the ballot box and try to create a whole different scenario with Prop 10 2.0. So, I think that the politics for the matter are the legislature has acted and the state is funding the housing shortage issue to a pretty substantial extent. And let those things run their course. So, that's what we hope happens. Obviously, Prop 10 2.0, they submitted around 950,000 signatures in December. We're still waiting to see if the ballot qualifies. I'd say that compared to the first go round, obviously, we're early innings. And so, the proposal has not received a great deal of attention at this point in time. And as I go back to think about Prop 10, the early polling was that it would pass. And that was noted obviously throughout the investment community. And it was in fact overwhelmingly defeated in the end. And even though this current proposal is a little bit more palatable to the owners, I still think that it will be difficult to pass. And by that or in support of that, I would suspect that it will be an ongoing discussion, and we will have an entity that will essentially commit to a robust opposition to Prop 10 2.0. And, again, given the outcome of the last go round, I expect it will be successful once again.

So, my first question is for John. So, as you go into this new first half of the year with more downtown supply, and you're really focusing on that occupancy. I just kind of wanted to get this sense of in terms of cadence of that 10 basis points of occupancy headwind, how's that going, how do you anticipate that to play out through ‘20? Is it going to be pretty much an equal spread, or is it going to see more deceleration in the first half first versus the second?

That's a great question. Let me take a moment to explain our approach to occupancy and the adjustments we've made. We put considerable effort into analyzing market supply, and historically, we know that demand tends to slow down in the fourth and first quarters. As we approached the end of the third quarter, we held off on changes for as long as we could, but then we quickly implemented adjustments to boost occupancy in response to what we anticipated would be some market disruptions, especially in Northern California where supply was expected to increase during this lower demand period. Now, as we progress into the first quarter, our occupancy remains strong, and we expect it to continue that way. The adjustments were made to strengthen our position, allowing us some flexibility if we notice localized decreases in pricing. This way, we may accept a slight drop in occupancy if necessary. It's worth noting that every lease we secure at the year's start affects the entire year, so we are in a strong position. Overall, I anticipate our occupancy will be higher in the first quarter, decrease in the second and third quarters, and then rise again in the fourth. Does that address your question?

Yes. That's extremely helpful. For my second question, Angela. So, previously you did mention the earlier redemption, which played out in 4Q. So, I was just kind of curious, is there still that expectation for more deals in your portfolio to be redeemed early or are those mostly done so far? And in terms of pipeline what's in the works to backfill from those deals?

Hey, Shirley, that's a good question. We do anticipate increased redemptions in 2020. You might remember we've mentioned that investments usually have a three-year lifespan, but sometimes they get extended, which is great. This means redemption timing can vary. For 2020, excluding the mortgage-backed security investment and the preferred equity event, we expect around $145 million in redemptions. The distribution is fairly even between the first and second halves, with possibly a bit more in the second half. Additionally, there are likely around 110 million redemptions in total. That's the general trend. As for the pipeline, Adam will provide more details on that.

Yes. Shirley, this is Adam. We're pursuing and underwriting several deals in parallel at this point on the pref equity side. These deals inherently have long lead times, just like any development deal. So, when they actually come to fruition, it can always be an unknown. But, we are pursuing many and have quite a few in the pipeline.

Yes. And Shirley, you may recall, we have a guidance between $50 million to $100 million, so it’s 75 midpoint. So that's a good number too for modeling purposes. And then, the one thing I'll add is really the timing of the funding because they do lag a little bit. And so, you want to layer that consideration.

You highlighted the decrease in permit in your markets? But given the current pipeline and the tight construction environment that you talked about, when do you expect the actual benefit from the decline in terms of delivery?

Yes, Nick, it's Mike Schall. When we analyze permits, we should consider the longer-term outlook, as there is typically a delay involved. Therefore, while we have seen a drop in permits over the last few years, the actual impacts will take time to materialize. It's important to remember that California's permitting and delivery processes are notably longer than in many other regions of the country. Additionally, the tight labor market in construction poses further challenges in finalizing and progressing projects. I would say we need to look beyond 2021 to truly see a significant impact.

Thanks. And then, maybe following up on Shirley's question, and I think in your prepared remarks you talked about continuing to pursue development but seeing better risk-adjusted return with preferred equities and the other structured investments. Obviously, you can get a better return from those, but there's a difference in duration and length of investments. So, how do you think about the size of both of those and the stickiness of the cash flows?

I'll start with a broad overview, and then Adam can elaborate. Essentially, it's about balancing risk and reward. We prefer to engage in direct development, particularly when the market is at the bottom of the cycle, as conditions tend to be more favorable then. This means lower construction costs and greater willingness from cities to permit development, as they aim to keep their labor force employed. As the cycle progresses, we face increasing challenges, such as securing public artwork approvals and obtaining temporary certificates of occupancy. These obstacles tend to grow over time. Thus, within our preferred equity strategy, we are eyeing the same projects we could pursue as direct developers, but we are focusing on the risk-reward balance. Given equal conditions, we prefer acquisitions and preferred equity over direct development. That said, I'll hand it over to Adam, who has been actively exploring development opportunities and has identified a few promising projects. We're committed to making informed decisions and remaining mindful of the current cycle, including the rising construction costs and other related factors. Adam, would you like to add anything?

Yes, we are continuing to evaluate and monitor all the land deals in our markets. However, due to significant increases in construction costs compared to the growth in net operating income, we have been able to observe the situation in real-time through our preferred equity program. Overall, we are not seeing the yield premium necessary to pursue most of the development deals currently available. As Mike mentioned, there are a few opportunities that meet our criteria and offer an appropriate risk-adjusted return, but in general, evaluating deals is challenging at this moment.

I have two questions, both related to Seattle. You mentioned the job growth in that area is looking positive and that supply is expected to decrease. However, your 2020 outlook shows only about a 20 basis-point increase in revenue growth in Seattle at the midpoint. This leads me to wonder if the market might actually be stronger than what you've indicated. Are you being cautious in your assessment? Is there something influencing you to maintain revenue growth that is relatively flat, or how should we interpret this?

Sure. That's a fair question. And at this point in time, you're right, Seattle is doing really terrific. Its rents are roughly 5% up year-over-year. At the same time, the unemployment is very low. It's 1.7% in that zone. So, we do expect the employment growth rate to slow down, and that's partly driving it. We are showing in our S-16, employment slowing down pretty significantly across the board, still staying 50 basis points over the U.S. average for the Essex portfolio, but slowing down because of the low unemployment. And Seattle has the lowest unemployment of all the areas. So, that's the scenario that we have out there. At this point in time, obviously, employment is beating that expectation, and we'd love to see that continue.

Okay. And then, I guess as kind of the other side on the expenses, clearly, you had very low expense growth in Seattle. I know there were some kind of tax benefits, real estate tax benefits you got. Can you just sort of remind us of the aggregate benefit in 2019 from that that kind of acts as maybe a headwind on the expense side in 2020?

In 2019, our Seattle property tax bill was actually lower than in 2018, primarily due to assessment bills. This presents challenges when comparing year-over-year figures due to the less discernible nature of these numbers. Specifically, the property tax was 3% lower than the previous year based on the assessment. However, during the five years prior, we saw increases ranging from 13% to 17%. Looking ahead to 2020, we are estimating a base run rate increase of around 6%, plus considering refunds, we anticipate a low single-digit increase of about 8 to 9% for Seattle property taxes.

Hey. Thanks, guys. I'm not sure if you answered Austin’s question in the beginning in terms of the new and renewals that you had in 4Q. But just curious as what you're kind of seeing in January for new and renewals, and what occupancy stands at for the portfolio today.

In the fourth quarter, new rents were approximately 2.2% and renewals were around 3.5%. The significant difference was seen in Northern California, where new supply entered the market. Looking ahead to the first quarter, renewals are tracking at about 4.4%. Currently, market rents are up year-over-year by about 2% to 3%, which reflects a period of slower demand. December and January can be somewhat unpredictable. We anticipate reaching the market rents outlined in our S-16, with Seattle showing the strongest performance.

Right. And then, what’s occupancy?

Occupancy is 97.2.

Okay, great. And then, next one, preferred investments obviously you've highlighted is what you guys are choosing to do in terms of capital allocation. Just curious on either the current book or the ones you're underwriting, is there an option, are you trying to get options to actually roll your preferred into equity or essentially take ownership of those deals when they complete, or is the financing market just too easy for the developer to sort of get permanent financing?

So, this is Adam. We look at it in several ways. I would say the most straightforward kind of preferred deal is going to be paid off after a certain time, whether that’s two or three years. However, with every deal, we discuss potential hybrids, where there’s an opportunity to convert into equity. This is evaluated on a deal-by-deal basis, and we're noticing a bit more of that opportunity now given the current stage of the cycle.

So on the MAA call this morning, they kind of outlined a sort of a silver lining in the supply that the rents are 25% above their in-place rents. And so, it's an opportunity for them to deploy some redevelopments on. And so, a little bit of a good and a bad situation. Do you see a similar dynamic in your markets, considering you also are sort of B, B plus type of product? Is the incoming new supply, while problematic, provides some opportunities for you to redevelop and sort of find that middle ground between what's being delivered and where your market - where your rents are today?

Yes, Rich. That's a great question. I'll begin and let John add afterward. From our viewpoint, there is no production in category B, which means all supply falls under category A. Consequently, the closer you are to category A, the more you are affected by the concession environments and new deliveries. Additionally, we see a trend where supply is moving toward urban downtown areas rather than suburban ones. All these factors play a role in this situation. I believe the most promising opportunities for redevelopment lie in suburban B markets, and I expect that trend to persist. John, is there anything I overlooked?

Yes. No, I think you picked it up.

Great. And then, second question, perhaps for anyone. But, any comment on Park Merced? I know you know were gathering that years ago and not this time with AIMCO jumping in. I’m curious if you took a hard look at it, soft look at it, not looked at it at all? Anything, any kind of color would be interesting.

Yes, Rich. This is Mike again. It was widely advertised, so it wasn't an exclusive deal. When considering our preferred equity business, we focus on two main areas. One is development deals where we get involved right before construction starts, allowing us to understand the construction costs better and manage that risk. The other area is providing preferred equity for stabilized portfolios, which was how we initially invested in Park Merced at a significantly lower valuation. However, this transaction doesn’t align with either category, as it involves evaluating development deals. It didn't quite fit our primary strategy. While we occasionally veer from our strategy if we see substantial value, we didn't find that to be the case here.

Okay. Sounds good. Thank you.

I was wondering on the CPP portfolio, if you could provide some color on where the assets are located? Do they contribute immediately to the same-store pool? Or will it be 24 months from now? And also, how do you think the performance of this portfolio will be on a same-store basis relative to your existing consolidated assets?

We sold Masso in the fourth quarter in Downtown San Francisco. Angela, please continue from here.

Yes. And the rest of the portfolio, it's all throughout Northern California. So we have one in San Mateo, one in Dublin, one in Pleasanton so in the East Bay, and San Jose, and of course, Walnut Creek. So those are the locations, but it's all Northern California. And as you know, we built these and have operated them. So we know the assets very well and certainly like them very much and glad to have all of them into our consolidated portfolio. They will be in the same store next year because, as you may recall, we roll them in, and we'll have one year of comparable results before we add them to the same-store pool.

Okay. And can you just remind us why the co-investments generally are accounted for under the equity method when you own, in many cases, 50% or more of the joint venture?

Yes. It's an off-balance sheet because of the control reasons. Our partners have essentially comparable approval authorities on basic items like budgets and financing, and so it's really a technical reason.

So is there anything different in asset management that you're going to do as you take these assets under your control?

Yes, this is John speaking. No, not at all, operationally and in terms of asset management, we manage all of our assets in a consistent manner. We have strong partnerships, and there isn’t a divided approach; it’s all integrated like a family. We maintain a unified approach across the board, so no changes are expected there. We are quite pleased with the locations of the assets as they are situated in growing technology markets, and we’re excited about that. However, this is not a change that would occur when acquiring an asset from a third party.

Hey, guys, Mike, maybe I'll start with you. Just wanted to think about the age of your portfolio and sort of the age of your assets within your portfolio? And how that influences your capital allocation decisions to maybe buy some assets and sell others?

Sure, Rich. Our portfolio is somewhat older than others, primarily because we produce less than 1% of our housing stock each year. Over 20 years, that results in less than 20% of our stock being new, meaning 80% is over 20 years old. We believe this is beneficial since we don't develop a lot of housing. This aspect reflects the nature of our markets. In terms of opportunity, you can't build a category B property, leading to less competition. Early in the cycle, category A assets may outperform B, but later on, B might outperform A. Additionally, as category A becomes more luxury-focused, it allows for thoughtful redevelopment initiatives that can increase value and yield above the cap rate, benefiting from both growth in the redevelopment and portfolio value increase. So, those are the key elements at play.

Got it. That's helpful, Mike. John, I have a quick question for you. We agree that there's not enough supply of apartments compared to demand, which ties back to what Mike mentioned. Most of the questions on this call have focused on supply, which is certainly a short-term concern. However, we believe that demand and job growth are significant long-term drivers. I'm curious if you could provide some insight on what you're observing in your West Coast markets where demand might grow. Additionally, what factors might make you more cautious?

Certainly. We currently see strong demand in the Seattle area. This high demand, combined with a decline in supply, is significantly tightening the rental market, which is positive. When it comes to caution, it relates to the temporary and disruptive effects of new supply entering the market, mostly in downtown locations. There are some issues in L.A. as well, though conditions are improving slightly with less supply than last year. However, downtown L.A. still faces challenges. Oakland also has its difficulties, but it is important to consider Oakland in the context of the broader Bay Area since people commute across by BART to San Francisco. Therefore, understanding demand in that wider area is essential. The supply situation raises concerns, but it is temporary, as you pointed out. Does that address your question?

Yes. Yes, yes, it does. It sounds like what you're saying is that the demand side of the equation remains very, very strong. And although, tech is diversifying across the United States, tech remains very strong and the economies you operate in are quite diverse.

That's true. The tech industry is expanding across the U.S., but our headquarters and the highest-paying jobs are still based here. It makes sense for companies to shift more back office functions elsewhere while keeping the creative design and top quality aspects of tech on the West Coast. This is evident in major companies out here, and the incomes associated with these roles really drive income growth, which is certainly advantageous.

Great. Just building on the current discussion, the great affordability migration is alive and well, and although you have a really good property tax-driven competitive advantage in your markets and with an ability to really grow outsized FFO. Any chance you would ever look at the higher-growth markets, whether it's Denver, Phoenix, Austin, Portland, places like that?

John, its Mike. Well, we've been in Portland before and exited Portland and we do look at it from time to time. It's definitely on our list. Portland, the reason why we exited is because they had an urban growth boundary that they essentially kept expanding, and we convinced ourselves it was not supply constrained. So I guess it depends on what housing and how these markets adjust. So in our experience, it's not just the apartment supply, but relatively inexpensive single-family housing meant that essentially as soon as rents get to a certain level, people go, you know what, I don't need to pay this rent anymore. I'll just go and buy a house. And so we look at that dynamic of what we charge for rent and what the comparable house and how difficult it is for our renter base to be diluted by homeownership. And so if we could find markets that satisfy and that look appealing from both those perspectives, good job growth and the overall amount of supply is somewhat limited and the transition from a renter to a homeowner is somewhat limited. We think that, that is a good market. Practically speaking, and we go through this process with our Board every year in terms of current markets and other possible markets. So Portland is definitely on that list. And there are some other markets that are on the list as well. Generally speaking, they are the more supply constrained markets.

As I look at your guidance, your same-store revenue guidance, just focusing on Northern California. That range of 2.6% to 3.6%. Can you give me some color around what has to happen in the market for 2.6% to be achieved? And then what has to happen for 3.6% to be achieved? What are the scenarios there?

The situation really depends on the supply of new homes and the corresponding demand and how they interact. We believe we are likely to reach the midpoint of our targets. However, the introduction of supply into the market in the first quarter could have a negative effect. This might lead to locking in lower rents for a longer period throughout the year. Conversely, if supply is delayed and enters the market during the peak demand season in the second or third quarter, that would be advantageous. Thus, we expect to reach the midpoint, given the supply and demand dynamics we are aware of, but any shifts could alter our expectations.

No, it does. And just as a quick follow-up, I noticed you guys are going to be planning on being net acquirers and you discussed why with your cost of capital. Just the type of product you're looking to buy, is it going to be more of selling older stuff that others see as value-added and buying recently built stuff? What is kind of the niche there that you're targeting?

On the disposition side, we will focus on the assets that are growing more slowly within the portfolio to enhance our overall growth. For dispositions, we are aiming for between $100 million and $300 million. As you mentioned, we anticipate being net acquirers this year, with the objective of increasing shareholder returns. We will concentrate on our higher growth markets and, as previously mentioned, we are likely to target the A- to B category, specifically the newly developed properties, as the supply of those has not kept pace with the performance of B-level properties over the past few years.

Are there plans to renovate something when you buy it, or do you prefer to look for something that doesn't need any additional capital?

Yes, this is Mike. We handle a variety of situations. If a property requires a renovation plan, we'll incorporate that into our financial projections. Conversely, if a property is in good condition, we will consider that too. Our focus is not limited by the property's origin, whether it's at the B- to A level; it's primarily about growth, as Adam pointed out. We're open to growth arising from redevelopment or from gaining a deeper understanding of the market and its growth rates compared to others. Ultimately, we concentrate on the returns from our investments in relation to the entire portfolio, and that guides our decisions.

Thanks. Just one question for me. John, you mentioned there is a 40 bps lift to other income this quarter, largely due to lease break fees. It's a lot larger than the last several years in the fourth quarter. So just curious, what's driving the outsized lease break fees right now?

Yes. Lease break was one component, it's the biggest component and I called that out. There was other items as well. But yes, what was driving the lease breaks really relates to the supply that was coming into the market in Q4. And again, that goes back to our decision as we saw that the supply was going to start hitting the market, and we filled up or increased occupancy. We did anticipate this type of thing to happen. But you go into the low demand period. The concessions start to increase at the new supply, and you get to about eight weeks free in some cases, and people will break their lease and transfer. So that's what was driving it.

I can add that the move to purchased homes has recovered significantly and reached 12.1% in Q4, which is a bit higher than it has been recently.

Good afternoon. Mike, does the continued legislative environment and ballot initiatives in California make condo projects any more attractive in certain submarkets? And any chance we see some of the under-construction apartment projects go condo before leasing?

Yes. And that is a good question. One of the conundrums that we've experienced over the last several years, as we bought many failed condo buildings in the last cycle, and we had hoped to convert them back to condos and sell them at a lower cap rate than we could otherwise sell apartments. We have not found that that's the case at all. In fact, if anything has gone the other way, we've produced more rental housing, much more rental housing than we have for sale housing, and that's been an ongoing dynamic. So we haven't seen that spread that we had hoped for in purchasing a condo versus an apartment value, and which of course is what triggers that. And with the recent past increases in the price of the single-family home being in the minus 3, I think in San Jose to about 1% in the best of our locations. It hasn't helped that condo versus apartment valuation.

Okay. And then I think I heard you guys say that the negative impact of 1482 is 10 basis points in 2020. Given your supply issue commentary, do you guys really have that many units where you'd be raising rents by more than 5% plus inflation this year if you could?

Yes. This is John. The negative impact we are experiencing affects revenue and is primarily linked to short-term rentals and the associated premium. At the end of a lease, we always offer our customers the options they prefer. If they choose a shorter-term option, there’s a premium tied to that. However, 1482 restricts that premium, which is where the 10 basis point headwind originates.

If a unit was renting for a market rate of $1,000 for 12 months, theoretically, you could raise that rent to $1,200 and offer two months free, which would keep you in the same economic position and allow for greater rent growth of over 5% plus inflation by reducing discounts.

Yes. I mean, first, let's go back a step. So the 1482 really impacts renewals, right? When a unit goes vacant, it's the market rent. So at the end of the lease period, we typically and the residents typically respond to direct renewal. There's not generally concessions in there. And we are not anticipating going that direction.

Okay. Just curious, given your sub-50% turnover, and it keeps heading south every year, whether or not you get into a situation where you actually are going to need at some point greater turnover.

Yes, I really appreciate that we have lower turnover. It reflects the quality of service from our assets and our fair pricing approach. We align with the market and do not push rents beyond what is reasonable. The site teams are doing an excellent job, and I believe the lower turnover is a result of that. I don't expect it to drop much further, as there will always be a natural need for people to move.

Thank you, operator. I want to thank everyone for joining the call today and look forward to seeing many of you at the upcoming Citibank Conference. Have a good day. Thank you.