Essex Property Trust Inc (ESS) — Q3 2022 Earnings Call Transcript

Thank you for joining us today, and welcome to our third quarter earnings conference call. Angela Kleiman and Barb Pak will follow me with prepared remarks, and Adam Berry is here for Q&A. I will begin by congratulating Angela for her appointment to the Essex Board and for being chosen as the next CEO of the Company following my planned retirement in March 2023. I’ve known Angela for almost two decades and we have worked closely together since she joined the Company 13 years ago. Angela embodies and exemplifies Essex’s strategy and core values and is a dedicated, thoughtful leader as well as an excellent negotiator. Our recent leadership announcement was a culmination of the multiyear succession plan administered by the Essex Board, and I appreciate each participant’s commitment to the plan that resulted in its success. It has been an honor to lead this amazing company, made possible by my great leadership team and the coordinated effort of every Essex associate. My thanks to all of you. Today, I will touch on our third quarter results, introduce our initial market level rent forecast for 2023 and provide an update on the apartment investment markets. Our third quarter results represent our fifth consecutive quarter of improving core FFO per share. On a year-over-year basis, we reported core FFO per share and NOI growth of 18.3% and 15.4%, respectively, with core FFO exceeding the midpoint of our guidance by $0.04 per share. The positive results reflect the team’s execution and the continued recovery throughout our markets, largely driven by the ongoing rebound in Northern California and Seattle, with Southern California remaining a consistent and strong performer. Year-to-date, the economy on the West Coast has shown resiliency, with job growth as of September 2022 of 4.3% in Southern California and significantly higher in the tech markets of Northern California and Seattle. The positive job growth is partly attributable to the recovery of workers lost amid the significant shutdowns early in the pandemic, especially leisure, hospitality and service jobs that were added throughout the summer. As a result, it is not surprising that the unemployment rate in each Essex market, with the exception of Los Angeles, is under 4%, including San Francisco and San Jose in the mid-2% range. The unemployment rate in Los Angeles is higher at 4.5%, likely related to the ongoing eviction moratorium in the city of Los Angeles, which is expected to end in February 2023. Job openings at large tech companies have declined from record levels during the pandemic, although they remain significant, with approximately 20,000 jobs available, roughly consistent with the number of job openings reported between 2016 and early 2020. Thus, while we recognize that tech job growth is slowing, the large tech companies are well-capitalized and continue to expand and hire in our markets. As in previous years, we’ve included our initial forecast for 2023 market-level rent growth on page S-17 in the supplemental. Our forecast begins with the consensus estimates of third-party economists for the national economy with respect to GDP and job growth, indicated at the top left of page S-17. Based on these estimates, our data analytics team estimates job growth in each Essex metro. On the supply side, we use our ground-up fundamental research to estimate apartment deliveries, which has proven to be highly accurate over many years. Everyone’s visibility into next year is limited by uncertainty related to past and future Fed actions and their impact on the overall U.S. economy, and therefore, the forecasted rent growth may vary if the key assumptions prove inaccurate. In summary, housing supply across the Essex markets is expected to grow at 0.6% of existing housing stock, with the greatest increase occurring in Seattle with a 1.1% increase. Job growth is expected to be muted next year, growing at 0.4% overall in the Essex market, with the best job growth expected to be in San Francisco at just over 1%. As a result of these demand and supply assumptions, we expect net effective new lease rents to increase 2% in 2023, with our California markets expected to marginally outperform Seattle. On a year-over-year basis, we expect apartment supply to decline about 10% in 2023, with Northern California having the largest expected reduction down 45%. We also expect 2023 single-family deliveries to be similar to 2022, even with permits growing modestly given the much higher mortgage rates. With respect to for-sale housing, declining housing production and reduced affordability are tailwinds for apartments in the Essex markets, representing a small positive factor contributing to our rent outlook next year. Given economists’ expectations for a modest recession in 2023, I’d like to summarize our historical experience operating our portfolio in previous economic downturns. Generally, in each significant past recession, our weakest market has been Seattle, which is due to the confluence of negative job growth and higher levels of housing supply deliveries. Northern California follows a similar pattern to Seattle regarding job losses during recessions, although with significantly less supply that results in outperformance relative to Seattle. Finally, Southern California is our best performer during recessions, given its diverse economy and minimal supply. That being said, each recession is unique and there are several factors that could lead to a different outcome. First, most of the previous recessions followed a long economic expansion where rents grew substantially. It’s those higher rents that pressure affordability, fostering a higher level of apartment supply. On the West Coast, rents plummeted in the early part of the pandemic and our recovery was much delayed compared to the rest of the country, with Southern California’s recovery beginning in mid-2021 and Northern California and Seattle in early 2022. As a result, the West Coast is still in the early stages of recovering from the 2020 recession, and housing supply has not had sufficient time to fully recover. In addition, with many offices closed during the pandemic, it was common to hire remotely with the expectation that workers would need to relocate closer to offices upon re-openings, which is now occurring. The relocation of employees back to the West Coast pursuant to return-to-office programs represents demand for apartments that is generally not included in job growth. Finally, we expect less outward migration in the next few years, primarily because those that typically leave California, such as the newly retired, probably left early in the pandemic when businesses were shut down. In a moment, Angela will comment further on migration. Turning to the apartment transaction market, we have recently seen a few deals close at valuations that were negotiated before the most recent increase in interest rates, and conditions have changed enough since then to significantly impact transactions. As expected, the immediate impact of higher interest rates will result in diverging buyer and seller expectations for property values, resulting in a larger bid-ask spread. Generally, it takes more than higher interest rates to create financial distress, especially with recent strong rent growth amid inflationary pressures. However, pockets of distress may develop from credit or liquidity events or excessive Fed tightening, although no major issues are apparent at this point. Broker price talks with respect to apartment transactions indicate that cap rates for high-quality and well-located apartments are in the mid-4% range in the Essex markets. Finally, I wanted to note that our balance sheet is in great condition, thanks to the unwavering urgency of Barb and the finance team over the past several years. When the markets turn positive, we expect excellent opportunities to invest creatively, and we will be in a position to be opportunistic. With that, I’ll turn the call over to Angela Kleiman.

Thank you, Mike. I will begin by expressing my sincere gratitude to Mike for his mentorship and guidance over the past 13 years. I am honored to have the opportunity to lead this organization and to build upon the Company’s long history of thoughtful capital allocation and operational excellence. My comments today will focus on our third quarter performance, followed by some regional highlights, then wrap up with the key operational initiatives that we are excited about. Starting with the third quarter, during much of this period, we capitalized on the strength of the underlying fundamentals in our markets by pushing rents and achieved 10.3% year-over-year growth in new lease rates in the third quarter. Although this is a deceleration compared to the 20% growth in the second quarter, keep in mind that new lease rates in the first half of last year declined by about 6%, but in the second half, new lease rates surged to positive 17%. The tough year-over-year comps are the key driver of the deceleration, and the third quarter results are in line with our expectations. In general, we have seen a normal seasonal rent pattern. Accordingly, as we approached the end of the third quarter, we shifted to an occupancy-focused strategy. Turning to delinquency, in recent months, we have begun to recapture more units from nonpaying tenants. With the ending of eviction moratoriums, it is no surprise that the number of move-outs related to nonpaying tenants has increased. Looking forward, we plan for a higher volume of move-outs, which may create a temporary headwind in occupancy for the rest of the year and into 2023. For this reason, even though we have shifted to favor occupancy, we anticipate our occupancy to be slightly lower than historical levels. The good news is that regulations are being pulled back, which is allowing us to finally make progress on delinquency. Moving on to regional highlights, starting with the Pacific Northwest. After a strong start to the year, rents in this region have peaked in late July. The seasonality through the third quarter, which includes the typical decline in market rents subsequent to the peak is consistent with what we have experienced between 2016 and 2019. However, since mid-September, we’ve been facing softer demand along with higher levels of supply deliveries in the second half of the year. So, we are monitoring this market closely. As for Northern California, this region has led our growth in net effective new lease rates since the start of the year. Strong job growth and return-to-office are two key contributing factors. Bay Area net in-migration has continued to accelerate this year. In the third quarter, over 35% of move-ins were primarily from outside of our markets, which is an increase from 15% in the first quarter. Notably, we are seeing positive migration trends from markets as diverse as Dallas and Boston. Consistent with our previous commentary on the commitment of tech giants to continue to expand in Northern California, we are excited to see Google break ground last week on its massive mixed-use development in San Jose. This development is expected to bring 25,000 high-paying jobs and effectively double the amount of office space in Downtown San Jose. This will be a long-term benefit for Essex as we own almost 6,000 units in this region. On to Southern California, healthy job growth is continuing to drive incremental demand for rental housing. As such, this region continues to perform well. We’re also seeing positive in-migration to Southern California, with 30% of our third quarter moves coming from outside the region compared to 17% in the first quarter. Turning to key operational initiatives, we have completed the rollout of the first phase of our property collections operating model, which focuses on leasing, administration, and customer service. By way of background, this model optimizes our geographic density and transforms our business from operating each property individually to a collection of around 9 to 12 properties. The shift in business strategy enables us to leverage our team and technology to improve the customer experience and achieve significant efficiencies. I’m pleased to announce that Phase 1 is fully rolled out across the entire portfolio, ahead of plan, and the progress is beginning to show up in our financial results. Year-to-date administrative expenses were up only by 1.4%. Despite significantly higher wage increases, along with other inflationary pressures on expenses. The next step is to apply the collections operating model to the maintenance function. As we have demonstrated previously, this model has created more career advancement opportunities for employees through specialization while improving efficiency and customer service. The maintenance collections highlight is currently underway, and the rollout is planned to start by mid next year. Lastly, on the technology front, the implementation of the Funnel software suite is progressing well. As you may recall, Funnel is a RET Ventures company with whom we have chosen to co-develop applications to enhance our platform. The Funnel product will handle the end-to-end customer experience from initial prospect inquiries through the full resident lifecycle, resulting in better experiences for our customers. From an employee perspective, this technology will streamline or automate the manual tasks associated with roughly 60,000 transactions each year. Our initial pilot showed a promising 35% reduction in task time associated with these activities. Continued refinements are underway, and we are excited to work toward a full deployment by the end of 2023. With that, I will turn the call over to Barb Pak.

Thanks, Angela. Today I’ll discuss our third quarter results followed by an update on investments and the balance sheet. I’m pleased to report third quarter core FFO per share of $3.69, a $0.04 beat to the midpoint of our guidance range. Half of the outperformance was due to lower operating expenses, which is timing related, and the other half was from higher co-investment income due to better NOI growth at the joint venture properties and higher preferred equity income. For the full year, we are raising the midpoint of core FFO by $0.02 per share to $14.47, representing approximately 16% growth compared to last year. As it relates to delinquency, we are seeing continued improvement in our gross delinquency, which is helping to offset less emergency rental assistance funds. The same-property portfolio gross delinquency improved sequentially from 4.5% in the second quarter to approximately 3.5% in the third quarter. October improved further to around 2%. We suspect the gross delinquency trends will continue to improve as we work to recapture delinquent units. However, the improvement is unlikely to be linear. One additional positive development that recently occurred is that the City of LA approved removing eviction protection starting on February 1st next year. This will allow us to recapture delinquent units in an area that accounts for approximately 40% of our outstanding bad debt and will allow us to finally get back to our historical level of delinquency. However, it will take time to achieve this goal, and we would expect delinquency to remain elevated through the first half of 2023, with the expectation that we will get closer to our historical average of 35 basis points of scheduled rent by the end of next year. Turning to our stock repurchase and investments. Consistent with last quarter, investing in our own portfolio and select preferred equity investments offers the best risk-adjusted returns in today’s market. In the third quarter, we repurchased $97 million of common stock at a significant discount to our internal NAV, which we plan to match fund on a leverage-neutral basis with proceeds from a disposition expected to close in the fourth quarter. As it relates to other transactions, we closed $65 million of new preferred equity and subordinated loan investments during the quarter and committed to one additional investment in October. These new commitments are expected to be match funded with redemptions of two structured finance investments that are slated to close in the fourth quarter. Finally, I want to provide some additional color on the strength of the balance sheet. Our net debt-to-EBITDA ratio remains healthy at 5.8 times, and we expect this to further improve as EBITDA continues to grow. It should be noted that we operated around these same leverage levels before the pandemic, and our balance sheet metrics are strong. In addition, we are well-positioned from a capital needs perspective. In October, we closed a delayed draw term loan that will be fully drawn in April of 2023 with proceeds intended to repay $300 million in bonds that mature next year. We have swapped this debt to an all-in fixed rate of 4.2%. As a result of this transaction, we have all our known funding needs addressed until May 2024. The company has no significant unfunded development needs and can fund dividend, operations, and capital expenditure needs from free cash flow. Additionally, our variable rate exposure, excluding our line of credit, is minimal at less than 4% of our consolidated debt. With over $1.1 billion in liquidity, no funding needs for the next 18 months, and access to a variety of capital sources, the balance sheet remains well positioned. I will now turn the call back to the operator for questions.

Thank you. And congratulations, both Mike and Angela. Maybe just starting on the building blocks for next year. Obviously, you provided the market rent growth of 2%. What’s the earn-in expected from 2022 lease in? And then where is the loss per lease today, and where would you expect it to be at the end of the year?

Hey Nick, it’s Angela here. Regarding the earn-in for 2023, I wanted to clarify our consistent definition. We determine earn-in by looking at the September loss-to-lease, which is around 7%, and taking half of that for a 3.5% earn-in, while assuming no market rent growth. There have been questions about how earn-in affects 2023 revenue growth. In the past, we've explained that you take the earn-in and add 50% of our 2023 S-17 market rent growth, which is 2%, giving us an additional 1%. This results in an overall estimate of about 4.5% for revenue growth in 2023. Currently, our loss-to-lease in October is about 2.5% for the portfolio, down from 6.7% in September, showing a deceleration. However, this level is better than our historical patterns, as we usually see around 1% loss-to-lease this time of year, trending towards zero by year-end. So, at 2.8%, we feel positive about the portfolio.

Thanks. That was very helpful. And then maybe just on the transaction market, given kind of the expected rent growth and where debt costs are today, does the 4.5% cap rate make sense for most buyers, or how are they thinking about getting to their unlevered IRRs, given maybe the negative leverage situation initially right now?

Yes. Hey Nick, this is Adam. As Mike mentioned in his opening comments, the transaction volume is definitely down from where it was a quarter ago. But there are still deals being priced. There are still deals going non-contingent. And in talking to buyers who are still active in the market, they’re willing to take a certain level of negative leverage for 18 to 24 months is the number that I’m hearing now. And so, with various assumptions about rent growth, repositioning, and those types of strategies, that’s what we’re seeing in the market.

Yes. Thanks. Look, I guess the biggest thing that everyone’s focused on is the 2%. And Angela, you walked through the math, and I know this is not trying to get this into a debate about ‘23, but the math that you just walked through would, I think, basically imply your revenue growth is several hundred basis points below several of your peers. And I guess I’m just trying to understand, is that really a function of market mix; is that a function of the conservatism, the 2%? I don’t know what the history of that number is. And if you start low and kind of work that number high over time, but it just strikes me as your implicit growth for next year is kind of well below the peers.

Hey Steve, I'll address that. S-17 began a few years ago by aligning with the consensus of third-party economists regarding the U.S. market, and then analyzed what that means for our specific markets. We have Chairman Powell discussing potential hardships and a mild recession, which informs our view. Instead of relying on our personal opinions, we believe it’s essential to base our scenario on the insights of experts who study these trends, and we take their perspectives seriously. We acknowledge that this macroeconomic outlook appears somewhat bleak. However, we decided years ago to rely on the perspectives of macroeconomists, which indeed paints a somber picture. We shouldn't dismiss the Federal Reserve’s warnings about potential economic challenges. While we believe conditions may actually be somewhat better, if we based our projections solely on our own feelings, we might adopt a more optimistic stance. Nevertheless, it’s crucial to address the realities presented by macroeconomists and their implications for us. It's also important to note that the economic challenges, if they arise, will be felt nationwide, not just on the West Coast. Our analysis starts with U.S. job growth, and we examine historical trends to understand what those figures mean for the West Coast.

Yes. No, look, I agree that there are storm clouds. It would seem like you would need to see negative job growth occurring in order to really diminish the pricing power that’s out there. And so, when I look at your job growth forecast or the market’s job growth forecast of 40 basis points, again, supply growth of 60 basis points, those are largely in lockstep with each other. There’s not big dislocations on the supply front in your market. So, it would feel like occupancy is going to be relatively stable. And so, I would have thought that rent growth wouldn’t be off to the races, but that it might be better than 2%. If you told me job growth was very negative, I would agree with you.

Well, that’s exactly what the third-party economists are saying. The consensus from these third-party macroeconomists indicates that job growth is expected to decline by 0.2% next year. This information informs our expectations, as we anticipate that we will perform better in job growth compared to the U.S. economy. In fact, while the U.S. is projected to experience a decline of 2%, we expect a growth of 0.4% for ourselves. It's not a significant increase, but the overall outlook is concerning. However, based on the current data we have, we are experiencing some seasonality in October, which we anticipated. Loss-to-lease usually turns negative by year-end, and we expect that trend to continue this year. It's important to remember that job demand significantly impacts our situation. While we monitor seasonally adjusted job figures, total nonfarm employment tends to soften in the fourth quarter. Such trends are common. We believe the current projections are quite severe, yet we strive to be consistent with our communication regarding S-17. By following historical patterns and considering the economists' predictions, we accept this outlook. Could the scenario change? Certainly, and we hope it does. However, we cannot overlook the significant concerns raised by macroeconomists.

I appreciate that. Thanks. And then, I guess maybe just in terms of return hurdles and how you’re thinking about underwriting. Can you just give us a sense for how you guys have altered either acquisition hurdles, development hurdles in light of given where stock prices have gone, where bond yields have gone? I mean, how much have you raised your cap rates, IRRs in today’s environment?

Hey Steve, this is Adam again. So, consistent with what we just talked about, the 4.5% range is kind of where we see the market. We’re probably not buyers at that range; we have a better use for our capital and development yields will need to move off of that base if not maybe slightly higher. So, when we look at development deals, depending on where they are in the entitlement process, we’re looking at a 20% to 25% spread over to adjust for the risk related to development.

Hey. I just wanted to maybe dive a little bit deeper into some of the markets. Looking kind of at the October new lease growth, kind of the 2.8% figure. Wondering if you can maybe just give some color just on performance across kind of the different markets. I think that would be helpful.

Sure, I'd be happy to. The new lease rates for October are at 2.8%, which represents a broad range. Starting from the Pacific Northwest, we see a decline of about 90 basis points, which aligns with my previous comments about the weakness in that market. Conversely, Northern California is performing the best at about 4.5%, while Southern California is around 2%. Southern California remains stable, and Northern California is showing the rebound we expected.

That’s really helpful. Looking at the occupancy figures, it appears consistent from October to the third quarter. Could you comment on whether concessions are being utilized? I would assume they might be used in the weaker Northwest market. I'd like to understand if concessions are being employed as a strategy to maintain occupancy.

Sure. Concession usage is important for us, and we focus on areas with competitive supply. During our own lease-up, we utilize concessions as part of our pricing strategy. However, outside of that, it depends on the number of lease-ups near a property and how we can stay competitive and meet market demands. Regarding concession usage, there has been a noticeable increase between October and the third quarter, primarily driven by the situation in Seattle. In the third quarter, we experienced a very normal period that lasted less than a week, and it has now extended to about two weeks, marking the most significant change. Other markets have seen a slight increase of a few days, which aligns with our expectations. Overall, across the portfolio, our concessions have risen from approximately half a week to about a week, with Seattle being the main contributor to this change.

Angela, congratulations. Now you get to respond directly to George after each earnings season, and I’m sure that will be enjoyable for you. I have two questions for you, starting with Steve's question. Typically, your team takes a conservative approach. I won't elaborate further than that. However, you generally aim to under-promise and over-deliver. Mike, I understand your perspective on the economic forecast in S-17, which reflects independent consensus; this isn't within your control. But when we discuss bottom line earnings growth, especially considering the adjustments from the COVID rebound, it seems you're indicating that revenue was 4.5% while your lost lease is currently at 7%. Yet, you’re only projecting revenue growth of 4% to 4.5% for next year. The Prop 13 tax measure will benefit you next year, which should make your operating expenses slightly better than the national average since you won't face property tax pressures. As we consider bottom line FFO growth, if 2023 isn't marked by a severe recession, should we expect a return to more typical earnings growth? I'm trying to understand how much year-over-year statistics are influencing our perception of the FFO growth you've outlined.

Yes. There are many factors at play here, and you're asking important questions about the implications for our bottom line. Let me clarify a few points before handing it back to Mike to discuss S-17 and possibly address the FFO. The 7% you mentioned relates to the September loss-to-lease. Typically, we take half of that into account with earn-in, which is how we arrived at the 3.5%. This calculation is consistent for proxy purposes. Regarding expenses, I believe we should perform slightly better than the average inflation rate. Specifically, on the administrative side, we should be significantly below inflation. Since we have not yet implemented maintenance collections, that will be higher than the growth in administration costs. Therefore, we expect our controllable expenses next year to be similar to this year, around 4%. These are the foundational aspects from a P&L standpoint. Now, Mike?

Yes, Alex, I wanted to add a few points. First, Angela believes that for next year, the proxy formula indicates a growth of 3.5 plus half of next year’s growth, which is projected at 2%, representing a rather concerning scenario. There is potential for upside if this pessimistic outlook does not materialize. Additionally, we feel confident about the Company's current position. Our core FFO is at the high end compared to our bicoastal peers when reviewed against Q4 2019. This has been achieved with Southern California showing full recovery, while Northern California and Seattle are still lagging. We attribute this discrepancy to the fact that both regions were affected more severely and require a longer recovery period. For instance, in Northern California, current rent levels are approximately back to pre-COVID rates, indicating no rent growth there. Historically, tech markets drive growth, and I expect that they will continue to do so in the future, though we haven’t reached that point yet. We are optimistic as median household incomes in San Francisco and San Jose now exceed $145,000 a year, which is remarkable and suggests affordability in relation to rental values. This is what attracts individuals to the West Coast. While there is talk of higher costs here, the reality is that people are drawn by much higher incomes. We anticipate ongoing recovery as jobs lost during the recession return in Northern California and Seattle. We believe these areas will once again become key drivers for the Company moving forward, and little of this potential is currently reflected in the stock price, indicating good upside potential.

The second question is about your debt and preferred equity programs. One of your competitors recently faced a default and is reclaiming a property in New York, while an office company converted two DPE positions. Considering your various investments, how do you assess the risk profile of DPE? Are you observing that all the deals are meeting your financial expectations, and have you noted anything outside your ongoing performance and financing evaluations?

Yes. Hey Alex. At this point, we’re not seeing any significant potential for defaults. We continuously evaluate our preferred equity portfolio. So, the short answer is no, we’re not observing anything concerning at this moment. To provide some context, over 75% of our preferred and mezzanine book was underwritten in 2020 or earlier. We didn’t pursue risky deals during that time, staying away from mid-3 cap rates. With the recent increase in cap rates, it doesn’t affect our position. Additionally, with the considerable growth in net operating income, we believe we’re in a strong position.

I’m wondering for one of the comments I think Angela said in her opening remarks on the higher move-outs is, I think, what you’re expecting going forward. Are those higher move-outs from non-payers who I guess you’ll be able to address with LA restriction going away? Just trying to get a sense of like, will that lower occupancy kind of impact same-store revenue.

There are two main factors driving the higher move-outs. Firstly, there is a softness in Seattle due to an increased level of supply in the second half, which leads to more concessions that encourage people to leave stabilized properties. This is unusual during a time when corporate hiring is slowing. Secondly, in California, the rise in move-outs is largely due to nonpaying tenants leaving, which we view positively. With the LA moratorium ending next year, we see this as another opportunity to make progress on our delinquency issues.

Yes, that's helpful. You mentioned shifting more focus on occupancy. What's driving that? Is it a desire to maintain occupancy, especially considering the macro view that there may be a recession?

I understand your point. Yes. Normally, when we experience market strength, which typically occurs during strong demand periods, we increase rents. As we approach the end of the third quarter and enter the seasonal low in the fourth quarter, we tend to change our strategy to prioritize occupancy. What we’re doing now aligns with our historical approach. I want to emphasize that we are operating in a stable, normalized market, and we are adjusting our strategy to optimize revenue during this time. Typically, in the fourth quarter, our occupancy rates might be in the mid to high 96%. However, due to the eviction challenges we are facing, it may be slightly lower, around the low 96%. I want to reassure everyone that this isn’t indicative of any issues; in fact, it’s a positive development.

Angela, I wanted to ask about your approach to the earn-in. I understand this is a relatively new metric for us. You've mentioned using the September loss-to-lease and estimating it by taking half of that figure. I assumed the earn-in represented the rent contribution for this year compared to next year based on the leases you've signed so far. I'm curious about how this earn-in measures against previous years and how reliable you think the estimate of September loss-to-lease divided by two is in terms of the actual contribution.

If I assess the September loss-to-lease and consider 50% as a benchmark, comparing it to previous periods before COVID, the September figure is approximately double the normalized rate. Typically, around September, the loss-to-lease is about 3%. This is one of the reasons we feel optimistic about our portfolio as we move into next year. Provided there is no recession, we should perform quite well.

So historically, your earn-in is about 1.5% per year?

Yes, that sounds about right. Now the one thing I do want to clarify is that everybody calculates it a little bit differently. And so for us, we are not including concessions. So, if we include concessions, that earn-in number, obviously, will be much higher. But we’re trying to just keep it apples-to-apples, so to minimize confusion. So, it’s the same baseline.

Okay. And I know this has been asked a few different times. But on your 2% rent forecast, I’m just trying to get a sense of what kind of range that you see is at and how difficult it was to forecast job growth for next year versus prior years when you come out with this initial forecast?

Hi John, it’s Mike. We are beginning with insights from third-party economists regarding the macroeconomic situation. The developments across the country will depend on that. Typically, we tend to perform better than the national economy in terms of job growth. The consensus among leading economists predicts a decline of 2% in U.S. job growth next year, and we believe we will exceed that with a growth of 0.4%. However, that translates to about 4,800 households against over 50,000 new units entering the market. Do we truly expect this to happen? Given Angela's earlier comments, it appears quite bleak. However, we cannot dismiss the economists’ insights or the Federal Reserve's warnings about potential adverse effects. Our outlook for next year is uncertain, and while we feel fairly optimistic at the moment, we must consider these figures. I prefer having this conversation with you so you understand our perspective rather than creating an arbitrary scenario that lacks relevance. In our budgeting process, we base it on expected economic rent growth. It’s challenging to prepare a budget without that, as property teams alone cannot determine rent trajectories. We require a broader economic view to inform our budgets, which we then adjust based on local supply and demand. I am not implying our budgets rely solely on this scenario since it appears somewhat grim. Nonetheless, we are aware of the macroeconomic conditions and the Fed’s messages, and we will make adjustments as needed. Does that make sense?

It does. I know it’s difficult time, too. I appreciate it. Thank you.

Thanks. The first question is about your portfolio. Are you noticing any differences in operating trends, considering your diverse portfolio with varied price points in suburban and urban areas? As we consider the challenges related to the return to office on the West Coast, particularly in places like San Francisco, Seattle, downtown LA, and possibly downtown San Diego, are your apartment assets in these urban centers performing differently compared to the rest of your portfolio?

Yes, it's Mike. I’ll begin and then hand it over to Angela shortly. The answer is yes, we are noticing various disparities. I’ll provide an overview of our portfolio strategy and its rationale, which is to establish properties in the fastest growing metropolitan areas. We focus on supply and demand dynamics to guide our capital deployment. Our preference is typically for the B or renter by necessity segments. When new supply enters the market or there is a supply-demand imbalance, which could occur next year, the properties most affected are usually those near the new supply. For instance, if a nearby property offers eight weeks of free rent and you have a brand new apartment competing with that, your property may suffer significantly. Our portfolio is primarily suburban. We aim not to be situated in San Francisco and San Jose, but rather throughout Northern California's metroplex, ideally within an hour's commute from major job centers. This is the composition of our portfolio. We believe there is inherent safety in B-class properties because the quality properties are not easily replicated. In a landscape where demand is more concentrated in downtown areas and new developments are more vulnerable to concessions if they increase significantly, we anticipate that those locations might be impacted the most. Conversely, B-quality properties are expected to perform quite well. Angela, I'll now pass it over to you.

Well, I think maybe I’ll just give you a quick example of what Mike is talking about. Concessions in downtown LA are about 1.5 weeks, and concessions throughout the rest of the LA area average about a week. And so that gives you the magnitude impact of the downtown versus the market.

Great. Thank you. Mike or Angela, I know you guys are talking about that 2% market rent growth feeling a bit dire, but I guess how do we get comfortable with the fact that the loss-to-lease was 7% in September of this year versus a historical level of 3%. Yet you still expect the loss-to-lease to go negative in December, which would imply kind of a disproportionate slowdown here. So, how do we get comfortable with that? And then, why do we expect it to get better as we enter into early next year?

Yes, I'll begin and perhaps Angela can chime in. There's a seasonal pattern that occurs each year, although it's not identical every time, with some variations. This is mainly driven by the decrease in demand, such as jobs, from October to December, while supply continues to be delivered during this period. This leads to a seasonal slowdown, which is uneven and has its complexities. We're just referencing historical trends. By the year's end, we might see loss-to-lease at zero or a negative gain-to-lease. Then in January, as new budgets and hiring start up, we typically observe a market recovery in the first quarter. That's how it has worked for many years. Angela, is there anything specific about this year that seems different?

No, other than that, it’s so far better than historical patterns. I don’t see anything different.

Congratulations to both of you, Mike and Angela. Angela may be the first order of business. Can you simplify the page numbering, S-18.2? There’s an infinite number of numbers just so you know, you can make it a little simpler, all of us. But that’s just a little side note. When I think about this 2% number that we’re all talking about, if you were to go back and say in a normal time and you were to look at S-17, and you look at the supply number that you’re referencing of 0.6, and the job forecast at 0.4, and it’s a normal time, what would be the number? So, what’s backing into that? What would be the Fed impact that’s come to the 2% number? But, if it were more of a normal type of world, would that be 4, would that be 5, would that be 8? Could you comment on that?

I want to ensure I understand your question. The figures 0.4 and 0.6 lead to a 2% rent growth, mainly because we primarily operate in the B sector. Most properties on the West Coast are classified as B, and there is a significant housing shortage, which underpins our situation. We are optimistic about achieving some rent growth. As for the transition to for-sale housing, many people remain in the rental market within the B sector, which suggests we can attain modest growth. Therefore, we believe a 2% increase is achievable. Typically, except during recessions, job growth and household growth follow a 2 to 1 ratio, consistently outpacing supply. A recession is the only time this doesn’t hold true. If there isn't a recession next year, we anticipate improved job growth that will help address supply issues quickly. Other markets may have greater supply, but they face similar demand challenges, so we still expect to perform better in our area. Does that clarify things?

This is Mike. Once again, I want to thank you for joining our call. Angela and I both really appreciate all the congratulatory sentiment out there. Much appreciated. We look forward to seeing many of you at NAREIT in a few weeks, and have a good day. Thank you.