Essex Property Trust, Inc. (NYSE:ESS) Q1 2024 Earnings Call Transcript May 1, 2024
Essex Property Trust, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good day, and welcome to the Essex Property Trust First Quarter 2024 Earnings Call. As a reminder, today’s conference call is being recorded. Statements made on this conference call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made based on current expectations, assumptions and beliefs as well as information available to the company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found on the company’s filings with the SEC. It is now my pleasure to introduce your host, Ms. Angela Kleiman, President and Chief Executive Officer for Essex Property Trust. Thank you, Ms. Kleiman. You may begin.
Angela Kleiman: Good morning, and thank you for joining Essex’s first quarter earnings call. Barb Pak will follow with prepared remarks and Rylan Burns is here for Q&A. We are pleased to kick off our 2024 earnings with a notable increase in our full year guidance. This is primarily driven by solid first quarter results with core FFO per share of 4.9%, exceeding the high end of our original guidance. Barb will provide more details on our financial performance in a moment. Today, my comments will focus on market fundamentals and operational highlights, followed by an update on the investment market. Heading into 2024, consensus forecast was a slowdown for the U.S. and so far, U.S. job growth has trended better than initial forecast.
Job quality, on the other hand, has been concentrated in government and low-wage service sectors. In the West Coast, the tech industry is a primary source of high-paying jobs and job growth in this industry has led because of evolving business strategies as companies reallocate resources to artificial intelligence opportunities. However, we have seen encouraging signs, including a steady increase in job openings in our markets by the top 20 tech companies. As for our near-term outlook, recent information data and Fed commentary have resulted in elevated uncertainty regarding the path of interest rate cuts. With this in mind, we do not anticipate an imminent improvement in job growth in the high-paying sectors, which is typically the key catalyst to accelerate demand for housing and rent growth.
While job growth on the West Coast has remained soft. Our steady performance year-to-date is attributed to two factors: first, limited housing supply. This is a significant structural benefit and a pillar of our California investment thesis. Lengthy and costly entitlement process effectively deters housing supply. To this point, total housing permits as a percentage of stock continues to remain well below 1% in Essex, California markets. Our performance today demonstrates this supply advantage. It is a key stabilizer during soft demand periods and a driver of rent growth outcomes over the long term. The second positive factor is rental affordability which is driven by wages growing faster than rents in FX markets. Additionally, the cost of homeownership continues to rise.
The median cost of owning a home is 2.5x more expensive than renting in our markets. Likewise, the percentage of our turnover attributed to purchasing a home has fallen from around 12% historically to 5% today. Accordingly, rental affordability supports a long runway for rent growth in the FX markets. Turning to first quarter operations. We achieved a 2.2% growth in blended lease rates, which consists of 10 basis points on new leases and 3.9% on renewals. Our new lease rates are tempered by delinquency-related turnover in L.A. and Alameda, which comprise of approximately 25% of our total same-store portfolio. If we excluded these two regions, new lease rates would have been 150 basis points higher at 1.6%. Moving on to regional highlights. Seattle was our best-performing region, achieving blended rates of 3.6% with new lease rate growth of 1.3%.
New lease rates turned positive in February, led by the east side and the positive trend has continued. Northern California was our second best performing region with 2.1% blended rate growth and flat new lease rates. San Mateo was our strongest market, offset by the east side, which remained challenged, primarily from delinquency impact in Alameda County. Excluding Alameda County, new lease rates in Northern California would have been 70 basis points. As for Southern California, this region continues to be a steady performer, generating blended rate growth of 1.7%, with negative 30 basis points in new lease rates caused by delinquency in Los Angeles. Excluding Los Angeles, average new lease rates would have been positive 3.1% in Southern California.
Along with the improvement in eviction processing time, our operations and support teams have done an excellent job recovering long-term delinquent units at a faster pace, which has led to lower delinquency. We welcome this trend and continue to proactively build occupancy in anticipation of recapturing more units in this region. We view this temporary trade-off as net beneficial to long-term revenue growth. As for current operating conditions, at the end of April, we are in a solid position with 96% occupancy heading into peak leasing season. Concessions for the portfolio averaged only 3.5 days. And aside from areas with delinquency headwinds discussed earlier, we see opportunities to increase rental rates throughout our portfolio. Lastly on the transaction market.
Deal volume remains thin compared to recent years, and we continue to see strong investor demand for multifamily properties in our markets. with cap rates ranging from mid-4% for core to mid-5% for value-add communities. Against this backdrop of limited transaction volume, we have created external growth opportunities, generating FFO and NAV per share accretion through our joint venture platform. In the first quarter, we purchased our partner’s interest in a $505 million joint venture portfolio that will produce almost $2 million of FFO accretion for us in 2024. In fact, since inception, our private equity platform has delivered a 20% IRR and over $160 million to promote income for our shareholders and remains an attractive alternative source of capital.
In conclusion, we intend to pursue growth through acquisitions while maintaining our disciplined capital allocation strategy and our core principle of generating accretion to create significant value for our shareholders. With that, I’ll turn the call over to Barb.
Barb Pak: Thanks, Angela. I’ll begin with comments on our first quarter results, provide an update on key changes to our full year guidance followed by comments on investment activities, capital markets and the balance sheet. I’m pleased to report core FFO per share exceeded the midpoint of our guidance range by $0.09 in the first quarter. The outperformance was primarily driven by higher same-property revenue growth, which accounted for $0.06 of the $0.09 beat. The first quarter also benefited from onetime lease termination fees within our commercial portfolio totaling $0.02, which are not expected to reoccur for the remainder of the year. Turning to our full year guidance revisions. As a result of the strong start to the year, we are increasing the midpoint of same-property revenue growth by 55 basis points to 2.25%.
The increase is driven by two factors: First, delinquency has improved faster than our original expectations, which accounts for 40 basis points of the revision. We now project delinquency to be 1.1% of scheduled rent for the year. The second factor relates to higher other income as we have been successful at optimizing our portfolio through various initiatives, which has led to 15 basis points of better growth. While we are trending slightly ahead of our expectations on blended lease growth so far this year, especially on renewals, we have not factored any revision into our guidance as we want to get further into peak leasing season when we sign the bulk of our leases. The other key driver of our full year guidance revision relates to the consolidation of our partnership in the BEXAEW joint venture, which accounts for $0.03 of FFO accretion.
And as Angela highlighted, this acquisition reinforces the value Essex has created for shareholders through our joint venture platform as well as our ability to grow externally in an otherwise challenging market. In total, we are raising core FFO by $0.20 per share, a 1.3% increase at the midpoint. Turning to our preferred equity investments. Subsequent to quarter end, we assume the sponsor’s common equity interest affiliated with a preferred equity investment. This investment was previously on our watch list and was placed on nonaccrual status in the fourth quarter of 2023. As such, this transaction is beneficial to our 2024 core FFO forecast. The property is located adjacent to an existing Essex community, which will allow us to operate it efficiently within our collections model.
Overall, we view the outcome favorably given that quality of the asset, our initial yield and our long-term view on the growth in the Sunnyvale submarket. Turning to Capital Markets. In March, we issued $350 million in 10-year unsecured bonds to refinance the last remaining portion of the company’s 2024 debt maturities and to partially fund the BEXAEW transaction. We are pleased to have locked in 5.5% fixed rate debt in today’s volatile interest rate environment. As it relates to equity, the company did not issue common stock to fund our year-to-date investments nor do we plan to issue equity at our current stock price. We have alternative sources of equity capital, such as retained cash flow and preferred equity redemption proceeds from last year and expected this year that can fund up to $400 million in investments, including transactions completed to date without the need for new equity.
We will continue to look at all our sources of equity capital, including disposition proceeds or joint ventures in order to maximize growth in core FFO and NAV per share while preserving our balance sheet strength. We have been prudent stewards of shareholder capital over our 30-year history, which has served our shareholders well. In conclusion, Essex is in a strong financial position. Our leverage levels remain healthy with net debt-to-EBITDA at 5.4x, and we have over $1 billion in available liquidity. As such, we are well equipped to act as opportunities arise. I will now turn the call back to the operator for questions.
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Q&A Session
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Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets. Please proceed with your question.
Austin Wurschmidt: Hi, everybody. You guys flagged the impacted select submarkets are having on your new lease rate growth this year, but I’m just curious if that overhang has been lifted in L.A. and Alameda or if you think that the continued improvement in sort of the long-term delinquency continues to have an impact or impacts others in the market, and you could continue to see kind of that weighing on — are those markets weighing on new lease rate growth moving forward?
Angela Kleiman: Hey Austin, it’s Angela here. You kind of cracked up in the earlier part of the question, but I believe you’re asking whether the L.A. Alameda overhang is going to continue on new lease rates?
Austin Wurschmidt: Yes, that’s correct.
Angela Kleiman: Okay. Great. What we’re expecting is that L.A. is going to continue to provide — be an overhang on the delinquency. Alameda improvement is steady, and it’s a smaller part of our portfolio. So the heavier influence is really coming from L.A. just because when you have such a large volume that we’re working through, it’s going to take a longer period of time. The good news is that we are not seeing that bleeding into other markets. So it’s really more focused in L.A. and our other markets are doing quite well.
Austin Wurschmidt: So how should we think about, I guess, when you guys underwrote at the beginning of the year, you had a relatively tight spread in your new versus renewal lease rates. You flagged renewals are trending better, but that’s been a little bit volatile, which I suspect is due to some factors on the comp month-by-month. But can you just give us a sense of or kind of updated thoughts on how you think the two of those trend from here?
Angela Kleiman: Yes, sure thing. No, we have not reforecasted yet just because it is important to see how peak leasing season activities progress and because that’s where the bulk of our leases occur at that point in time. So our data is with a few months into the year and a smaller set of leasing terms is turning. It’s more limited. But having said that, what we’re seeing right now is that Seattle and Northern California are trending slightly ahead of our original market rent forecast. Southern California is generally planned, but there is an LA drag. And so because it’s not a huge outperformance relative to plan at this point. The outperformance is really mostly in the benefits from delinquency that we’re getting the — recovering the units much faster in other income, it’s once again, it’s just too early to try to reforecast where market rents is going to be.
I do want to say that with our performance on delinquency and our ability to essentially turn those units quickly. It speaks to the underlying fundamentals of our market, so that is quite solid.
Austin Wurschmidt: Maybe more specifically, I mean trying to get to this in the question a little bit, but can you just give us a sense where renewals are going out for the next couple of months? That would be helpful. And then that’s all for me. Thanks.
Angela Kleiman: Sure thing. So renewal rates for, say, May and June, they’re going out in kind of that low to mid-4% range. They average for the portfolio around 4.3%. And we do — there is some negotiations there. And what we try to do is anticipate where the market is going to be. And because we are seeing that we are trending slightly ahead, we, of course, are going to push renewals wherever possible. But keep in mind, our approach on renewals is still same as before. We are setting market appropriate pricing and with the goal of maximizing revenues.
Austin Wurschmidt: Thank you.
Operator: Our next question comes from the line of Nick Yulico with Scotiabank. Please proceed with your question.
Daniel Tricarico: Hey, good morning. It’s Daniel Tricarico on with Nick. Angela, you talked about the jobs backdrop in your prepared remarks. I was wondering if you could expand on the tech hiring trends in your markets? Are you seeing any green shoots from AI companies starting to take office space? Or general tech companies more active in return to work. Just want to understand the current state of the demand backdrop that many are hoping, obviously, including yourselves to drive an acceleration in the recovery within the Northern California and even Seattle markets.
Angela Kleiman: Hey Daniel, it’s a good question there. We are seeing anecdotally hybrid workers moving closer to the office to essentially trying to reduce the commute because traffic has picked up. And — we are seeing also the top 20 tech openings increasing, although it’s very gradual. And so what we’re seeing is that these job openings bottomed last year during the first quarter, and the opening was only about, say, 8,000 jobs. Today, in March, it’s about 16,000 jobs. So it doubled but it is well below our pre-COVID average. The three-year run rate was about 25,000. So hopefully, that gives you some sense of how things — what we’re seeing is that the fundamentals are moving in the right direction. But in order for acceleration to occur, we really need to see a more robust pickup on the high-paying jobs. And we do believe that we have the fundamental backdrop for that to occur. It just it’s all about when, and that’s the big question on our mind.
Daniel Tricarico: Yes, thank you for that, Angela. I wanted to follow up on the Seattle market. It saw a nice sequential increase in occupancy and revenues in Q1. Could you talk a little bit about what you’re seeing throughout the different submarkets, maybe give a breakdown of your portfolio, urban versus suburban exposure? And where you’re expecting to see the greatest magnitude and timing of new supply in that market?