While most apartment REIT leaders spent their time talking about elevated supply in Sun Belt markets on third-quarter conference calls, executives at Essex Property Trust reported a relatively brighter outlook.
The Palo Alto, California-based REIT only operates on the West Coast, where supply is relatively muted, with new deliveries at only 0.5% of total housing stock.
“Unlike many other U.S. markets, total housing supply in our markets is expected to remain at low levels,” said CEO Angela Kleiman on Essex’s Q3 earnings call in October. “And we do not see a near-term catalyst for increasing housing supply growth in Essex’s markets.”
Essex’s management team covered many topics outside of supply. Here are three takeaways from the REIT’s earnings report and call.
West Coast fundamentals
Despite the relatively lower supply than the rest of the country, the West Coast has pockets of issues, especially in San Francisco, where Essex has around 1,000 units. In Northern California markets, the REIT is offering concessions of a week or more — much less than months of free rent in the Sun Belt.
But Kleiman sees upside in the Bay Area, especially with hiring for remote or hybrid workers in the market declining from 25% last year to 8% this year. Occupancy has suffered in the region as many office workers have left to work remotely in low-cost areas over the last three years.
As tech firms ramp up their AI offerings, Kleiman expects more hiring in her region, which could further boost rental demand. “We know that success in this industry will require immense scale and capital resources, and these types of companies are largely concentrated in the Bay Area and Seattle,” she said.
Seattle is currently Essex’s strongest market for job growth and is seeing minimal concessions but has about two times the supply as a percentage of housing stock as California’s markets. In Southern California, concessions are also minimal outside of Los Angeles.
“Southern California continues to be our top-performing region, led by San Diego,” Essex Senior Vice President of Operations Jessica Anderson said on the call.
While supply may not be a significant problem in Essex’s market, delinquencies have been a concern. Although eviction moratoriums have expired, court delays meant evictions took 10 to 12 months to process in many places, which led to “protracted exposure to non-paying tenants and uncertainty on the timing of when we could recapture these units,” Kleiman said. For the first nine months of the year, delinquencies were at around 2% as a percentage of rent, which was five times the company’s historical average.
BY THE NUMBERS
|Net operating income||$280 million||2.7%|
|Operating expenses||$118.5 million||4.4%|
|Funds from operations||$3.69||7%|
|Occupancy rate||96.4%||40 bps|
But things improved dramatically in October as they dropped to 1.3%. “One month certainly doesn't make a trend, and we've seen some choppiness in delinquency as we've worked through it the last couple of years, but we're certainly encouraged by our recent results and we're going to be monitoring that closely,” Anderson said.
Residents who can no longer pay are also moving out on their own, which allows Essex to fill their apartments with paying customers. “There is no more emergency rental assistance,” Anderson said. “So overall, the tenant sentiment has changed and there is a greater sense of urgency. So we are seeing increased move-outs as tenants are realizing this.”
Deals remain slow
Kleiman said overall deal activity in Essex’s markets slowed even further in the third quarter. With interest rates compressing returns, buyers stayed on the sidelines. “We have seen several marketed deals not transact this year as sellers await a less volatile interest rate environment,” she said. “There is little evidence to suggest transaction activity will pick up in the near term as bid-ask spreads remain wide.”
Like most other REITs, deal activity is on the back burner for Essex, but the company remains open to making acquisitions if the situation makes sense.
“We're turning over every rock and looking for opportunities, and I'm optimistic we're going to see more in the next few years,” said Rylan Burns, senior vice president of investment strategy at the REIT.
Essex also has the ability to provide capital to developers or other owners. In the past, the REIT financed more development projects. But as the market is changing, the opportunity to recapitalize struggling owners of existing assets is growing.
“We've seen several deals in the past couple of years with above 50% leverage and very low interest rates capped or swapped that will roll in the next few years at a very different interest-rate environment,” Burns said. “So with the limited NOI growth we've seen in several of our markets, we think there are going to be opportunities to put some capital to work.”
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