Essex Property Trust, Inc.

Good day and welcome to the ESSIC Property Trust Second Quarter 2020 Earnings Conference 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 in the company's filings with the SEC. It is now my pleasure to introduce your host, Mr. Michael Schull, President and Chief Executive Officer for Essex Property Trust. Thank you. You may begin.

Thank you for joining our call today. The unprecedented reactions from the COVID-19 pandemic have presented many challenges that have affected every part of our business and indeed our lives. We'd like to offer our best wishes to all those impacted by COVID-19 and thank you for participating on the call today. On today's call, John Burkhardt and Angela Kleinman will follow me with comments and Adam Barry is here for Q&A. Our reported results for Q2 reflect these unprecedented challenges as we reported 5.1% decline in core FFO from a year ago, representing an abrupt turnaround from very favorable conditions throughout this economic cycle. Our first priority upon receiving COVID-19 related shutdown orders was to ensure the safety of our employees and residents while reacting thoughtfully to shelter in place restrictions and regulatory hurdles that have been especially pervasive across our market. Unprecedented job losses from mandatory shutdown orders in March, suddenly and significantly reduced rental demand, leading to lower occupancy in April, followed by a steady recovery throughout the quarter. Ultimately, occupancy fully recovered and was 96.2% in July. Delinquencies also spiked due to job losses and anti-eviction ordinances, which often contain collection forbearance provisions. Proposed regulations that could further impede collection of COVID-19 related rent receivables led us to adopt a conservative approach to bad debts. During the second quarter, the direct cost of the pandemic in the form of greater residential and commercial delinquency, lost occupancy, and COVID-19-related maintenance totaled $27 million. We view these costs as mostly temporary and have seen improvement in each category in the second quarter. John and Angela will provide additional detail as part of their remarks. Fortunately, the economy improved quickly from its April trough as measured by resumed job growth, lower continuing unemployment claims, and fewer war notices. In addition, many businesses have found ways to adapt to the virus by creating new safety protocols and procedures. After declining nearly 14% in the ethics markets during April, by June, year-over-year job declines had moderated by almost 400 basis points to 10.1%. We expect gradual improvements to continue in the second half of the year. Turning to the West Coast markets, technology companies are primary driver of wealth creation and growth in the Bay Area and Seattle. Most of the leading tech companies remain in a growth mode with minimal damage to their business models. And many of them, such as Amazon, Netflix, and Zoom, have benefited from the shelter in place restrictions, resulting in greater market share. Generally, It appears that many large tech companies have slowed their pace of growth while allowing greater flexibility for employees to work from home. We tracked the open positions at the 10 largest public technology companies, all of which are headquartered in an Essex market. Recently, these companies had approximately 17,000 job openings in California and Washington. These large company tech jobs are down by about a third on a year over year basis, and are now at about the same levels as we saw in 2017. Many of the top tech companies including Apple, Alphabet, Microsoft, Amazon, Salesforce, are planning for employees to return to the office and have established related dates, which range from October 2020 to July 2021. This is consistent with our comments during our June NAVRE meetings, whereby we expect employees in the post-COVID era to have a greater work-from-home flexibility while also needing to report to the office at various times to maintain team dynamics, acclimate new hires, and pursue career opportunities, all of which require periodic face-to-face contact. Venture capital has continued to flow at a healthy pace according to the most recent data. However, we understand that the mix of investments is more focused on companies that have business models that are not directly impacted by COVID-19 and have lower cash burn rates. Southern California has a more diversified economy that has outperformed during previous recessionary periods, while San Diego, Orange, and Ventura Counties have generally continued this trend, Los Angeles County has notably underperformed. LA's preliminary unemployment rate was 19.5% in June, well above the level implied by recent job losses of 12.3% on a trailing three-month basis, and partially explained by the unusually large number of gig and freelance workers in LA that are not captured by the BLS payroll survey. Filming and content production is a key contributor to jobs and wealth creation in Los Angeles, and the industry came to a temporary standstill. Film LA reported that the number of shoot days during the second quarter declined 98% from the prior year across television, film, and commercials. Despite these challenges, the demand for content is unabated, amid the pandemic and there are reasons to be optimistic. In a joint report called A Safe Way Forward, various organizations including the Screen Actors Guild have outlined the process for content production amid the pandemic, which is building production momentum. A key factor impacting all of our markets is the loss of leisure and hospitality and other services jobs, which represented from 12% to 17% of total jobs at June 2019 in the Essex metros. Compared to the total jobs lost in the Essex markets this past year, these service jobs declined an average of about 30% year over year, with the greatest declines in Seattle and San Francisco. These job losses are throughout each metro area, although the downtown locations have the greatest concentrations of affected businesses. We see the recovery path ahead as reversing the pandemic-related declines we experienced this last quarter. In the near term, progress will depend on the direction of COVID infection rates and the associated governmental limitations on business activity. Given the COVID-related shutdown of film and digital content industries and its potential for value creation, its recovery is essential in Los Angeles. Fortunately, that recovery is underway with a recent restart in the production of daily TV shows such as Jeopardy and Wheel of Fortune in Culver City and several soap operas produced by CBS and ABC. Necessarily crowded motion picture sets and safety mandates will probably make this a slow process. Wealthy areas create demand for restaurants, bars, and other services, and the related jobs contribute to housing demand, particularly in the cities. That makes service jobs systematically important to housing, and we believe that they will recover. Finally, most of the technology industries are in great condition and should be expected to resume greater hiring and growth. Along with unspent wealth accumulated during the pandemic, we expect the recovery of jobs to be strong as the outlook for managing the pandemic improves. In light of the unpredictable nature of the pandemic and with the recent surge in COVID-19 cases and hospitalizations, the course of the pandemic and governmental responses have become intertwined with job growth and other economic outcomes. Thus, we've made the decision to withdraw our forecast on page S16 of the supplemental until we have better clarity on the direction of the pandemic. Finally, turning to the apartment transaction market, we sold two properties during the quarter, both of which were placed under contract in May. Pricing for both represented a small discount compared to the pre-COVID period. Both properties were in downtown San Jose continuing the theme of the past few years of selling downtown locations that are more susceptible to added supply and a diminishing quality of life. Going forward, we expect to grow the portfolio near major employment centers that offer a better living experience. Generally, the transaction markets have been slow to recover with very few closed apartment sales and even fewer properties being marketed. The industry is working through key issues in the selling process, such as travel restrictions and due diligence challenges. Given a dearth of transactions, it's too early to conclude on how buyers will value apartment properties going forward. The few closed transactions since the onset of the pandemic traded at prices at or near pre-COVID levels suggesting that highly motivated buyers had taken a longer view when valuing property by treating the COVID-19 specific impact, such as delinquency, as a purchase price adjustment rather than long-term reductions in NOI or higher cap rate. At quarter end, we had two additional properties under contract for sale. Both are smaller properties and one of them closed in July. Going forward, Our intent is to mostly fund our growth with disposition proceeds. We announced one new development deal in suburban San Diego, and we have a robust preferred equity pipeline. As before, plenty of money is searching for distressed real estate, which will be scarce with institutional-grade apartments, given extraordinarily low financing costs. As with prior recessions, the existence of Fannie Mae and Freddie Mac virtually assures a source of liquidity for apartments. Yields or cap rates for apartments generally substantially exceed long-term interest rates on related debt, and the resulting positive leverage remains a powerful force in the market. Unlike REIT stocks, private market values in terms of cap rates are generally sticky, meaning that they don't change immediately in reaction to events but rather seek to reflect the longer-term financial performance of a property. At the end of the day, we believe that the transaction markets will likely recover because lower interest rates will provide sufficient incentive to offset greater perceived risk. Historically, we found opportunities to add value as markets transition and in periods of disruption. I'm confident that we have the team, resources, and strategy to thoughtfully act on these opportunities consistent with our long term track record about performance. And now I'll turn the call over to John Burkhardt.

Thank you, Mike. Our priority during this period was our people, the safety of our residents and our employees. I'm incredibly proud of what our team accomplished and how they work together to serve and support our residents through this challenging time. Thank you, E-Team. Looking at the second quarter of 2020, the occupancy challenges that we faced early on related to a reduction in demand when the initial stay-at-home orders were implemented, as opposed to an exodus of existing residents. During May, trafficking substantially, and we took advantage of the relative strength in our market by lowering our rental rates and offering significant leasing incentives to certain markets of two to eight weeks on stabilized properties. leading to an increase in our same-store occupancy of 110 basis points in June. The relative strength in the market continued into July, enabling us to increase our asking rent, decrease our leasing incentives, and add another 80 basis points in occupancy. Our availability 30 days out as of the end of July was 10 basis points lower than where it was last year at this time. As our customers adapt to the new COVID-19 environment, we are seeing some consumer behavioral changes that make intuitive sense. For example, with the current work-from-home practices, the value proposition of living in downtown San Francisco has temporarily changed since the restaurants, entertainment, and sports venues have shut down. Additionally, the value of having more private indoor space for Zoom calls, high-speed internet, and access to open space for outdoor activities have increased demand for suburban assets, despite being a greater distance from corporate offices. We have also noted that work from home has turned into work from anywhere, as we've seen several consultants moving back to their original home and continuing to work for their West Coast employer. Regarding the work from anywhere theme, we believe this trend will reverse when conditions permit. We were all positively surprised by the ease in which we all adapted to Zoom and believe that this experience will have a lasting impact on future same-day business travel. However, the loss of a personal connection, frozen screens, and barking dogs in the background show that Zoom cannot replace the value that comes from in-person interaction. I heard someone say recently, I am done with living at work. We see the changes in consumer behavior within our portfolio. Our same-store portfolio in Contra Costa, Ventura, Orange, and San Diego have higher occupancies today than in pre-COVID March. Turning to our Q220 results, as presented on page two of our press release, year-over-year revenues declined by 3.8%. On delinquencies, various governmental bodies have enacted and continually extend resident protection along with prohibitions against late fees and eviction. These regulations have been a strong headwind for the industry in our markets compared to other metros. Thankfully, they are temporary in nature. Referring to the S-15, delinquency for our total portfolio on a cash basis was 4.3% in the second quarter of 2020 compared to 34 basis points in the second quarter of 2019. In the month of July on a cash basis, Delinquency was 2.7%, which is down from the prior month. In July, 18% of our same-store assets had positive delinquency, meaning the delinquency line item contributed positively to the revenues due to residents paying past due amounts. We appreciate that our residents continue to prioritize their rental obligations. Moving on to our operating strategy in this new environment, Our operations objective continues to be focused on maximizing revenue. Given current conditions, our strategies will evolve as the market changes and will vary across our markets. For example, we will likely run lower occupancies in certain urban markets, such as downtown San Francisco, while targeting higher occupancies in highly desirable suburban markets, such as San Ramon. Overall, we believe that market occupancy has fallen about 150 basis points, and our same-store portfolio is expected to run at a lower occupancy for the remainder of the year. As noted on S15, our supplemental, and consistent with our expectations, our new lease rate, excluding leasing incentives, were down 5.8% in July compared to the prior year's period. We expect that market rental rates will remain depressed in the fall due to the seasonal decline in demand. That said, some of the historical factors, such as contractors moving home in the fourth quarter, are not an issue since they've already moved out due to work from home policies in place. On to tech initiatives. We continue to make considerable progress on the technology front as our employees learn how to optimize our new tools. For example, we currently have several leasing agents that are leveraging these tools that enable them to be two to three times more productive than the average leasing agent. We are seeing similar progress with our maintenance systems as well. Our emphasis will continue to be on people first as we try to bring everyone up to speed. However, we expect that through the increased productivity and natural attrition, we will both lower our headcount and increase our compensation to our top performers. Another advancement in our technology roadmap includes the development of our mobile leasing app that is on target for pilot at the end of this year. The app is fully integrated with our other sales tools and will fundamentally change how we interact with our prospects, providing them with a simple, seamless, 24-7 mobile experience. Finally, we are now offering ultra-fast internet. Offered by market-leading fiber providers at 10% of our assets, and we expect to complete installation at another 50% of our assets by year end. The ultra fast service is in great demand in our current work from home environment and is expected to be a great value add asset for our residents. Turning to our markets in the Seattle market, year over year revenues in Q2 was down 20 basis points and occupancy was down 1%. The greatest decline during this period was in the Seattle CBD where revenues declined 70 basis points, followed by the east side with a 20 basis point decline, while revenues in the south saw an increase of 10 basis points in the same period. In July, unemployment in Washington remained 90 basis points below the US average of 10.7%. In the same period, Amazon's job openings remained at just over 8,000 a year-over-year decrease of about 25%. Moving to Northern California, in the Bay Area market, year-over-year revenues in Q2 were down 3.4%. Revenues in San Francisco, Oakland CBD declined by 6.3% and 7.8% respectively, while our San Jose revenues declined only 1.5% in the same period. San Jose job growth declined the least of our markets in Q2 and was 100 basis points below the U.S. decline of 11.3. Down in Southern California, year-over-year revenues in the second quarter declined 5.7%, while occupancy declined 2.1%. L.A. was our hardest-hit market, with a year-over-year revenue decline of 8.6% in Q2. Our L.A. County sub-markets declined between 8.4% and 9.7% in the same period, with the greatest decline in LACBD. The LA economy has been the most impacted out of all our markets, with an unemployment rate of 19.5%, leading to a higher delinquency rate than our other markets. In Orange County, the South Orange submarket outperformed North Orange submarket, with year-over-year revenue declines of 2.6%, and 5.1% respectively in the second quarter. Finally, in San Diego, year-over-year revenue declined 2% in Q2, with the exception of the Oceanside Submarket, which grew revenues by 2% in the same period, likely benefiting from a military stay-in-place order through the end of June. Currently, our same-store portfolio's physical occupancy is 96%, Our availability 30 days out is at 5.5%, and our third quarter renewals are being sent out with an average reduction in rate of 1.4%. Thank you, and I will now turn the call over to our CFO, Angela Kleinman.