Essex Property Trust, Inc.

Good day and welcome to the Essex Property Trust third quarter 2022 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 on the company's filings with the SEC. It is now my pleasure to introduce your host, Mr. Michael Shaw, President and Chief Executive Officer for Exix Property Trust. Thank you, Mr. Shaw. You may begin.

Thank you for joining us today, and welcome to our third quarter earnings conference call. Angela Kleiman and Barb Pack will follow me with prepared remarks, and Adam Barry 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 have known Angela for almost two decades, and we have worked closely together since she joined the company 13 years ago. Angela embraces 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 the culmination of the multi-year 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 awesome 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 are reflective of 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 at 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 the 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 they 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 have included our initial forecast for 2023 market level rent growth on page F17 of 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 S17. 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 red 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 new next year, growing at 0.4% overall in the Essex markets, 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 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 about 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 with respect to 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. And it's those higher rents that pressures affordability and fosters 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 its recovery 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 reopening, 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 given 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 talk with respect to apartment transactions indicates 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 accretively, and we will be in a position to be opportunistic. With that, I'll turn the call over to Angela Kleinman.

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 is 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 approach 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 non-paying tenants. With the ending of eviction moratorium, it is no surprise that the number of move outs related to non-paying tenants have 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 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 have been facing softer demand along with higher level 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 immigration 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 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 doubling 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 are also seeing positive immigration to Southern California, with 30% of our third quarter move-ins coming from outside the region compared to 17% in the first quarter. Turning to key operations initiatives, we have completed the rollout of first phase of our property collections operating model, which focused 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 nine 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 one 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 and 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 our employees through specialization while improving efficiency and customer service. The maintenance collection pilot is currently underway and rollout is planned to start by mid-next year. Lastly, on the technology front, the implementation of Funnel software suite is progressing well. As you may recall, Funnel is a RET venture 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 inquiry through the full resident lifecycle, which will result in better experience 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 Pat.