Essex Property Trust, Inc. (ESS) Q3 2012 Earnings Report, Transcript and Summary

Michael J. Schall - Chief Executive Officer, President, Director, Member of Executive Committee and Member of Pricing Committee Erik J. Alexander - Senior Vice President of Property Operations Michael T. Dance - Chief Financial Officer and Executive Vice President John D. Eudy - Executive Vice President of Development John Lopez - Vice President and Economist of Research & Due Diligence

David Bragg - Zelman & Associates, LLC Robert Stevenson - Macquarie Research Jeffrey J. Donnelly - Wells Fargo Securities, LLC, Research Division Karin A. Ford - KeyBanc Capital Markets Inc., Research Division Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division Michael J. Salinsky - RBC Capital Markets, LLC, Research Division Eric Wolfe - Citigroup Inc, Research Division Richard C. Anderson - BMO Capital Markets U.S. Andrew McCulloch - Green Street Advisors, Inc., Research Division Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division Andrew Leonard Rosivach - Goldman Sachs Group Inc., Research Division Ross T. Nussbaum - UBS Investment Bank, Research Division Michael Bilerman - Citigroup Inc, Research Division

Greetings, and welcome to the Essex Property Trust, Inc. Third Quarter 2012 Earnings Conference Call. [Operator Instructions]. 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 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 Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, sir. You may begin.

Thank you, Dan. And welcome, everyone, to our third quarter 2012 earnings call. Before we begin, I would like to acknowledge the tragic impact of Hurricane Sandy, our hearts and prayers go to our friends and colleagues that have been affected by the storm. With that said, I'll begin by noting that Erik Alexander and Mike Dance will follow me with brief comments, John Eudy, John Burkart and John Lopez are here for Q&A. I'll cover the following topics on the call: number one, Q3 results and market commentary; number two, investment markets; and number three, an and update on what's happening in the State of California. So the first topic, Q3 results and market commentary. We are very pleased to announce another strong quarter in which we reported core FFO of $1.71 per share for Q3 2012. That result was $0.02 ahead of the midpoint of the guidance range announced in connection with our Q2 call. This positive variance would have been $0.02 per share higher if we did not accelerate the timing of our $300 million debut public unsecured bond deal, which led to higher interest costs versus forecast. We continue to see strong growth in Northern California and Seattle, and improving conditions with pockets of strength in Southern California. Same property revenues improved once again, to a 7.2% increase over Q3 2011, which was the best year-over-year growth in the last 20 quarters. These results lead us to reiterate our expectation for strong conditions for the remainder of 2012 and continuing in 2013, driven by growing, but still limited supplies of housing, and job growth that exceeds national averages in Northern California and Seattle, and continues to improve in Southern California. With have provided our preliminary market forecast for 2013 on Page S-16 of the supplemental package. The weighted average estimated rent growth for our primary metro markets is 6.5% for 2013. The primary macro assumptions, which are integral to the rent growth estimates, are indicated on S-16 and are not materially different from the estimates of our economic data providers. However, some of the expected 2013 supply and job growth estimates, and consequently, the projected economic rent growth, are significantly different from the data providers. As an example, there are around 10,000 apartment homes under construction in the Seattle Metro, for which we estimate that 1,100, 4,100 and 4,800 will be delivered in Q4 '12, all of '13 and all of 2014, respectively. Accordingly, the timing of these deliveries can vary significantly based on a variety of factors. We believe that this overview of housing supply and demand information provides the appropriate [indiscernible] in our 2013 market rent growth assumptions for each MSA. We will update these numbers in connection with our formal 2013 guidance, which will occur in conjunction with our Q4 earnings conference call. We also recognize the inherent uncertainty in the U.S. and global economies, which could lead to significant changes. We view job growth as the key to the estimates, and as you know, that is dependent upon forces that can change rapidly and are not easily predicted. I'd like to make 2 additional points about the 2013 preliminary market forecast on Page S-16. First, construction of for-sale housing remains muted on the West Coast, partially due to the hard landing it experienced in 2008, relatively high cost for-sale housing and mortgage qualification issues. However, median home prices are spiking dramatically and have experienced year-over-year increases as of September, of 17% in Northern California, 7% in Seattle and 6% to 12% in the various Southern California metros. If those median price increases continue, we would expect for-sale housing supply to accelerate. Second, the relationship between jobs and supply is at the core of our economic research effort, and John Lopez attempts to quantify housing demand and supply on a submarket basis. From a broader perspective, it takes, on average, about 2 jobs to create a household in the coastal markets. In 2013, our forecast indicates the addition of the total of 192,500 jobs, which should produce around 96,000 households. This is sufficient to cover 2.8x the 33,800 combined expected deliveries of for-sale and rental homes in 2013. Our 10-Q will indicate that the investment in common stock, at cost, increased to $72.7 million from $42.9 million last quarter. Nearly all of that increase related to purchases of common stock of one company that we consider strategic in nature. As such, we will not provide additional information about this investment. My second topic, the investment markets. Cap rates continue to be aggressive in the coastal markets and have not changed materially since last quarter. Cap rates range from 4% to 4.5% for A quality property in A locations, and from 4.5% to near 5% for B quality property in A locations. Page S-15 of the supplement summarizes the closed acquisitions through last Wednesday, which aggregate $515 million, including the buyout of our partner's interest on Skyline. These deals include properties acquired both by the company and in the Wesco co-investment. We also have 3 transactions aggregating $186 million, in contract with contingencies removed, most of which should close by year end. You can expect a greater focus on Southern California from an acquisitions perspective in 2013. By the end of 2012, we expect to complete the sale of 7 properties representing roughly 1/2 of our Fund II portfolio, for an aggregate contract price of approximately $413 million. Essex owns the 28% limited partnership interest in Fund II, and up to 20% of profits as it's general partner promoted interest. The remaining properties are expected to be sold in 2013 in anticipation of the Fund II term date of September 2013, which is extendable to September 2014. The trailing 12-month cap rate on these sales was less than 4.1%. Development deals in the West Coast markets, underwritten based on today's rents, generate development cap rates ranging from 5% to 5.5% or 6.25% to 6.75% upon stabilization. Our development pipeline did not change materially during the quarter, and at estimated cost, we have approximately $1 billion under construction. We estimate that the average cap rate of the development deals is about 6% based on current market rents and approximately 7% at stabilization. And finally, my third topic. Dealing with the State of California. We'll be paying close attention to the election results this coming Tuesday, as California goes to the polls to vote on 2 ballot measures that propose to raise state taxes in support of education and other needs. Prop. 30 which is being championed by Governor Brown, would increase the California sales tax by 0.25% for 4 years, and the state income tax, based on a sliding scale for those that earn over $250,000, for a period of 7 years. Prop. 38 seeks to raise income taxes on those making over $7,300, based on a sliding scale that begins with an increase of 0.7% and has a maximum increase of 2.2%, and is for a 12-year period. If both measures pass, the one with the greatest number of yes votes will supersede the other. Important to note that none of the ballot measures impact Prop. 13. So I'd like to thank you for joining us, once again. Now, I would like to turn the call over to Erik Alexander.

Thank you, Mike. Operations performance during the quarter was better than expected. We continue to have strong demand in most of our markets. Rental rates grew throughout the quarter. We finished the period in a strong occupancy position and are poised for a solid fourth quarter. Once again, rent growth reached its highest point in July but remained strong into October. During the quarter, we completed more than 4,100 new lease transactions and signed nearly 4,300 renewals. Portfolio-wide, renewal rates for the period were up 5.3% and were steady throughout the quarter. New lease rates were 6.4% higher than expiring rates during the quarter, peaking at 8.7% in July. October leasing activity has been good, and we now have seen an average coupon rates for new leases and renewals above $1,500 for the past 4 months. So on a combined basis, achieved rents in October are 11% higher than last year. So while we expect overall rent growth to moderate at some point next year, strong job growth in all of our markets should continue to produce solid revenue gains throughout 2013. Looking ahead, renewal offers for November and December averaged 5% to 6% portfolio-wide. At the end of October, our loss-to-lease for the portfolio was 4%. Turnover remains within expectations, and for the quarter, was within 1% of last year's move out rate. Given our low availability and expiration profile, the turnover expectation for the year remains in the low 50% range. The reasons given for move-out were consistent with last quarter's results, and we saw declines reported in home purchases and affordability. These factors represented 10.5% and 13% of all move-outs, respectively. I think these numbers remain low due to persistent high occupancy in our markets, a steady demand for rental housing, and the affordability and qualifying hurdles facing home purchasers. We do expect these reasons for move-out to increase in 2013, but should be well within manageable ranges. Expo was our only active lease-up during the quarter. This community is in the very popular lower Queen Anne neighborhood of Seattle, and is less than 1 mile from Amazon's world headquarters. These apartment homes, average nearly 700 square feet and rent for almost $3 per square foot. Again, this project was delivered 6 months ahead of schedule and we had our first move-ins during October. Thanks to strong pre-leasing efforts, Expo is already 25% occupied and 38% leased. We expect to stabilize this asset during the second quarter next year. Operating expenses continued to be within expectations, and year-to-date are up 1.1% compared to 2011. Turnover and onetime service items drove the typical sequential growth, but there's nothing unusual to note. Next quarter's expenses could be slightly higher as we continue to improve property presentation and enhanced services for our residents. Operating expenses for the year should end up 2% higher than 2011, and within our guidance. Now, I will share some highlights for each region, beginning with Seattle. Essex's market rents are up 10.6% year-to-date and the job picture in the region continues to be robust, and we're seeing more tech applicants, including employees from Microsoft and Amazon. Our outlook through 2013 is 2.3% job growth. Job growth projections for all of our markets are detailed on Page S-16 of the supplement. Office absorption slowed during the quarter to about 200,000 square feet. However, Zillow, eBay and Intel are all expanding operations in the region. Additionally, Amazon Phase 5 is slated to be delivered during the fourth quarter of this year, and a nearly 400,000 square-foot expansion will commence next year. Other large projects are scheduled to start in 2013, including Amazons' 3.3 million square-foot project in the Denny Triangle area of the city. This would be Seattle's largest commercial development in history. Turning to Northern California, Essex market rents are up 10.1% year-to-date. Job growth expectations remained strong in Silicon Valley, with the highest forecast for any of our markets, at 2.4% through 2013. Commercial absorption in Silicon Valley also remains strong, as another 1 million square feet were absorbed during the quarter, including the balance of Amazon's research unit in Sunnyvale, which is expected to add 2,000 jobs. The balance of the region accounted for another 600,000 square feet of leasing activity, with 230,000 square feet in the open MSA. Commercial leasing activity in this market is increasing, and we expect stronger absorption in the coming quarters with subsequent benefits to our East Bay portfolio. Supply expectations for the year remain unchanged and the new apartment offerings in San Jose continue to lease well. We have yet to see an adverse affect from these projects. Next year's growth expectations include this new competition, with contingencies for possible concession activity. Again, it is our view that strong job growth in Silicon Valley and tight occupancies in the submarket, coupled with very limited single-family home deliveries, will allow for the new apartment supply to be absorbed and rents to grow as well. Finally, looking at Southern California. The jobs picture in Southern California is improving. We have experienced a year-over-year decline in unemployment of 2%. September's jobs report was up 1.8%, 40 basis points higher than the national average. Next year, we expect the region to match the national average, with Orange County leading the way. Office space absorption for Southern California was positive for the fifth consecutive quarter, as another 1.1 million square feet was absorbed during the period. Of note, Orange County accounted for 700,000 square feet of that space. Downtown Los Angeles and the West Side remain the best locations for us in Southern California, but Orange County improved in occupancy and rent growth during the quarter, and we remain optimistic that this region will continue to enjoy improved performance throughout 2013. Our performance was strong enough to increase our year end guidance, but more importantly, we feel confident about 2013. All indications are that Seattle and the Bay Area will remain strong, as Southern California continues to build steam. With that, I'll turn the call over to Mike Dance.

Thanks, Erik. Before I turn the call back to the operator for questions, I will quickly highlight the accomplishments during the quarter from 4 key activities. First, our same property operating results, from both a year-over-year increase in revenues and a year-over-year increase in net operating income, were the best quarterly results reported by the apartment REITs. We believe that these sector-leading results should continue throughout 2013. Second, the accretion from our 2011 and 2012 property acquisitions, and from our Via development, is reported in our net operating income from non-same property results on S-7. These results have far exceeded our '12 guidance and are key contributors to our leading year-over-year FFO growth. With the recently announced property acquisition and the earlier-than-expected delivery and lease up of Expo, we expect to have sector leading FFO growth continue into '13. Third, we demonstrated the strength of our balance sheet by executing a $300 million public bond offering at a 3.625% fixed coupon, which is a record low coupon for a public debut of REIT 10-year unsecured debt, and within 20 basis points of a fixed 10-year rate from Freddie or Fannie. And lastly, with the dispositions and expected sale of the Fund II assets, our co-investment activities demonstrate the capabilities of the Essex platform by attracting institutional capital, which is deployed into the best apartment markets on the West Coast, coupled with better-than-market rent growth, with value creating improvements and property operations that improve the resident experience, enables us to sell these assets and generate attractive returns that meet our investor's high expectations. I would now like to turn the call back to the operator for questions.

[Operator Instructions] Our first question comes from Dave Bragg of Zelman & Associates. David Bragg - Zelman & Associates, LLC: I kind of just have to ask, since you've put it out there and elaborated a little bit. But could you just set some parameters for us in terms of how would you define a strategic opportunity?

That's an interesting question. I don't think I really have a way of defining it. I would say it is something that is -- what we're trying to indicate that we're not doing is just going out and buying common stocks and making that type of investment. We view this as something that we think there is some strategic fit for the company. But the problem is, if you go down that road and start talking about any part of it, I think it diminishes what we're trying to accomplish. And so, that's all I'm going to say at this point, Dave. David Bragg - Zelman & Associates, LLC: And then just going over to the 2013 rent growth estimates. I'd be curious just to maybe get some color around the relative outlook for Class A versus B assets. When you think about the supply coming on in some of your markets, I'm sure that John would have some thoughts on that, and that would be helpful.

Yes, actually this is Mike. I'll take that one and John can add to it if he wants. We view the A's and B's as being fairly similar. It depends on what's going on in the local market. I'll give you an example. Probably the area that has the greatest, Dave, would be the area around the Irvine Ranch, because Irvine Ranch has the ability of producing a lot of A-type product. And so what we try to do is look at the amount of A in the marketplace relative to the broader stock and try to judge whether that's the appropriate amount of A product, again, relative to the high-end renter demand. And so, based on that, we will make a decision as to whether we think the As are going to outperform the Bs or vice versa. So that's how we approach it. We do it on a submarket-by-submarket basis. We don't believe these broad statements about As doing better than Bs or Bs doing better than As, really has a lot of merit overall. As, obviously, we're producing more apartments going forward, and as that happens, we are going -- almost all of the apartment deliveries are going to be in the A category. We are going to become more sensitive to how much A product is in the market relative to the overall housing stock. David Bragg - Zelman & Associates, LLC: Got it. That's helpful. Mike, one other just big picture question for you. Shortly after you took over as CEO, you kind of set forth some thoughts, and one of them was keeping the size of the Essex portfolio in the total capitalization range of $7 billion to $10 billion. Do you continue to think that way or has that changed?

The backdrop for that comment was trying to balance the external growth component with the internal growth component. And we -- and Essex, I think, has a reputation for being a very savvy investor, and clearly, I don't want to lose that. And we want the impact of being a savvy investor to show up in the numbers, right? By not having the base so large that it doesn't matter what we buy or build because there's so many shares outstanding that it gets diluted in that effort. So what we're trying to do is have a balanced program of internal and external, and still, we are still comfortable within the $7 billion to $10 billion range at this point in time And we'll look to that. But I will also make a comment that we are spending, really, considerable time and effort, now that the size of the portfolio is $8.5 billion, roughly, in terms of value, more time and effort as it relates to the asset management and operations in automating the operating process, re-thinking the platform. Because when you get to a certain size, the relationships between what you spend on new systems and processes and that type of thing, are easy to allocate over a broader portfolio. So I think there's some real opportunity in that area as well. But for now, still comfortable in the $7 billion to $10 billion.

Our next question comes from Robert Stevenson of Macquarie.

Sitting with a $925 million development pipeline, with your share roughly $550 million or so, how are you guys thinking about incremental starts over the next 6 to 9 month? Especially given that most of your deliveries right now are '14, and so, starting anything in the near term would probably accentuate that.

This is John Eudy. Everything that we have in the pipeline now, the 9 deals, the $940 million you referenced, are under construction. Behind that, we don't have a lot in our shadow pipeline, quite frankly. So I think what you're going to see is most of our product delivers in the second and third quarter next year, going into first and second of '14. And from there it's just a matter of whether or not we decide to pull the trigger on future deals.

Okay. How aggressively are you guys pursuing land for future development today?

Well, it's hard. As you know, the genesis of our portfolio that were developing and under construction now were started 2 years ago, and if you mark the land basis that we're in at, to market, we're about half of market today. And as Mike noted, our current cap rate on the pipeline is in the low 6 range. The same with current land values would be in the low 5 range, and that's a harder thing for us to make an easy decision on. Really good location would get some -- a deal that we can't pass up or some accommodation from the city on fee waivers, there could be a deal that pops up, but it's going to be difficult.

Okay. And then, Mike Dance, where are you seeing the greatest upward pressure, today, on the expense side?

Not really anywhere. I mean, we continue to manage expenses. They're more timing when they come. That happened to be -- last year our expenses were really low in the fourth quarter, as we tried to make some stretch NOI goals for fourth quarter last year. So we have a hard comp on expenses for next year. We do -- I've mentioned in the past, property taxes in California. We do have some Prop. 8 adjustments. We'll be seeing those in our 2013 numbers, likely to start coming in. They were muted for the second half of this year. So my concerns were not -- have been alleviated, and for Prop. 8 adjustments for the second half of this year, but it should show up in the second half of '13. And then probably, one area where we don't have as much cap on or being able to predict property taxes would be in the Seattle area. And in Seattle, set values have increased significantly. We haven't gotten the levy rates yet. But depending on where those levy rates are, that could be an area in '13 that could be an area beyond our control.

Okay. And then just last question. When you guys look back over the last 5, 7, 10 years, how have you guys historically done versus the overall market and submarkets from a rent growth standpoint?

How have we done relative to our expectations? Is that what you're...

No. I mean, is it -- so if I tell you that San Jose is a 4% rental rate growth market over the last 10 years, I mean, where are you guys normally in those...

I see, relative to the broader market. We are somewhere within the broader market, and I think that the opportunities to outperform the market are really -- from the perspective of rehab, certainly there is some incremental growth over the market. A number of buildings that we bought have been bought from owners that have owned property for long periods of time. They haven't spent a nickel on them for 30 years, the old syndicators and that type of thing. And the opportunity to both put some money in the building and improve the quality of management, I think adds some incremental value as well. And so I think that those are the main opportunities out there. Those are things that we're looking for when we are buying properties in the marketplaces, where we have an information advantage and our information advantage can lead to a little bit better performing acquisition, which I think we've pretty clearly demonstrated over the last couple of years.

Our next question comes from Jeff Donnelly of Wells Fargo Securities.

I'm just considering your forecast for 2013, specifically for the Bay Area. It looks like you’re expecting rent growth to decelerate about 250 to 300 basis points from what you've realized year-to-date. Just trying to understand your assumptions, because with an expectation of what I think is increased net absorption, and pluses [ph] in the forecast, you should have the same or better pricing power. So, I guess, I'm curious. Is that a degree of conservatism in your forecast or on your rent growth prospects or are you expecting to hit some degree of, I guess I'll call it, a ceiling on affordability?

Yes, I think. This is Mike. Clearly, when you look at the jobs that we are assuming and the broader economic recovery, which we think benefits probably the left Coast over other parts of the nation, that would -- I totally agree with you. That looks like we have another undersupplied housing scenario. But I guess the other thing that concerns us, and tempers that a bit, is how much of income is being -- how much of people's income is being consumed by rent. And so, we think -- we use the metric of rents-to-median-income as an indicator of the point at which people choose to move farther out into the hinter lands, let's say, or double up more and/or other things that change the world. And in fact, if I go back into our history bank, we hit the all-time high rent-to-median-income around year 2000, in San Francisco. And if you just look at what happens in that scenario, you will find employers moving people to Denver and Phoenix, and a lot of things that have a muting impact on what's going on in the local marketplace. So, our view is to try to keep our expectations within the range of sustainable, let's say, rent-to-median-income levels. I guess, the other related point is that median incomes, their personal income growth has been very substantial over the last couple of years. So, obviously, that could add fuel to the ability to get very large increases over a longer period of time. But it's more difficult to predict and so we're assuming that we're going to hit some resistance is, in effect, what's happening. And that's what's causing us to lower our expectations relative to what we have in 2012.

Where do you think is the ratio is today, and can you remind us what the peak was?

Yes, this is John Lopez. We're a little bit ahead in San Francisco, in the low 20s. The peak was 30-plus percent in Silicon Valley. In Oakland we're a little bit below. In Seattle, we still have a ways to go to get there, so it's the ones with the most gaps that build up. So San Francisco is our only market where we're a little bit above. But I think if you historically, that, in expansion [ph] period, it gets very high.

I guess I had the same question for Southern California, but there I would say that it's a similar dynamic of net absorption, but you're expecting revenue growth to accelerate. Is that because you think it's a little bit more affordable down there, if you will, you have a little bit more leeway to push?

Yes, Southern California is, in our view, much different position. We've had very limited rent growth in Southern California. It's the last major metro in the country to recover. Whereas in Northern California, we've had 25% rent growth over the last couple of years, we've had a fraction of that in Southern California. And at the same time, Southern California has not had nearly the job growth that the tech markets in Northern California and Seattle have benefited from. So it's actually a much different dynamic and so we just think it's a couple of years behind Northern California in terms of its recovery. If you look at rents now to the prior peak, in many places it's still below prior peak rents, where we are well above prior peak rents in Seattle and Northern California. So all those factors combined lead us to believe that Southern California accelerates, Northern California and Seattle are modestly lower.

And just a last question. Could you tell us what the move-outs to home purchase and home rental were?

Yes, this is Erik. It was 10.5% for the most recent quarter, down from about 11.5% in the second quarter.

Our next question comes from Karin Ford of KeyBanc Capital Markets.

I just wanted to follow up on that conversation about Southern California accelerating, and it sounded like in your comments, Mike, that you guys are really going to be focused there on the acquisition front in the coming quarters. Can you just talk about how much of your portfolio you'd like to potentially position in Southern Cal in an ideal world, today? And which markets specifically you'd be targeting?

Sure. Well, our Southern California portfolio has been high as 60%, and we've made efforts to invest more in Northern California and Seattle over the last couple of years. Because we predicted, I think correctly, that those markets would experience the strongest growth and it would happen sooner than Southern California. And so, again, with 25% rent growth up north over the last couple of years, the natural inclination is to shift more of the acquisition focus in Southern California. Not to say, though, that we won't buy in Northern California. I don't want to create that image at all. Over the long haul, if you look at this 20-year compounded annual growth rates of rents, Northern California has been the strongest market in our portfolio. So we have sort of the long-term in the back of our minds, and in the shorter-term, obviously, I think it has to decelerate to some extent. I think it'll still remain a very good market, but it's not possible, in my opinion, to produce 7% to 8% rent growth over a prolonged period of time. So we'll move to Southern California. To get to your -- the specific relationships, I think that Southern California could go to maybe up 10% from where it is now. So it could get in the high 50% range. But, again, I think that we are -- Northern California is the area that has the best longer-term growth and we're going to be protective of our allocation here because of that factor.

And are you equally interested in L.A., Orange County, San Diego or is there one particular area that you're more focused on in Southern Cal?

No, we definitely have submarkets that we like more than others. And, in this case, we like to the CBD L.A. We like the West side, the Marina. We like, really, the tri-cities area, Pasadena, Glendale and Burbank. The coastal markets through Orange County would be the targets that we're focused on.

That's helpful. Next question, just on development and it sounds like you're not planning to add much new to that pipeline in the near term. Is that -- I guess the part of it is that, as you said, yields on -- if you bought new land today, yields would be relatively low. Is it also that you're starting to see some maturation in the cycle? And given the long lead time to get something done that you're maybe expecting slower growth for new starts if you started anything new today?

Yes, the thought process really goes back to how do you deal with uncertainty as it relates to the broader markets and the broader economy. And the decision early on to match fund all of our acquisitions, i.e. not increased leverage on the balance sheet, the decision to use a institutional partner, with respect to a lot of our development transactions, and the decision to -- essentially the day that we commit, very shortly after that, start construction. So not have a long delay period where construction costs can increase and you're subjected to other risks that can pretty dramatically change your expected results, which is exactly what happened in the last cycle, by the way. And so the combination of uncertainty in the -- as to the general economy, and our preference to try and have a more risk adverse view of our external growth platform, is really where we've come, and how our portfolio and our development deals have evolved. So, going forward, that uncertainty certainly hasn't abated, and we're still looking at a lot of deals. In fact, John, a year ago, set up triage because we had so many deals to go through. And most of them didn't qualify for what we were looking for. We continue to look at a lot of deals and there's certainly no shortage there. But in terms of actually hitting what we consider the sweet spot of the development program is something that we're struggling with. So not to say we aren't looking at a lot of deals, we are looking at a lot of deals, and we may do some. And we do have a couple of deals that are land banked that we could start in the next couple of years. But it's just finding the deals that we think fit our profile and fit our parameters, is a struggle.

That's helpful. Last question. I think there was some talk on the last call about rent control concerns in Northern California. Is there anything new, positive or negative, on that front?

No, nothing new on that front. It continues to be an issue just because of the magnitude of the rent increases and the politicians in terms of an issue that they can get their arms around, that is certainly one, but nothing recently has happened. I did talk to the President of CAA the other day, and he was -- he acknowledged that we've been pretty helpful in some of the efforts to mediate between cities and residents, some of the rent increases. So yes, I think it's more of the same. I think it's -- I haven't heard anything new at this point.

Our next question comes from Alexander Goldfarb with Sandler O'Neill. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: The first question, Mike, just goes to the stock investment. When you guys bought the unsecured bonds, clearly, there's an ability to underwrite what the cash flows are. When you're doing a stock investment, it's based on sort of how the market interprets the story, which is obviously different than how bonds are priced. So while I understand that you want to keep quiet on the strategic part of it, how do you guys gain comfort, the same comfort that you have on that downside protection?

Alex, the problem with this whole topic is, without revealing the nature of what we're doing and how we're going to do it, yes, I can't answer you, I can't answer the question. I mean, to answer that question, I would have to be able to talk freely about the nature of the investment and why we are pursuing it. So I'm kind of in a difficult spot with respect to this question and other related questions. I understand that the market would like to understand what we're doing, but let's keep in mind that it's a relatively small investment to the size of the company, and we will disclose what we can, and we will. I mean, it's our practice, I think, to be pretty open and transparent as a company. We'll disclose information as we can, we just can't do it right now because who knows how that could impact what we're trying to accomplish. So I can't add anymore at this point. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: No, I think that's fair. Listen, you guys have clearly, as you said, demonstrated savvy and the market certainly gives you guys credit for doing this stuff. It's just -- help us gain further insight, but understand that you want to keep it close to the vest. Let me ask you a question, for Mike Dance. On the Fund II dispositions and the policies, I don't have a supplemental in front of me, I don't have working Internet. Do you -- what's the potential for any promote cert [ph] , chocolate chips, if you will, in '13 versus '14 that we should be thinking about?

There's possibility for both in '13 and '14 depending on the timing of the last sale. So it's back-end loaded because the promote is very sensitive to how these last assets are going to sell. And if we get to the extension in the '14, that will either put them in last half of '13 or early '14. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. And if you can't provide any color right now, when you guys provide fourth quarter guidance, would that include a range of potential for those promotes? Or because they're really subjective to when the sales finalize even in the fourth -- even in the '13 guidance provided in the fourth quarter, it still wouldn't been in there?

We would provide in, as we have in the past, a range of possible other income. So I could see some wide [ph] range of possibilities there. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. And then just the final question. In Seattle, saw a news item that you guys sold Tower 801. Just sort of curious if that's a submarket decision or if that was an asset-specific decision.

That was a Fund II decision and -- so that was one of our Fund II assets. And as you know, there is a lot of downtown Seattle development that will be coming online, so looking at the Fund II assets to sell and the timing, we thought we're going to have to sell it eventually. If we could own it, we would have bought it from the Fund, but that's not our deal. But we just figured it was the right time to sell that, pass that this year rather than next year when some of the new deliveries will be occurring.

Our next question is from Michael Salinsky of RBC Capital Markets.

First question. In the guidance that you provided, you talked about some of the acquisition upside. Can you give us a sense of what the pipeline looks like today, what could close in the fourth quarter? And also, just any change you've seen in pricing in the last 90 days would be helpful as well.

No change in pricing in the last 90 days. It's interesting because obviously, given said efforts to keep interest rates low and lower, we're seeing some pretty amazing debt rates on 10 years from Fannie, Freddie and certainly, in the unsecured market. In my comments, I noted that we have $186 million in contract, contingencies removed. The timing of that will be mostly fourth quarter. There are some loan assumptions and some other things that could impact that timing, but most of it will close in the fourth quarter. There's a lot of product on the market as well, and so our acquisition people are busy now. Every year, there are some tax-motivated sellers that need a quick close type of scenario. We're hoping for that this year, still too early to tell, but we always like those deals because there's such strong motivation on behalf of the sellers. So $186 million, thus far, and we're looking at lots of other things. So hopefully that helps.

Okay, that's helpful. Second, probably a question for Erik. In the third quarter of last year, your occupancy dropped then picked up sharply towards the end. I think in October, you had a very good pickup. Can you tell us how kind of October trended versus last year and where occupancy is at this point versus the occupancy last year?

Better. Seriously, the -- again, it's been smoother this year. So I think our strategy on pricing, particularly renewals and on the new lease side, we paid attention to some of the relationships between net availability and pricing earlier, and again, just worked that equation a little bit differently. I think last year, I talked about how the pickup really started in September, maybe second week of September, and then ran through the middle of October, and by the time it got to the end of the month, settled in at whatever that ending rate was. As of yesterday, physical occupancy was in the 96.3% range portfolio-wide. And so that's the reason -- that's where we stand.

How does that compare versus last year at the same point?

I don't have that in front of me, but I think it's about -- I don't have it in front of me. It's similar though. I mean, I can -- it's either at the same level or it might have been 10 basis points higher because we got after the leasing aggressively to make sure that we got to essentially the point that we wanted to be, which is where we are today. We like exactly where we are today in that 96.3% range with 5% availability looking out 45 days. So a very manageable supply between now and the end of the year.

Then, finally, Mike Dance, not to leave you out. On the Fund II sales, did you give what the gain on a gross book value basis was? And can you comment what the IRR on those, the 7 that were sold were, at Fund II [ph] ?

Yes. We will have the gain -- Bryan gave me his number. I'll have to get back to you on that. I just -- it escapes my memory right now. But we do have a number that we can provide. And the IRRs today are around 10%. So we're expecting the promote to come with the second half sales, where some of our bigger gains are in the Bay Area assets we bought. And those will be sold either late '13, early '14. But given the high rent growth we continue to see in -- on the peninsula, we didn't want to sell those yet.

Can you remind us what the hurdle rate on that -- on Fund II was?

It's 10%. So we're -- we've now paid out the hurdle rate. So everything else that we earn above the 10% will have a promote.

Next question comes from Eric Wolfe of Citigroup.

I think in your opening remarks, you talked about the home prices in your markets being up, I guess, 7% to 17%, so pretty strong on a year-over-year basis. Just curious, if you look at it, if it's not your renters and other first time homebuyers that are moving out to single-family housing that's pushing up pricing. Is this just a sort of temporary short-term squeeze due to a lack of supply or do you see these gains as being stable?

Well, that is a very good question, and I'm not sure I have the complete answer. I can tell you that as you start getting these big numbers in home prices, a couple of things happen, one good, one not so good. The good part of it is that the affordability, the ability to shift from a renter to a homeowner becomes more difficult to occur. So we like that. But at the same time, as the price goes up, you're going to start seeing more homebuilding in these markets. And our view is that apartments are essentially the shock absorber within the market. So to the extent you build a home, we assume that it's going to be bought by someone and it's going to absorb a household. So the confluence, I guess, the relationship between the 2 is, I guess, number one, for a couple of years, I think we're good because we have very muted levels of for-sale housing coming at us. But we're going to be mindful of that and we're going to track it carefully because again, our view is that to the extent they're built, they are going to be occupied and they're going to take away from the renter demand.

Eric, I just want to add that our affordability levels are returning to more normalized levels we'd expect to see. So I would believe that these gains are not a temporary jump, but sustainable.

Okay. That makes sense. And I guess, along the same line, you talked a little bit about the supply of single-family homes maybe coming back. As a response to these gains, which I guess may not be stable, but how quickly do you think that could happen? And do you see it being more of a trickle or a flood, and is it likely to hit more of your sort of peripheral markets versus your core markets?

I think that we don't have the ability, except in a couple of places where you have massive tracts of land that are ground zero, competing against our apartments. I guess one of the notable exceptions would be the South Orange County market, where there actually is quite a bit of open space and the ability to build homes that -- and they can be built fairly quickly. If we use the last cycle as sort of an indication of what's going to come at us, there were a lot of thousands of condo buildings that were built in the coastal markets. The timeframe for building that type of product is obviously much more like an apartment, it's going to take longer. Our ability to track it and identify it and understand its impact is much greater. So I think that in the coastal markets that we focus on, you're going to see -- you will start seeing that again, but I think it's a couple of years off. And so with respect to the product that can be generated more quickly, which is more like the single-family homes, I think that, that's going to be -- it's going to be muted, but there are a couple of areas that we're concerned will have more of that. San Diego would be the other example of an area that we'd be concerned about in terms of the ability to produce single-family housing.

Right. Great. And sort of a weird question here, but you talked a little bit about strategic position. You wouldn't ever consider some type of position in a homebuilder or something sort of outside your core focus. I mean, what you're talking about is something that's really more specific to Essex.

Again, I have -- this is the problem Mike. It's almost like I can't say anything without providing a piece of information that I just -- I can't do it. It sort of handcuffs me as a question, so I just can't comment. Sorry for the frustration that might cause.

[Operator Instructions] Our next question comes from Rich Anderson of BMO Capital Markets.

So to what extent that you mentioned the 13% of move-outs for financial reasons are -- I'm not exactly sure how you put it, affordability or whatever it was, but you indicated that might be growing in 2013 as well. To what extent is that influencing your rent growth assumption for 2013 moderating? Does it have an influence on that calculation?

No, it doesn't. Again, I've talked about it before. It's been higher in the past. I think same period last year, it was closer to 17% or 18% of the move-outs. We're citing this as a reason. And again, basically, I'm combining people that tell us that either their apartment is too expensive or that they're specifically moving out due to a rent increase. And so again, we've seen that number stable or even come down. So at this point, it is not impacting how we are projecting 2013.

Okay. Mike, or whoever, you'd mentioned that you could see Southern California climb 10 percentage points to 50% from about 40% currently. How is that going to accomplish it? Will it be purely through acquisitions or will it also be a time to be a seller following the huge rent growth in Northern California?

I could see, Rich, us selling some assets in Northern California and Seattle, and we would tend to look at these secondary locations. John Burkart is actually here. He is the keeper of the dispo list, and he -- there are some assets on there that are more secondary areas of the San Jose MSA and the other Northern California and Seattle markets. So it'll be that, and to the extent we can build in Southern California, we still would like to do that. We have a couple of development deals that are under construction in West Hollywood, and so that could be a component of it. But again, most of the -- there's so little production of housing in these markets that almost by default, most of it is going to be acquisition-oriented. So it will be a combination of all those.

Okay. And regarding some of your past and most recent investment activity, buying buildings that are more better-suited potentially for condominiums, Skyline for example, to what degree is that strategy something that you'll continue to pursue or is it kind of gone? Or maybe from a risk perspective, you don't want to go down that path much more. Or where are you on that strategy from an acquisition standpoint?

We still like it. We think that the opportunities to execute it are few and far between. Most of the transactions that we did in 2010, 2011 involved a financial institution of some kind, which are great sellers because they're very motivated and you have certainty of closing, in some cases, actually in a couple of those cases, we had to underwrite the asset and remove contingencies within a week, for example, because they're so motivated. And so we don't see the motivation of the financial intermediaries to nearly that -- nearly the same extent at this point in time. There are a few transactions that we see that have condo maps and we give a little bit of extra credit, let's say, to those transactions just in recognition of the scarcity of condo maps within these markets. And so we -- contingencies, some transactions that have that. But I think most of the real opportunity has been -- has been realized on that front. I note that the increase in single-family home prices is obviously a tremendous benefit as it relates to that strategy. So it's a mixed bag for us because on the one hand, we know that if housing prices go up significantly, we're going to see more housing, more for-sale housing being delivered, but at the same time, the condo optionality becomes more meaningful on our portfolio. So again, a good and a bad.

Okay. And then my last question is, first, I'm hopeful that you won't bite my head off by asking it, but I'm just going to ask it anyway. And obviously...

It is your nature, Rich, to do that.

So, but I think it's benign enough. And I'm just curious, not on the stock investment issues specifically, but just a general rule of thumb, to what degree is this a normal course of business for Essex? How often do you make stock purchases as a general rule of thumb and is it something that isn't so far afield from what you've done in the past?

It's a good question. Obviously, most people know that we were pursuing Town and Country several years ago. I guess the other factor that's a little different now is we self-insure. We've got an insurance captive with somewhere around $30 million in it. And so we tranche that, by giving it a very safe tranche, and then less safe tranches. So as you get more money in the captive, we're going to be buying -- we will be making investments and they will be, by their nature, liquid. Mostly bonds probably, but there is a chance for some common stock investments within that entity. But this, I would view this as being very unusual and something that we think we can add value. I think we have a reputation as being a very value-oriented company and try to be opportunistic. But at the same time, I think that we're also pretty darn risk-adverse as well. So certainly, that's the influence of George Marcus for many years, being both sides, opportunistic and sensitive to risk. So where we see opportunities that sort of fit within that box, we feel compelled to move on it. I think the other bias of our board is, let's not do things that are so large and such large bets that we undermine the good thing that we have going. I mean that comment is something that is often stated at the board level. And so within that discussion, I would expect this to be sort of within that same vein. There's an opportunistic element, there's a strategic element, there's an element that says don't make it so large that it could affect the good thing that we have, the good things that we have going, and I think that's what we're doing. It will all become clear down the road as we all know.

Our next session comes from Andrew McCulloch of Green Street Advisors.

Just back to the common stock investment, I'm sorry to beat a dead horse here, but I think one of the things that makes investors a little uneasy, in addition to the fact that you're not letting anyone know what you're investing in, is that you're also issuing common stock at the same time. When you issue common stock at a big premium to either [ph] buy apartment assets, that's arbitrage. But when you issue common stock to buy common stock in another company, unless it's another apartment REIT, that's pure speculation. And I guess my question is, why would investors want Essex issuing common stock to make purely speculative investments in other common stock?

I mean, I don't necessarily agree with your characterization. I mean, we're issuing common stock and we've got a very robust acquisition and development pipeline. And so I don't think you really know that, that's exactly what we're doing. Having said that, I don't think you should -- you know who we are. We have a 20-year track record and I don't think we have too many crazy things that we've done over that period of time, so I would ask that you see it through with us, and in the end, I don't think that anyone will be disappointed or think that it's something that's hugely speculative or out of character. So again, I go back to what I just said, which is we have, we try to be opportunistic, I think you all want us to be opportunistic within the balance of let's not do anything that's going to undermine the great things that are happening out here, and I think this fits nicely within that. So I think if we were talking about an enormous investment, I would agree with you, Andy. But in this case, I just think we're making too -- making much out of something that just really is not all that large.

Our next question comes from Tayo Okusanya of Jefferies. Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division: Just a quick question on the development side. If you could talk somewhat about development costs and just where you see that trending?

Sure. This is John Eudy. Fortunately, the pipeline that we have, the 9 deals, $934 million, all but the last probably 10% has been bought out and we priced it for the most part, on average, about a year ago. And we don't -- we're pretty safe there and we're trending on the portfolio to come in at or better than budget. At present, there has been some moves. We have the recent Sandy event, which is going to probably give a little spike to some of the material costs. We do think that costs are increasing, not as substantial as I think the recent Wall Street Journal seemed to indicate, of anything gross, but they are going up and that's one of the risks that we're being averse to. Better have your landing from 2 year ago prices and your costs in from 1 year ago than going forward. And that's why we're moderating our forward-looking activities carefully. Omotayo T. Okusanya - Jefferies & Company, Inc., Research Division: Okay, that's helpful. And then just going back to the comments about rent income ratios. I mean, I did get this idea that the rent to income ratios are nowhere close to where their historical highs have been. But I'm just curious, with everything you're seeing in regards to job trends and overall market trends, whether you actually expect rent-to-income ratios to get as high as they were, kind of in the dot com era, or in the last real estate boom of 2004, 2005, 2006?

Yes, this is John Lopez. Only San Francisco is above its long-run trend. And so I would say that most of our markets are still below the long-run average, not anywhere near the highs. And San Francisco, where it's at right now, is not at the level you would expect to see in a very hot market. The second thing I'd like to add is we look at Seattle as a market where it was hit pretty hard in that it's becoming more of a market like our Northern California markets, and we expect that long-run average to actually increase over time.

Our next question comes from Paula Poskon of Robert W. Baird. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: Just one big picture question. Just given how strong the fundamentals have remained, are you surprised that the apartment sector has not done better, has really just underperformed year-to-date?

Wow, that's a great set up question, thank you. Thank you, Paula. I'll send you a check within the mail. Obviously, we're disappointed in the performance of the stock. I think the multifamily REITs are the poorest performer, stock-wise, this year, which may not be -- was true about a week ago, I think, but maybe changed a little bit. So, I mean, obviously, yes, but at the same time, we view our jobs as putting numbers on the board, growing cash flows, doing just smart real estate deals and we believe that the stock price will follow that effort. So we remain optimistic and we're happy with lots of things that are going on, and we hope that the stock reacts appropriately over time. And I think it will. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: Do you think that investors though are -- that the concerns, particularly around that return of homeownership, have been overdone or do you think those are warranted given what you were saying in your comments earlier around housing prices and your fear that the inventory will increase?

Yes. The comments that we've made are in no small part, trying to put that issue into perspective because I think there is sort of a homogenization of America in terms of the data. And I think that the regional variations are very significant, and so I think that what works in the general theme may not work as to every company and every location. We recognize this as being a very local business, and relationships that may apply on a national basis will probably, ultimately apply to us, but there can be a couple of years of lag between them. So I think in this case, there's a couple of key points that really matter here. Number one is our rents fell further than most. Our prior peak to the trough was off 15% as a company. And so we expected a strong bounce and we got a strong bounce. From that though, we started at a very low point. We were about 2 years later to recover, given the fact that head [ph] Companies prove that they can restructure very quickly, and so we had very significant job losses for a period time, which led to the rent reductions, but it also set up the opportunity to add jobs quickly when conditions were better. So our view is that if you have those 2 things in context and then you also look at what happened in the for-sale area, where you had all these vacant condo buildings, really demonstrate the distress within the for-sale markets. And again, we were able to buy 8 of them over that period of time, and it just shows you how much distress there was. And again, that will recover as well, and -- but it's not happening yet. And so I think you have -- you've got to look at regionally, with respect to the different elements of supply and demand, and you'll see why we're as optimistic as we are in our comments.

Our next question comes from Andrew Rosivach of Goldman Sachs.

Really quickly in the call, you guys have done a lot of transactions both on the buy and the sell side in California. And I'm just curious, have you been able to have any kind of efficiency in terms of Prop. 13 when you're entering or disposing of assets?

No. I mean, when you buy or sell an asset, which is different than development, they're going to use your purchase price, and whatever adjustments we do for GAAP accounting, they kind of ignore. They just use the -- what's recorded in the purchase sale agreement. Development is more of an art. They try to come in and assess us a fair value. They can't mark up the land, but they can mark up the improvements on the development. So there, we have had some success on the development side, but acquisitions and the dispositions, it's pretty black and white.

So even in the history of the company, like way back when, when you sold the Fund straight to UDR, even if you do an entity-level transaction, that you're still going to get a markup?

Well, with UDR, you'll have to talk to them. But I imagine if there were assets outside the state, they would've tried to change the allocations. I can't remember all of the assets of the Fund, but there may have been some allocations because there was a purchase price, they had some flexibility and ability to allocate within or without the State of California to maximize their tax position. But you'll have to check with them on what they did.

Right. And this just one thing. This is indirect to this year purchases. You increased your interest in other income guidance by $600,000. Is that because you're carrying the additional common stock, which is producing a dividend?

I think that falls under Mike's previous comments. We're just not going to go there, Andrew.

Our next question comes from Ross Nussbaum of UBS.

I guess, there's a lot of talk about this common stock investment. And while you've been on the phone, your stock is down $1. BRE's stock is up $1. So I don't know why everybody's beating around the bush here. Can you at least tell us what this is not as opposed to what this is? If this is BRE, can -- do you have any intent or are you buying BRE Stock? Do you have any intent of merging with BRE? Are you in discussions with BRE?

Ross, you know I can't answer those questions. I mean...

Well, if I asked you if you had any intent of merging with IBM, you'd answer the question. So, I guess, you guys opened the door by making a strategic investment, you've told us nothing about it, you won't tell us if you're going to be buying the entity, selling the position and I guess, maybe the question then becomes how long do you plan on keeping us all in the dark for on this?

Well, I would argue that you're really in the dark. We have disclosures that we have made. And you know the relative size of the investment and you can judge that relative to the size of the company. And there are laws that concern other disclosures that are out there. And so again, I can't say anything more.

All right. I mean, I hope you can understand there is a sense of frustration out there because I think people are concerned that this isn't just a small investment, that it is going to be something bigger, and they don't want to get in front of that until they know more.

I understand.

The next question comes from Michael Bilerman of Citigroup.

Michael Schall, you mentioned Town and Country in your response to a question. I guess, what is your thoughts on new markets and markets outside the West Coast and your interest level?

Michael, we continue to be interested in markets outside the West Coast. The fact pattern of Town and Country is, I think, important and maybe instructive in that, at that time, West Coast was, I'd say, marginally ahead of the East Coast in terms of overall asset pricing and cap rate and just overall attractiveness in terms of where the West Coast was in the cycle and the East Coast. We view this business as, a good strategy is great and important, but only when coupled with good decisions with respect to timing and value create -- the value creation thesis. So in this case, I would say the reverse is -- has happened, which is, at least to this point, the East Coast was ahead of the West Coast in terms of recovery and in terms of asset pricing and valuation. So hopefully, that gives you some idea of how we think about these things.

Okay. And then the $73 million that's in marketable securities, so the $43 million that was there as of the second quarter and the $30 million that you added to it, the entirety of that is one single position and one single security or is there multiple positions in there?

The vast majority of it is one position.

And then has anything been added to that position during the fourth quarter or is $73 million the current standing position?

No.

And then, I guess, just from a disclosure perspective, there's obviously your own disclosure, which you've made, and I guess once you reach 5% of the entity, you would have to disclose a shareholder perspective, correct?

We will comply with the law, correct.

So then, therefore, the target has a minimum market cap of $1.5 billion because you haven't reached 5% yet, and potentially, you could be at 4.9%. And with normal leverage, the entity would be greater than $2.5 billion. And I think that just goes to Ross' question about it's a small position relative to the current size, but clearly, as a totality, if you were to move forward on the security, this obviously is a large investment at some point.

Can't argue with your math.

And then onto the last question, in a lot of M&A type scenarios, a lot of situations, people use derivatives, puts, calls in order to get their stake up. Do you have any of that today or is your position entirely built up of shares of common stock?

We have no derivatives.

It appears we have no further questions at this time. I would now like to turn the floor back to management for closing comments.

Well, thank you very much for the spirited debate this morning, and we appreciate your participation on the call. Obviously, we're pleased with the results of the company during the quarter and our outlook for next year, and hey, we look forward to seeing many of you at NAREIT in San Diego in a couple of weeks. Thanks so much for being with us today.

This concludes today's teleconference. You may now disconnect your lines at this time, and thank you for your participation.