Essex Property Trust, Inc. (ESS) Q3 2013 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, Chief Accounting Officer and Executive Vice President John D. Eudy - Executive Vice President of Development John F. Burkart - Executive Vice President of Asset Management

Nicholas Joseph - Citigroup Inc, Research Division David Toti - Cantor Fitzgerald & Co., Research Division Robert Stevenson - Macquarie Research Ryan H. Bennett - Zelman & Associates, LLC Jeffrey Pehl - Goldman Sachs Group Inc., Research Division Jana Galan - BofA Merrill Lynch, Research Division Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division Nicholas Yulico - UBS Investment Bank, Research Division Haendel Emmanuel St. Juste - Morgan Stanley, Research Division Michael J. Salinsky - RBC Capital Markets, LLC, Research Division Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division David Harris - Imperial Capital, LLC, Research Division David Bragg - Green Street Advisors, Inc., Research Division

Greetings, and welcome to the Essex Property Trust, Inc. Third Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference 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 Schall, President and Chief Executive Officer for Essex Property Trust. Thank you. Mr. Schall, you may now begin.

Thank you, and welcome, everyone, to our third quarter earnings call. We wish you all a safe and pleasant Halloween. As usual, Erik Alexander and Mike Dance will follow me with comments on operations and finance, respectively. John Eudy and John Burkart are available for Q&A. I'll cover 3 topics on the call: First, brief comments on our Q3 results; second, notable items related to development; and third, preliminary market expectations for 2014. So onto the first topic, our Q3 results. We are very pleased to announce another strong quarter, where which we reported core FFO of $1.91 per share. That result was $0.02 ahead of the midpoint of the guidance range that was provided in connection with our second quarter call. Growth in Northern California and Seattle and improvement in Southern California were obvious contributors to the results. Erik will comment further about these operating trends. Onto the second topic, notes on development. We are also pleased with the results at our lease-up communities. Since the June opening of our Epic community in North San Jose, we have leased 265 of the 280 apartments in Phase I, an average pace of 66 apartments per month, roughly double our plan. In August, Connolly Station, which is located adjacent to the West Dublin BART station was available for initial occupancy. We have now leased 166 apartment homes or a pace of 83 apartments per month, roughly twice as fast as planned. We formed a new co-investment entity and started construction at our Village community in Downtown Walnut Creek. The Village includes 49 luxury condo-mapped apartments averaging over 1,600 square feet and 35,000 square feet of retail space in the Downtown retail core of Walnut Creek. This property is adjacent to the Broadway Plaza Mall, which is the premier shopping destination in the East Bay. At our recently completed Expo community in Seattle, we received LEED Gold Certification and we're selected as the national finalist for Best Green Building by the National Homebuilders Association in its Pillars of the Industry Awards. In contrast to these recent results, our development strategy causes us to be less aggressive as we progress through the economic cycle. As a result, we continue to lower our development exposure as a target, which is subject to change, we believe that our pro rata share of annual development deliveries will range from $150 million to $250 million going forward. That is beyond the pipeline that's shown in the supplement. Then onto my third topic, which is market outlook for 2014. Page S-16 of the supplement provides an overview of the key housing supply demand assumptions supporting our market rent growth expectations for 2014. This is not necessarily the rent growth estimated for the Essex portfolio, but rather represents the primary economic input into our 2014 budgeting process. I have a few comments related to the information on Page S-16 as follows. Number one, Seattle multifamily supply is expected to be up about 20% from 2013 and should peak in 2014. Even considering the expected strong job growth, we expect market rent growth to slow to about 5.4% in 2014. Given greater concentration of supply in the Downtown, we believe that the East Side will produce the best rent growth. Second comment. We expect the continued limited supply of for-sale housing in the coastal California markets, which means that overall housing supply, that is both apartments and for-sale, will average about 0.7% of housing stock in Northern California and about 0.5% in Southern California. Thus, we believe the aggregate housing demand will continue to exceed supply in coastal California. And third comment. We expect Southern California to continue its slow improvement, slightly outperforming the nation in terms of job growth, but with limited supply. Our average market rent growth of 4.7% in Southern California compares to the actual revenue growth in the same property portfolio for the 9 months ended September 30 of 4.2%. Thank you for joining us. Now I'd like to turn the call over to Erik Alexander.

Thank you, Mike. Essex enjoyed another solid quarter in operations as the Bay Area and Seattle continued to record strong economic growth, which resulted in healthy demand throughout the period. Leasing activity met or exceeded expectations in all of our markets, highlighted by strong renewal activity, low turnover and solid schedule rent growth. For the quarter, renewal rates grew 5.8% over expiring rates and continued that trend into October. With lower volume we expect in November and December renewal rates to be similar given the offers extended to residents. Turnover for the quarter and through October continues to be in line with expectations, and we project the annual rate of turn to be just over 50%. We have seen limited impact from move outs due to home purchase as this metric fell to 10% of all move outs during the quarter. These factors, along with economic rent growth, led to a sequential gain in scheduled rent of 2.4% for the quarter. This is the highest sequential growth since 2008. We are also poised for a good fourth quarter as occupancy stands at 96.3%, with only 5.4% net availability. However, we do not expect to reach the highs that were achieved last year due to a planned increase in interior renovation activity. Now I'll share some highlights for each region, beginning with Seattle. As more new buildings come to market in the region, everyone has a watchful eye on supply. Many of these deliveries are in the downtown submarket, and we have witnessed a decline in competitor absorption rate. Concessions also increased downtown during the quarter, consistent with rapid lease-up strategies. We expect this trend to continue into the first part of 2014 when demand traditionally rebounds. There have been expected seasonal declines in economic rent outside of the CBD, but no additional pressure on pricing due to concessions on the east side, north or south end, where 80% of our portfolio is located. We still expect these submarkets to perform better than the Downtown next year. Employment growth in the region improved to 2.8% during the quarter, well above the national average. And office absorption remained strong with 630,000 square feet leased during the quarter and 2.6% of total stock has been leased year-to-date. In Northern California, it continues to lead the way for Essex with the highest growth in rental rates and revenue for the portfolio. In fact, new lease transactions in the division have averaged more than $2,000 every month since May, and average renewal increases reached 8% during September. August year-over-year job growth was over 2% in the region and once again was led by the San Jose submarket, which posted 3.1% growth. Office leasing and development continues to be brisk in all parts of the Bay Area, which creates job now and allows for continued employment expansions in the future. One of the more significant projects in the region, the $2 billion Transbay Terminal, continues on schedule and remains a catalyst for development in the vicinity, with approximately 3 million square feet of office space under construction, including the 1.3 million square foot Transbay Tower. So in Seattle and San Jose, our big brothers, it's hard to impress, but Southern California continues to enjoy steady growth. Market rates inched up during the period, and we made modest gains in occupancy. However, renewal activity remained healthy and has been above 4% since May. Overall job growth in Los Angeles improved to 1.4% during August. In Orange County, job growth remains above 2%. It is also worth noting that unemployment in Orange County has fallen to 6.2%. San Diego and Ventura remained steady and we have not experienced any negative impacts due to military activity. In fact, our exposure to military residents in San Diego remains below 13%. Commercial development and leasing activity remained relatively low throughout the region. But leasing on the west side of Los Angeles remains very strong, and industrial vacancy in Orange County is the lowest level in the country, with less than 5% of space available for lease. Economic and rental conditions remain strong and we are in good shape to deliver year-end results consistent with our guidance. Thank you for your time, and I will now turn the call over to Mike Dance.

Thanks, Erik. Today, I will provide color on the quarterly results, the 2013 guidance and our balance sheet position. Our same-property operating results continue to beat our expectations, and we have raised the midpoint of our guidance for revenues and net operating income by 10 basis points to 6.1% and 7.3%, respectively. During the quarter, consolidated net operating income results were offset by the $1.2 million in vacancy, which occurred during the renovation of 623 apartment homes during the quarter and from a fire that unfavorably impacted results by over $300,000. In addition, our share of the lease-up dilution during the third quarter from the Connolly and Essex development joint ventures was approximately $600,000. Moving to the change in guidance related to promote income. We have only 2 properties comprising 165 apartment units that are unsold from the Fund II portfolio. To date, we have returned all the limited partners' original capital and have distributed most of their preferred returns. Fund II promote income will be recognized in 2014 with the disposition of the 2 remaining assets. The decision to postpone the disposition was to capture some of the 7% to 9% loss to lease onto the rent roll and to reduce the prepayment penalties on the mortgages securing these assets. We will provide an update on the timing and estimates of the promote income after we begin the marketing process next year. I will conclude with comments on our financial position. As of September 30, we have over $600 million in capacity on our own secured lines of credit. Marketable securities and cash equivalents exceed $140 million. And in November, we will receive $55 million from the repayment of loans we made to our Wesco III joint venture. Our debt maturities through the end of 2015 are only $133 million and, as noted on S-9, our percentage share of development commitments are less than $300 million. At our Investor Day next month, we will share our 3-year plan for deploying our resources to achieve sector-leading shareholder returns. That ends my formal remarks, and I will now return the call back to the operator for questions.

[Operator Instructions] Our first question is coming from the line of Nick Joseph with Citi.

Can you talk more about what you're seeing in Southern California and when you could expect to see the same-store growth actually cross over and exceed Northern California and Seattle?

This is Mike. That is a good question and I think it, I think, has perplexed us for many years. We're originally expecting Southern California to recover more similarly to the North, and that, of course, hasn't happened for a variety reasons. Number one, just the composition of the labor markets in Southern California is different. Southern California is much more like the nation -- when you look at the components, it doesn't have the tech influence that we have in the North. And so, it's had a much more muted recovery. I think also another factor, especially in San Diego, if you look at job growth over the last year, has been a little disappointing. I think that's somewhat sequester-related and in some of the other areas. So I would say that it will be at least 2015 or 2016 before the crossover point is achieved.

All right. I think you mentioned that you're cutting back on development strategy, becoming less aggressive at this point in this cycle. When you're actually penciling development fields today, what kind of spread do you need to see between expected initial yield and transaction cap rates?

We measure it in a number of different ways. Essentially, we want to see about a 20% premium to the development cap rate measured with rent in place today relative to an acquisition-type cap -- or the similar quality acquisition cap rate. If we are able to minimize the development risk, which means to us trying to time the land close and start of construction within a very short period of time as opposed to holding land banking effectively for a longer period of time. So for the land bank type situations, we'd want a higher yield to compensate us for the additional risk.

And so for the new starts this quarter, what initial yields are you targeting?

I think everything that we're targeting, everything we're looking at is -- and John Eudy is here, he may want to add to this -- is somewhere in the 5% to 5.25% cap rate range, again, measured on rents in place today. We would think that, that would stabilize somewhere in the 6% to 6.25% range. Having said that, the other thing that we're all looking at is the permit data and there's a lot of permits being pulled. It's our belief that they're not all going to immediately go into the construction pipeline because a lot of them fail to meet the criteria that the investors require and the lenders require. And so, I think that it's going to be, even though you're seeing quite a few permits being pulled, I think that they're to be delivered over several years. I don't think that they're all going to get started, which is possibly one moderating factor as it relates to Seattle, because it's got a lot of for-sale and apartment permits being pulled and a pretty robust development pipeline through '14.

The next question is coming from the line of David Toti with Cantor Fitzgerald. David Toti - Cantor Fitzgerald & Co., Research Division: The first question I have has to do with your sort of market forecast that you provided in the back of the supplemental. And I'm just wondering, I know you guys produce this from some third-party sources, is there a specific relationship in your mind between supply forecast and then the rent forecast? In other words, if we see multifamily supply go up by 1% in your markets and jobs go up by 0.5% from where they are, do you calculate a specific rent impact or is that sort of separate from those functions in some way?

No, we absolutely do. I mean, again, this is the input into our budgeting process and we try to estimate really forward 3 to 5 years what we expect rent growth to be based on these variety of inputs. And it really starts with the U.S. economic assumptions of GDP growth, 2.8% for '14 is what we are assuming and job growth at 1.8%, and we'd look at historical trends. If the U.S. is going to 1.8%, what will typically happen, what do we expect to happen within each of these MSAs with respect to job growth. And then internally, we take job growth, try to predict what that means for household formations, subtract out effectively the for-sale component because we know that for-sale is going to essentially all be occupied. And whatever is left over is the rental demand and we compare that against the rental supply, and that's how we do it. And we have a -- I mean, it's more sophisticated than that, and we're not going to share our methodology as it relates to rent forecast. But absolutely, it's what we try to do, and that's why we present this. We had a discussion about whether we should drop it this quarter or this year given the actual metrics and others do a pretty good job at this stuff. We decided to leave it in because it's the -- it is effectively trying to define the scenario that we think is going to happen for 2014, because -- let's say, if we're completely wrong, let's say, job growth goes from -- the U.S. goes from 1.8% to minus 5%, then we will miss these numbers, I can assure you, but the scenario changed. So we're trying to create a consistent scenario, try to communicate what that is to the investment community. And then if we hit these numbers as to the U.S. assumptions, we would expect to be pretty darn close as it relates to the market forecast. David Toti - Cantor Fitzgerald & Co., Research Division: So I hope you keep it in because it's quite useful for us. And without getting too specific on formulas, relative to the market forecast, what's the most sensitive of variables? Is it supply or employment or the GDP underpinning [ph] guidance?

Well, as it relates to the U.S. economic assumptions, it's all very sensitive. I mean, the whole thing rolls together. If the U.S. does much better, I would expect it to -- essentially, all arising tide lifts all boats in effect, and I would expect that to happen. The same is true on the downside. So again, it would be almost impossible for apartments, and it's not just us, it's everyone, for apartments to do really well in a rotten economy, you've all seen that a bunch of times. So we're trying to demonstrate the relativity of how these numbers relate to one another. Our -- what we're ultimately looking for are inflection points of rents, both -- in each direction. And we're trying to predict -- we know that pricing power increases as market occupancy increases. So at 95%, you have x amount of pricing power at 96%, 97%, you build that and it has a pretty significant effect on rents. So using historical relationships, using our experience in these marketplaces, we're trying to understand those variables and then predict what's going to happen to this inflection point as it relates, certainly, to Southern California and try to predict when that's going to happen and invest accordingly. David Toti - Cantor Fitzgerald & Co., Research Division: Okay. And then just one last detail question, and forgive me if I missed it earlier. Turnover ticked down, which was sort of counterintuitive compared to some other reports we've seen from the space. And in particular, Seattle was down quite a bit. Is that really a function of the widening affordability gap to housing? Is it perhaps that rent increases were more modest than they could have been? What's your sense for that turnover rate change?

Yes. This is Erik. I mean, they're essentially flat. And again, I think we attributed it to a couple of things that you mentioned. One is the location or composition of the portfolio, but also, the renewable strategy as we've talked about before, and Mike has advocated for smart profits. We restrain ourselves when it comes to sending out the increases and voluntarily cap those at 10%. And I think that's appreciated by our customers, and we see a good conversion rate.

The next question is coming from the line of Rob Stevenson with Macquarie.

Mike, lowering the development exposure going forward, is it due to lack of opportunity, falling returns on the stuff that you're seeing, higher construction costs, some sort of view of increasing risk? Can you sort of help handicap the sort of components there that are sort of driving a bit of a pullback?

Sure, of course. All the above would be the answer. Deals, I think, are having trouble hitting the market acceptance point as it relates to cap rate, that's partially because construction costs have increased somewhere around 10% in the last year. Rents in Northern California, for example, are now 45% plus or minus higher than the low in the Great Recession. And so you've had a huge amount of rent growth already that have been booked. It would be, I think, erroneous to assume you're going to see that from this point forward over the next several years. So the return element is part of it, and part of it is its cost of capital as well. So I think every component has worked against us as it relates to the development side, and it just made deals more difficult to pencil. And again, John's here. John, you could talk about all the number of deals you look at, which -- John is looking at a ton of stuff. He was -- it wasn't that long ago, John was talking about triage, setting up a triage process for deals because there were so many coming in, in the door, so -- but not very many of them hit our thresholds. And so I think it's partially the market and partially our view of the opportunity and partially what's happened with the stock, which essentially we're at the same price now that we were at 18 months ago, yet we -- what our FFO core -- FFO per share was 20% growth last year and pretty healthy this year. So it's really all of those factors. We're looking for the spread between what we're buying or building and what is embedded in the stock, and we got to see a positive impact as a result of that as our core objective. And we become more aggressive when we see that being very exciting and less aggressive when we see it being less exciting. John, do you want to comment on the deals still out there? I know you're looking at a lot of stuff.

There's a -- continue to be a number of opportunities, but we've gone to the phase of the cycle where it goes from the wholesale side to the retail side and it's much harder to justify, I think, given the risk that development does bring to the table. That said, there are opportunistic deals that will pop in once in a while, but if you were to state today's land price and the increased cost of construction relative to future rent growth, it's more difficult for us to justify it. We're now probably predicting that we have our portfolio exposure that we are at now, a year from now, if you were to make an educated guess. As far as the pipeline we have currently, the 11 deals that we have under construction, most of those were formulated and decided on in 2010 and '11. And that's basically the answer. And I can say that the delivery execution on the cap rates of everything that will be stabilized during the next 12 months is in the 6% to 6.5% range. So hopefully, that answers your question.

Okay. I mean, given those comments, what's the redevelopment opportunity left in the portfolio today in terms of dollars that you guys figure that you want to spend over the next couple of years? And do you accelerate some of that to replace some of the external growth from development?

I have John Burkart to answer that. But to create a little context, you may all recall that we didn't do very much redevelopment prior to the Great Recession. And then during the Great Recession, we pretty much ceased that activity altogether, which means that we've got a pretty significant opportunity, which I'll have Mr. Burkart talk about. John?

Yes, absolutely. This is John. We'll go into it in a little more depth in the Investor Day. But as you can see, we've increased our unit turns dramatically. We're up over 75% year-over-year. It will increase them more into 2014. We're also increasing a number of larger full renovation or revitalizations that we're working on. The opportunity is pretty substantial across the portfolio. We'll probably be doing somewhere in the neighborhood of 2,200 unit turns next year, up from maybe 1,200 a year ago. And we'll keep it -- it will continue at that level for many years across the portfolio.

What does that represent? What is 2,200 units roughly ballpark on a dollar value, of incremental capital out the door?

The average unit turns, what we're doing is somewhere around $22,000 a unit. We're doing a little different than most of our peers. Most of our peers kind of do a fluff and buff with the apartment with appliances and carpets. We tend do a more full-unit turn where we're scraping the ceilings, doing the counters, hard counters, new cabinets, opening up walls, et cetera. So we're near around $22,000 a unit.

Okay. Mike Dance, core versus NAREIT FFO in the fourth quarter, is there anything that you guys have already identified that's going to call the gap there?

NAREIT, meaning the First Call consensus?

Yes, the reported. I mean, the difference between core and reported. Is there anything that's already impacted or is going to impact that you guys know about that's driving a gap there?

No. Just acquisition cost is the only recurring difference.

Okay. And then lastly, Mike, given your comments about capital, et cetera, any tolerance or desire at this point for a Fund III?

We -- it is something that we are considering and working on, and we haven't made a final decision at this point in time. Up to this point, we've chosen to go into smaller commitments of equity capital with a couple of specific partners. And we like that format because we can take a chunk of money at $50 million, $100 million in equity and we can dedicate our -- the next couple of deals to that equity and then make another decision about whether we're better off growing on balance sheet or in the fund format. Having said that, Fund III has some advantages as well and we are considering it, and there's a reasonable possibility that, that will come to fruition.

The next question is coming from the line of Ryan Bennett with Zelman & Associates. Ryan H. Bennett - Zelman & Associates, LLC: Just -- my question was just related to development. You're coming a little bit less aggressive on -- just given the headwinds there. Do you foresee more opportunities like the Slater 116 or the preferred investment that you made during the quarter as some of these developers look to exit deals instead of more attractive return opportunity for you?

That's a good question, and we're looking at everything. We have seen opportunities to buy new buildings that were produced by merchant builders throughout our marketplace. And it all depends on cap rate and cost of capital and risk associated with the development deal, and so we continue to do both. We are working on preferred equity deals that have a development component. We completed one last quarter, and it provides very interesting financing solution for a developer that has permitted deal ready to go that works for us and works for them. So yes, we're -- I think we've covered the gamut as it relates to how we approach the development process. We will do presales. We will do direct development. We will do preferred equity transactions on apartments, but only those that we want to own at the end of the day. Ryan H. Bennett - Zelman & Associates, LLC: Got it. And I know it would differ developer by developer, but any sense on -- generally, what kind of bogey they're looking for in terms of a profit margin from their development yields, what they would sell it at?

Yes, and it runs the gamut. We have a deal. The Avery in the Valley Village district of L.A., that was -- they wanted to take out and so that was priced at a little bit higher cap rate because we were -- we went through effectively the development of the construction process with them. Slater was a situation. We bought it effectively empty and are going through the lease-up ourselves, some preferred equity transactions that are -- will close typically around the time that we have everything lined up and ready to go. And they're all priced a little bit differently. In our view, we don't look at the development world as, "Hey, this is our cap rate threshold." It's really a cap rate or really a spread over an acquisition cap rate and risk discussion, what risks are we taking on and then how are we going to price that risk appropriately in the portfolio. So as I can't tell you that there's 1 or 2 formats that we're using. It really gets into a negotiation where we're trying to come to a thoughtful approach to risk and reward. Ryan H. Bennett - Zelman & Associates, LLC: Understood, appreciate the color. And last question for me, just specifically in terms of your Epic project. Is it your sense that other lease-ups in that Northern San Jose submarkets that are going on right now have been as successful? Or was it primarily specific to Epic in terms of the location within the submarket or the price points?

Yes, this is Erik. All of the competitors have reported successful lease-up activity. So again, I think this is a function, the 3% plus job growth, a quality location, accessibility to jobs. And all of the competitors have very nice products with amenity packages. So again, we're very pleased with the -- the overall submarket is strong and we continue to see it going that way.

Our next question is coming from the line of Jeffrey Pehl with Goldman Sachs.

I was just wondering if -- to get a sense on how much of your portfolio could potentially be converted to condos.

Yes. This is John Burkart speaking. We've got -- I'll kind of break it up into Pacific Northwest and California but California is a little bit different. It's somewhere between impossible. It's very, very, very hard to actually take an apartment property that was built apartments with -- without legal condo rights to convert it. And so the value of that conversion is pretty significant and the -- or the value of going condo is pretty significant, has a map on it and it's just not very easy to do. So we have probably in the neighborhood of 6,000 units in California. That's our -- condo maps on them, they have a legal right to sell those condos. In the Pacific Northwest, it's not that way. It's more like the rest of the U.S., where the opportunity, if the property is well-located, it fits the economic interest, you could convert it into condo. So that really impacts the whole portfolio out there. But the value is much greater in California for the 6,000 units.

And I believe John is going to spend some time at the Investor Day talking about that subject.

Yes, absolutely.

Okay. And then also, I believe, in the beginning of the call, you mentioned that the Village was condo mapped in your development projects. Are there any development projects in California that are condo mapped?

[indiscernible]

In our development pipeline?

Yes.

Basically, all of them, except -- all of them, excuse me. I thought I had one exception. We've got maps on everyone. The Hudson and Dylan have a map, but they're going to be restricted because of the affordability requirement for several years. I would exclude them for that reason. If having a map is one of the pieces of the development equation. If we are -- we pretty much map everything that we...

Yes, exactly.

Yes, it's an important consideration at the development process. So, yes.

Our next question is coming from the line of Jana Galan with Bank of America Merrill Lynch.

Can you comment on the transaction market and if you've noticed any change in the third quarter?

Transaction market is evolving. I think that in Q3, you saw interest rates spike, and the stock prices, certainly, the REITs were affected and -- but I still believe, as I said in the last call, that the institutional bid was pretty significant. You may not have had as many institutions participating in the acquisition program. And they were pretty focused on A locations, A properties, let's say. But you had enough of them that I think cap rates were relatively unaffected. Where you saw a little bit of an increase in cap rates was as you got away from the A product and A location, where you were dealing with a more of an entrepreneurial buyer. And you had the situation where Fannie and Freddie not only were -- that we had interest rate increase, you also had margin increases on Fannie and Freddie debt. So I think that those forces have moderated as we have gone through September and October and are less so. Although there is just a little bit of uncertainty about what's happening, because there haven't been that many transactions, and so we don't really know exactly what's happening. We know that we are -- on our own activities, we've had to fight harder for deals just because cost of capital has become a much bigger issue of late than it has been over the last 3 or so years. So we've had to try to pick our spots and find good opportunities where we can. It is -- but as a general statement, it's much more difficult than it has been in prior years. And I think that probably continues unless interest rates continue to go down, which we don't expect, and when the stock price rallies, which we don't really expect either. So hopefully, that answers your question.

That's very helpful. And then maybe specifically on the last 2 assets in Fund II, did you market those and feel that potential buyers weren't giving credit for the loss to lease? Or was that just something internally you decided to wait before putting them on the market?

Yes. This is John speaking. We had those assets on the market and during the turbulence of the interest rate move and the sellers did -- what the buyers did was one would expect -- try to come up back for prices and we didn't think that was justified. So we pulled them off the market to take advantage of the continued strength of the market and decided to remarket them into '14.

Our next question is coming from the line of Alexander Goldfarb with Sandler O'Neill. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Just some quick questions here. First, let me start with Mr. Dance. Just on expenses, year-to-date, yes, they're up 4.3%, which is really driven by taxes being up 6.8%. On the last call, you guys spoke about how even with Prop 13, when property values decline, you get to move those taxes down. But as property values recover, then that -- the taxes get bought -- brought back to trend. So given year-to-date, the taxes for you guys are up 6.8%. Do you feel like you're back to trend and -- well, you're not providing '14 guidance. Should we think about -- now that we're this much closer to next year, should we think about sort of a similar increase? Or are -- basically, the tax is back to trend, in which case, that should moderate?

Seattle, we are actually getting higher assessed values. Year-over-year, they're coming in kind of mid-teens again. So we're still waiting to hear what the levy rates are going to be in Seattle. So we are seeing continued property tax pressure in Seattle. We do have some properties in California that are still below their Prop 13 values, so we are expecting some increases. So yes, I think expense -- we're expecting expenses about 3.5% this year. We're still working on the budget. I hope we can bring it under that, but we're still working on that. So it's a little bit early to tell. We'll have that number ready for you at the Investor Day. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. But Mike, as far as the California goes, is it just a very few assets that are still below Prop 13?

Yes, California will probably be closer to 2%. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay, okay. The next question, and George is not in the phone, so I guess Mike, you'll have to take it. You guys have done the stock buyback thing before, although you guys seem to -- historically, when you've done it, it's more targeted, meaning that you'll buy the stock one quarter and then a few quarters later, you may dribble back out with the ATM, depending on how the stock has performed. Right now, you're one of the few apartment -- well, you're one of the few REITs in general that's still trading above NAV, which is -- kudos to you guys. But just a question. When you guys historically look back and evaluate where you have bought back stock, do you feel and does George feel that it's been a good use of capital versus your other opportunities, whether it's development, acquisitions, mezz [ph] or preferred equity investments?

Every scenario is a little bit different. As a general rule, we felt that given the weakness in the stock through the summer and into the fall that we wanted to essentially reset the share buybacks. So we took it to the Board in September. Obviously, I'm not going to talk about what prices we talked about. But we want to have that ability out there. And I think that everyone from the Board, from the Chairman of the Board, George, on down, believes in the same concept, which is we have a stock that is representative, a fractional interest in 160-some-odd properties and we can invest in a number of different ways, and we're looking for a net spread. And where we see that, whether it's running the machine in forward or reverse, it doesn't really much matter to us. Although, share buybacks get into leveraging issues as you're going to double leverage if you're using your line and/or some other balance sheet considerations. So I don't want to talk specifically about our exact criteria. But we absolutely believe that there's a price at which the best opportunity would be buying the stock back. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. And then just finally, you guys extended one of your preferred investments but reduced the rates from 13% to 9%. Just sort of curious, was there an opportunity to get this property? Or do you just figure that you had excess capital and therefore, extending it an extra year, you still were able to pick up a pretty healthy spread to your cost of capital?

I mean, it was more related to when it was originally -- it originated, the markets were different for that type of investment and the market was highly illiquid. This is -- I don't remember exactly when it was. Mike, do you remember? Was it 2009, '10? Somewhere in that timeframe. And essentially, the transaction had the ability to refinance us out. And so, I look at it more like a restructure. We look at the market in place today. The asset has appreciated significantly in value. So we're in a different part of the capital stack. And the market for that type of investment has compressed relative to what it was when the original deal was originated. So essentially, we were going to lose a deal and we decided that we're better off essentially restructuring the deal as opposed to letting it pay off.

The next question is coming from the line of Nick Yulico with UBS.

Going back to the renewal rate growth, you mentioned, I think, it was 5.8% this quarter. And that was higher than what you're getting earlier this year when it was closer to 5%. How should we think about your ability to push renewal notices even higher going forward since you're not facing increased turnover, you've been capping rent increases at 10%, as you mentioned earlier. It seems like that -- the ability to push renewals higher going forward could be a possibility here?

Yes. This is Erik. I think there are select opportunities maybe to push a little bit further, certainly not at this point in the year. As I said, our expectations are kind of being in that 5.5% to 5.8% for the next 3 months. We do expect economic rent growth. We expect the loss to lease to grow, so there will be opportunities in some of these submarkets to move that up a little bit. We are cautious. We're delivering new supply. The last thing we want to do is get people thinking about moving down the street and taking advantage of somebody's 1-month or 6-week free offer. So we look at these case by case and handle the strategy accordingly.

And can we get the new lease rate growth for the quarter?

Yes, you can. Let me get back to you in a second there.

And then I guess just the one last question is, I mean, at what point do you -- I mean, do you ever revisit that policy of capping rate increases at 10%? Or are you at the point now where you're getting more notices out that are closer to 10% than you have in the past year?

Yes. I mean, I think we're constantly monitoring it. But again, given people's individual agendas and their move out and our opportunity to mark markets in many cases, we still feel like we're being responsible and getting the results overall that we would like to see and leave opportunity on the table. So right now, we're satisfied with the policy.

Our next question is coming from the line of Haendel St. Juste with Morgan Stanley.

So curious on, I guess, on the asset acquired in Seattle, the one of 40% occupied. Was there an operational issue behind the developer's decision to sell and is there a greater opportunity with that specific developer?

There are some other opportunities with that developer, and we have certainly met with them and told them that we would love to have some kind of relationship with them, so it's not just a single one-off deal. Having said that, those concepts are difficult because every deal is different and everything changes and there's no assurance that we're going to necessarily be interested in the next deal, nor that we're going to be the high bidder. So as a REIT, remember your -- that our cost of capital is the key consideration and so if our cost of capital is out of whack, we could get outbid by someone else fairly easily and we accept that. And we acknowledge that as being just something that happens. As to whether there were some unique condition that caused us to get this deal, I don't think so. I think it was -- we would rather go through the lease-up ourselves as a general statement because then we can control the quality of the people that we bring in. We can control their credit statistics and we can make sure that it's populated with the right people for the long-term benefit of the company. So as a general statement, we have a fairly strong preference to do our own lease-up. But beyond that, I don't think there was anything unique about the situation.

Got you. Can you help us understand how you underwrote that acquisition, both in terms of in-place and stabilized NOI, and what type of, say, IRR are you expecting there?

I don't have those numbers in front of me. We typically capitalize the expense of a lease-up as a deal cost, so we're going to look at the stabilized yield on the deal. And so again, assuming the lease-up cost is a capitalized addition to the purchase price, and we'll look at the economic stabilization and then we will want to be paid for something, I don't remember exactly how much, for the -- for doing the lease-up, since that's probably the riskiest component of one of these transactions. So that's how we approach it. And again, we're risk reward-driven and we actually like adding value. If we can get a little bit higher cap rate and we add some value and some of our staffing capabilities to a transaction, we think that's a good thing. We will generally like to do that. And I think it's kind of win-win. We get a better tenant base as a result of doing a lease-up and the developer is not faced with doing something that they may not be incredibly good at.

Okay. And so as far as the underwritten -- or the yield that you were expecting, any range you can provide there?

I think [ph] we want to go -- I think that the typical IRR -- unlevered IRR for that type of transaction is somewhere in the 8% to 8.5% range. I don't remember the specifics for this deal, but it's somewhere in that range.

Okay, fair enough. One more, if I may. I think, correct me if I'm wrong, but the third quarter acquisitions were done on a wholly-owned basis and not through the JV. And I think last quarter, you mentioned that acquisitions near-term would be mostly through your Wesco JV. So I guess the question is, are you precluded from acquiring non-stabilized assets through that JV or there was [ph] not interest in -- from a partner or some other REIT?

Yes. No. As I said before, we are committing relatively small chunks of capital. And when we commit capital with -- in a co-investment format, then we're going to dedicate our deal flow to the co-investment program. And so in these cases, I don't remember specifically why, but I think that we were outside that commitment period. And for whatever reason, the deals didn't work. I think one of them was under 100 units. So small unit size is one of the criteria that might cause us to do something on the balance sheet, which I think was actually the case in this situation.

The next question is coming from the line of Michael Salinsky with RBC Capital Markets.

Mike, if I recall correctly, you also look at the other markets throughout the U.S. when you're looking at your market forecast and everything else. Just curious as to what you would expect across the U.S. as a whole in terms of market rent growth at '14, how the West Coast markets compare to that?

Yes. We do have been relying on AXIOMetrics in a lot of these cases since we don't have direct knowledge. I mean, I would say that our interest in tracking other markets is defensive in nature. In other words, if another market is going to dramatically beat the West Coast and we certainly want to know it and would want to consider it at some level. So acknowledging -- notwithstanding the fact that it will be incredibly challenging to enter a new market. So as a general statement, we think that the West Coast lags the national recovery by a couple of years and our recession was worse, as a general statement, than both the nation. And so we still believe that the West Coast is the place to be. Having said that, there are markets out there that are doing quite well. And we're not going to go to the energy market, let's say, just because we are concerned about the cost of for-sale housing alternatives. Cheaper for-sale housing is a concern to us. So that eliminates a number of the energy market that have strong job growth that will have an inexpensive for-sale housing option, and home builders will do what they do pretty effectively, we think. I mean, obviously, Boston is a great market. It's in the AXIO top 10 and there are other good markets around. But as a general statement, if you look at our geography and you look at our -- the position of our portfolio, we think we're well-positioned for the future and of course, this is where -- we know every corner and every neighborhood and so we've got a certain value-add here that we wouldn't have somewhere else.

Well, that's encouraging. Second question. You talked a little bit about asset pricing, but I'm more curious to get your expectations over the next 12 months as to where asset pricing goes, given the boom we've seen in the 10 year and some of the pent-up growth, this -- the recovery has already occurred. And then also, in light of that, how does that impact your decision on asset recycling now that you've wrapped up Fund II [ph] partially?

Yes, just a couple of comments. Our view is we're looking for, again, arbitrage between the return on something that we're -- on property we're going to invest in relative to the value of the stock. And so we're looking for situations where there is a net differential, the private, public arbitrage situation will work in our favor. And so it's not just about asset pricing. And in fact, you saw in coming out of the Great Recession that we were pretty aggressive as to the property that we wanted. And I would say, that was notwithstanding pretty pricey assets on a cap rate basis, but with stock and debt that was very attractively priced. So we look at the relationship between the 2 to try to drive our results. So we have to predict both is basically what I'm saying. I would say there seems to be plenty of demand for apartments and cap rates tend to be pretty sticky, and so I don't expect a lot of change there. The real question for us is what about the cost of funds, and we have a choice there between on balance sheet where we're using our stock on sort of leverage neutral basis or we're using the fund co-investment format. And so we try to look at a number of different ways and again, try to focus on how do we add value to the portfolio.

The next question is coming from the line of Paula Poskon with Robert W. Baird. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: Apologies if I missed this in your prepared remarks. What is the rent-to-income ratio? How's that trending across your markets?

Paula, it was not part of our prepared remarks and -- but I do have it here. So in Seattle, the Seattle is actually -- under the long-term average, it's 16.5% rent [indiscernible] income. The way that we calculate it, and everyone calculates it a little differently, we look at this as a broad-based market average. We're not really interested on a property-by-property basis, calculating the income -- rent to income or a property because it sort of misses the point, the broader point, which is what's going on in the marketplace as it relates to rental affordability. So Seattle, a little bit under the long-term average. San Francisco, almost exactly at the long-term average, same with Oakland. San Jose is actually about 1% ahead of the long-term average, 21%, they're around 21% versus the 20% long-term average. And Southern California, as a general statement, under the long-term average, but approaching the long-term average. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: And I'm sorry, can you give me the exact numbers for the San Francisco and Oakland?

Sure. So San Francisco, 24.9% versus 24.4% long-term average. Oakland, 20.2% versus 20.1% long-term average. San Jose, 21.3% versus 20.3% long-term average. Ventura 18% versus 18.7%. L.A., 20.5% versus 22.5%. Orange County, 20.9% versus 20.7%. And San Diego, 20.2% versus 21.2%. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: And just a follow-up on the question earlier about condo conversions, are you seeing the pace of condo accelerations -- condo conversions accelerate in your markets?

Yes. This is John again. What we're seeing is the housing prices increased pretty dramatically over the last year and feel very strong it's increasing. And so we're starting to see some of the developments that went out in condos and then ultimately were converted to apartments temporarily. Those are going back into the market as condos, and we're starting to see the very beginning that people actually starts and beginning ground up and build condos. But we're early in the process. There's still some room to run on this condo execution plan.

Our next question is coming from the line of David Harris with Imperial Capital.

I have to ask a question as a Brit about Bunker Hill. Now this must be the biggest, longest-lasting redevelopment that I can recall Essex ever undertaking.

I think it's up there. It's a very unique asset, yes.

This is probably something I might have to discuss with Mike Dance on a separate -- on another occasion, but is there an issue on really the accounting? I mean, you're going to lose tenants and income for periods here. And does it go into cost basis, and how are you going to capitalize things? I mean, is there an easy summary to this because it seems like it's a lot if this is a kind of sizable kind of development sum, if it was standing on the toe and we know how you treat out of it if it were a development?

Yes. Big picture is, as we're spending money, we capitalize it as if we are doing a development on the money we're spending. And then when we take units offline and as the -- these are going to be much more than the $22,000 because we're doing new windows and a lot. And the floor plans are pretty big here. So while we take the unit offline, we actually take the historical net book value and capitalize interest on that plus the spend. So there is capitalized interest and we can put together a model that summarizes the impact over that 4- to 5-year expected period of time. But yes, it's not easier.

Right. Yes. Now given the size of this project and the singular risk attached to one asset, how much of an extra return are you generating out of this project compared to your others?

This is John. Why don't I give kind of just an overview of the asset itself, just to start kind of on the beginning. So the asset -- these are obviously 2 towers in Downtown L.A. We bought it in 1998. They were built in 1968, it's a little bit old. When we bought them, we bought them for $86,000 a unit. Today, they're probably worth about $204,000 a unit, somewhere in that area. So our unleveraged return, somewhere in the 12% range, has done very well in these assets, obviously, anticipating the Downtown renewal. Now at this point, going forward, we're looking at this revitalization opportunity, put about $165,000 a unit into these assets to completely redo this with new -- with actually [indiscernible] balconies, all new windows, all new infrastructure, all new unit turns, et cetera. We're building a very large amenity building with a 10,000 square foot gym, a rooftop pool and deck, et cetera. Quite a wonderful asset. So in the end, we'll be in there somewhere around $370,000 a unit for an asset that would sell for somewhere around $500,000 plus a unit or $455,000 a unit. So we're probably roughly, say, 80% on the dollar for this asset from a post [indiscernible] standpoint. So when you look at the value creation, it's pretty dramatic in these assets. Does that give a bigger picture opportunity to you?

Yes. I mean...

The other thing that I did bring up is another piece to it, which is interrelated to the amenity building and just a general upgrade, which is we have development rights for another tower, a third tower. And so doing these work better positions us for that opportunity somewhere down the line, probably toward the end of this entire project, effectively through the neighborhood and taking advantage of the renewal in Downtown L.A.

Okay, good. Mike Schall, I think this one's for you. You fought very well at the bottom of the cycle. We're now looking at property markets, which if you will just look from 30,000 feet, Case-Shiller would suggest that we've seen some very substantial residential price appreciation over the last few years, particularly in Southern California. Any of those buildings getting close to sale, and particularly the condo quality assets that you bought?

David, I think John was alluding to this. It's interesting because the apartment values have done really well as well. So you have a race between the for-sale homes, home values and the apartment values. And I'd say the market that is closest to tipping over toward the condo being the appropriate exit is San Francisco. Southern California has really not had that much rent growth and therefore -- and it hasn't have -- the condo side hasn't appreciated as much as well. So I think we're further behind in Southern California than we are up here in the North. But having said that, and we have some apartments that are worth $800,000 a unit, and that means San Francisco, and that means that condo values have to be north of $1 million before that makes any sense at all. And there -- certainly condo values are going in that direction, they're just not quite there. So I would rank San Francisco #1, and I don't want to take away John's thunder at the Investor Day if he's going to be talking about this topic, but San Francisco, Northern California, #1 and Southern California, which has -- as you point out, we bought a lot of very high-end, beautiful buildings that are better condos than they are apartments candidly, and so there's some great opportunities in Southern Cal.

Our final question is coming from the line of Dave Bragg with Green Street Advisors.

On the rehab activity done on the turns, I think you mentioned $22,000 per unit. What returns are you targeting on those?

We tend to be getting IRRs of somewhere in the mid-teens, which also works out to cash-on-cash of, say 11%, somewhere in that zone.

Okay. And what was the impact of that activity on the same-store revenue growth in 2013?

Because we're ramping it up, it actually is somewhat offset by the vacancy we have. So we -- you have to do it pretty early in the year to recapture the downtime. So until we kind of levelize -- level off the amount we're doing this year compared to last year, you don't really see that much benefit because of the ramp-up.

So we'll see it next year?

Yes.

Okay, got it. And then...

Yes, Dave, yes. Make sure you hear that last one, he [ph] won't say it again. John [ph] said...

Yes. We're also increasing unit turns next year. I think Mike will give out more clear guidance in the future, but the increase in unit turns were pretty significant from '13 over '12 and will continue that way '14 over '13.

All right. Maybe we can get into it more on the next call when it's a little more relevant. And then the returns that you gave on the rehab activity, can you please provide those targets for the full-scale redevelopment activity, too?

Well, the full-scale redevelopment activity, as a general rule, the IRRs are going to be somewhere in the neighborhood of 10s, 11s, somewhere in that zone. They typically include all the new infrastructure, so we're going through and redo the HVAC, the plumbing, et cetera. So those returns are a little bit lower in that zone.

We have reached the end of our question-and-answer session. I would now like to turn the floor back over to Mr. Schall for any concluding comments.

Thank you, Stephie. In closing, we appreciate your participation on the call as always, and we are obviously pleased with the results in the quarter and the positive outlook for 2014. We look forward to seeing many of you at NAREIT next month in San Francisco. Have a great day. Thank you.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.