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Essex Property Trust, Inc. (NYSE:ESS)

F3Q08 Earnings Call

October 30, 2008 12:00 pm PT

Executives

Keith R. Guericke – Vice Chairman of the Board, President, Chief Executive Officer

Michael J. Schall – Chief Operating Officer, Senior Executive Vice President, Director

Michael T. Dance – Chief Financial Officer, Executive Vice President

John D. Eudy – Executive Vice President - Development

Analysts

Dustin Pizzo - Banc of America Securities

Analyst for Michael Bilerman - Citigroup Investment Research

Jay Habermann - Goldman Sachs

[Michelle Coe] - UBS Securities

Karin A. Ford - KeyBanc Capital Markets

Mike Salinsky - RBC Capital Markets

Lindsey E. Yao – Robert W. Baird & Co.

Richard Anderson – BMO Capital Markets

[Hanwell St. Jess] – Green Street Advisors

Operator

Good day ladies and gentlemen and welcome to the third quarter 2008 Essex Property Trust earnings conference call. My name is [Tawanda] and I will be your coordinator for today. At this time all participants are in listen only mode. We will facilitate a question and answer session towards the end of this conference. (Operator Instructions) As a reminder this conference call is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Keith Guericke, President and CEO.

Kevin R. Guericke

Welcome to our third quarter earnings call. This morning we will be making some comments on the call which are not historical facts such as our expectations regarding markets, financial results and real estate projects. These statements are forward-looking statements which involve risk and uncertainty which could cause actual results to differ materially. Many of these risks are detailed in the company’s filings with the SEC and we encourage you to review them.

Joining me on today’s call is Mike Schall, Mike Dance and John Eudy. Included in the earning’s release on our website you will find our market forecast for 2008. These forecasts have been revised this quarter to reflect the change in jobs and rent growth for several of our markets for 2008. Also included with our earnings release is a schedule titled New Residential Supply which includes total residential permit activity for the larger US metros as well as information on median home prices and affordability as compared to the Essex markets.

To get those details visit our website under investments and media. Last we reported a strong quarter with core FFO increasing 10.2% per share. For the quarter the portfolio grew revenue 4% greater than the same period in 2007 and 7/10% on a sequential basis. We are very pleased with that result.

The recent events in the financial market has increased the level of uncertainty and the likelihood of longer periods of weak economic growth. This uncertainty will affect all metro areas and apartment markets. We believe our markets are well positioned for the long haul. The view that all California markets are experiencing the worst and the same of the housing crisis is inaccurate. Real estate is driven by local conditions.

0Our high quality of life coastal supply constraint department markets have not been immune from the impact of the housing crunch, but are very distinct from the unconstrained inland areas of the state. I would like to discuss some of these economic indicators that separate our coastal markets going forward.

Our largest exposure to home construction and finance jobs are in the Orange County Ventura markets. The bubble in these sectors began in 2003 and peaked in mid 2006. As of September 2008 the jobs in these areas have been cut back to the 2002 to 2003 levels. Accordingly, we feel the majority of these cuts are behind us in these markets. Market occupancy in both these markets is at or above 95% currently.

Foreclosure activity has been relatively high in California. Again, California as a whole gets lumped together as one big market and this is actually a very inaccurate view of this area. Foreclosure activity nationally was down 7% sequentially in Q3 to 765,000 units resulting in a foreclosure rate of 6.2 per 1,000 of single family homes in the housing stock. In California that rate was 7.2 in Q3. However, if you disaggregate, in our coastal markets foreclosures were down sequentially 22% to 43,000 resulting in foreclosure rate of 5.4 per 1,000 stock.

In Silicon Valley and San Francisco, the foreclosure rate is half of the national average. By contract in the unconstrained inland markets of Modesto, Stockton and Joaquin in the North and Bakersfield through the inland empire in the South, the foreclosure in Q3 totaled 31,000 resulting in a foreclosure rate of 14.7 per 1,000 of stock. We believe these foreclosure rates are a proxy for exposure to single family rentals going forward and thus feel our core metro area will face less exposure to the single family rentals.

Last quarter we mentioned we saw a slight improvement in the seasonal pattern of transactions driven by price declines. This trend continued to a much larger degree in Q3. Transactions in Q3 increased by 16% sequentially and 12% year-over-year in our metros. Year-over-year prices are down from 35% in Oakland, roughly 30% across Southern California and 15% to 20% in San Jose and San Francisco.

A significant portion of these transactions were foreclosures. Despite the decline in home prices, single family affordability remains low in our markets in relation to both current incomes and historical levels of affordability in each market. It is still difficult to buy a home and more financially appealing to rent. In addition, single family permit activity has dried up. In our markets the trailing 12 month single family permits have represented only 3% of the single family housing stock. We believe this limited supply will lead to a quicker level of stabilization.

We continue to believe we have chosen the correct strategy of locating in limited supply housing markets with a high exposure to technology or Internet service jobs. Our portfolio has the largest exposure to venture capital funding which we think is an advantage especially particularly in the current financial environment. Year-to-date venture capital funding has been about the same as last year and up roughly 40% from the low point in 2004. Our markets represent 9% of the jobs in the country yet receive 51% of all venture funding particularly San Francisco and Silicon Valley which receive roughly 40% of all venture capital funding.

Big picture, we have two focuses at Essex, we want to operate our portfolio efficiently and we strive to keep occupancies high which we believe is going to produce the best NOI result going forward. And two, we want to maintain a liquid balance sheet which Mike Dance is going to describe a little bit in his comments, actually a lot in his comments. Given the uncertainty of the equity in the debt markets we believe it is important to know that we are covered or the next three to four years.

We also want to know that we have liquidity that will allow us to take advantage of distressed opportunities that we believe will be popping up in the next 12 to 18 months. We are currently finalizing our projections for the next year by submarket and completing each of our budgets. We are not far enough along to give guidance, but given what I have seen so far, next year’s FFO will not have the same growth we are enjoying in 2008.

Now I would like to turn the call over to John Eudy.

John D. Eudy

We have had on new additions to the development pipeline during the quarter and I have the following updates on our activity. Belmont Station in Los Angeles has been substantially completed and was open for occupancy on August 8th. We continue to make significant leasing progress and have leased 155 units or 56% of the property to date. The Grand in Oakland is nearing completion on budget and scheduled for occupancy in January.

Our temporary leasing office will be open tomorrow and early indications are showing significant pre-leasing interest off of our website and phone bank. The building will be the only new luxury high rise rental community in its competitive market much like the Essex on Lake Merit was in Oakland when we completed it in May of 2002. As you may recall we experienced a six month lease-up of 270 units in the post 9-11 dot com era meltdown period prior to the economic rebound which began in 2003.

I would expect the same type of market acceptance on the Grand. The remainder of the development pipeline and construction is on budget or less than the estimated development budget and slightly ahead of delivery time outlined in the S9 supplemental. We have added no pre-development projects or land held for future development during the quarter. On the pre-development projects we have in our pipeline all are currently leased at rates substantially below market rents and we have the flexibility to extend the leases or release should we desire to do so and extend our anticipated current scheduled start date.

On land acquisition activity, we continue to be actively engaged in the market and are attempting to take advantage of any overreaction to the current economic climate and add to our land pre-development pipeline for 2014 and later deliveries. With a time frame from the site identification to delivery between five and six years in our supply constrained markets the best time to contract to acquire land is counter cyclical to positive economic news. It is probably fair to say that right now we have that in our favor when we are talking to land sellers. Compounding the situation for land sellers is the fact that development and land financing is virtually impossible to obtain now but for the most well financed companies and developers.

For the time being the error of speculative merchant developers in our space is over. Construction costs has continue to go in our favor in contract buyouts on the deals we are currently building. We are seeing real time traction beating our budgets and expect to see that and continue to be the wind at our sails at least for the next 12 months.

With oil now balancing around $65 per barrel, wood at a 30 year low and other construction related commodities following a downward spiral, that will translate into significant savings to our high cost budgets going forward. On the labor side of the equation, I have never seen a more competitive market with general and sub-contractors in my 30 years in the business. The infrastructure of individual talent and companies built up during the home building boom of the last six years is at our disposal for a very limited number of construction activity starts on the rental development market.

We are getting the best of the best subs giving us both the competitive buyout situation as well as the most talented personnel which translates into more efficient productivity at the side level. At this time I would like to turn the call over to Mike Schall.

Michael J. Schall

Last night we reported another strong quarter operationally. As you may recall, our 2008 guidance originally assumed a second half economic recovery that clearly will not occur. Given that expectation we are pleased with the performance of the portfolio especially our ability to maintain strong occupancy levels throughout our critical summer leasing season.

During the quarter we experienced the following difficulties, overall sluggish employment growth especially in Southern California, localized supply issues in various submarkets including downtown Seattle, downtown Oakland and many Southern California submarkets and failed condo projects being rented as apartments. Partially offsetting these headwinds was a 24% reduction in move-outs to purchase a home.

What does this mean? In the short term, weaker job growth and lease ups of a finite number of newly developed apartments and former condo projects will drive moderating multifamily fundamentals. However, longer term current trends will lead to a future point perhaps in 2010, where the coastal markets will experience a pervasive housing shortage.

Typically three things happen when rental market conditions soften, first more people double up. This is difficult to track directly although we have anecdotal evidence that it is beginning to happen particularly in Southern California. Second, is a compression between A and B rents. Most of the newly developed communities in the coastal markets, including our own are A quality property. For the most part they require more concessions than anticipated indicating compression in rents.

In general, B quality properties near A quality lease ups are not doing well, but are less affected than the A’s. Finally, delinquency becomes a bigger issue. For the quarter same property delinquency actually declined although we are aware of the need to remain vigilant in our collection efforts. With strong occupancy throughout our markets we are well positioned for the seasonally weaker fourth quarter.

Our results follow a similar pattern as previous quarters with better than expected strength in Northern California and Seattle offsetting moderate weakness in Southern California. During the third quarter Northern California led the way with an 8.4% same property revenue growth well above our guidance range for 2008 up 5.5 to 7%. Our Seattle same property revenue growth of 7.5% also exceeded the top end of the 2008 guidance range in this case by .5%.

In Southern California our revenue growth of 1.1% fell below the guidance range of 1.5% to 3% for the first time this year. Conditions continue to deteriorate in Southern California due to greater supply and more job loss. Operating expenses grew at 3.9% for the quarter near the high end of our guidance range of 2.5% to 4%. Year-over-year expenses were influenced by large property tax reassessments in Seattle, higher utility costs and a couple of property specific issues.

As stated previously, we expect property expenses to remain near the high end of our guidance range for the remainder of 2008. Earlier this year we completed the conversion of our property management and general ledger systems to [Yarde] and the rollout of 24 hour call center support at all of our properties. During the quarter we finished the initial implementation of Yield Star’s price optimizer software.

With [Yarde], call center and price optimizer conversions now in place we are pursuing ways to leverage these investments in the form of higher rents and lower costs. Same property concessions both in total and per unit turned declined during the third quarter. Most of this decline is due to the implementation of price optimizer which provides an array of net pricing options, in other words without concessions to the residents.

Loss to lease which estimates the difference between market and in place rents without regard to concessions declined from 2.4% of scheduled rent in the second quarter of 2008 to 1.9% at September 30, 2008. The use of fewer concessions in Q3 resulted in lower economic rent contributing to the decline in loss to lease.

Now, I’d like to briefly review each major part of our portfolio starting in the northwest. The Boeing machinist strike has shut down production for several weeks. As of October 2008 approximately 2.2% of our Seattle properties were occupied by Boeing employees. Given that there is a tentative agreement to resolve the strike, we do not expect a significant impact at our Seattle communities.

Downtown Seattle softened this summer due to condo units reverting to the rental market and it is too early to determine the impact of the sale of Washington Mutual. During the quarter we completed the residential lease up of our East Lake at our Lake [inaudible], 127 unit property owned by Fund 2 consistent with our rent and absorption expectations. As of October 20, 2008 physical occupancy in Seattle was 96.4% and net availability was under 5%.

Home purchase activity represented 14% of our move outs for the quarter compared to 17% a year ago. In northern California the overall market continues to be strong but has some pockets of weakness due to supply issues. An example of this is downtown Oakland. As of October 20, 2008 physical occupancy was 97.5% in our northern California portfolio with net availability under 4%. Home purchases represented 9.3% of our turns for the quarter compared with 13.8% from the same quarter a year ago.

Now, to southern California. John noted that we commenced the lease up of our Belmont Station properties consisting of 275 units in downtown LA. Current rents average around $2.50 per square foot ignoring concessions which is close to our expectations. However, we’re using one to two months in concessions versus the half of month that was originally planned. We’re expecting stabilization by June, 2009.

Physical occupancy in southern California summarized as follows, in LA, Ventura, 95.6% physical occupancy, net availability of 6.1%. Orange county, occupancy 95.2%, net availability of 6.2%. In San Diego 97.2% physical occupancy with net availability of 5.2%. For our southern California combined move out activity attributable to home purchases was 7.7% for the quarter compared to 9.5% a year ago.

Now I’d like to turn the call over to Mike Dance.

Michael T. Dance

My comments today will briefly discuss the basis narrowing the range of our 2008 guidance and then I’ll highlight the activities that have strengthened our financial position, add ability to meet the 2009 and 2010 debt maturities and all commitments. After the $0.01 adjustment for the right off of unamortized loan costs related to the sale of Cardiff by the Sea, the third quarter funds from operations are in line with first call’s consensus estimate and the guidance we provided on the second quarter’s call.

As Mike highlighted earlier we have maintained high occupancies throughout the portfolio and we are well positioned to replicate the same property revenue results achieved in September in to the fourth quarter. The midpoint of our FFO range for 2008 assumes that there will be modest revenue growth from the apartment communities in the non-same property results with the ongoing lease up activities at Belmont Station and from the communities in the redevelopment pipeline that are close to returning to stabilized occupancy. The midpoint of the 2008 guidance assumes that short-term interest rates will continue their recent downward trends as the Fed continues its bias of reducing interest rates to stimulate the economy.

To achieve the high end of guidance we will need continued rental growth in our Northern California and Seattle markets, high occupancy in Southern California at current rent levels, lower volume costs on variable rate debt, and approximately $0.05 from a combination of increases in noncore income or expense reductions.

I’ll now comment on our capital plans. It is important to note that it is an Essex discipline to match fund investment decisions with the cost of capital that generates positive arbitrage and accretion to cash flow per share. Accordingly, to meet this match funding objective it has been the capital plan to fund the development commitments of almost $300 million and redevelopment commitments of $55 million with a combination of common equity, construction loans, forward-starting swaps, the unsecured and secured line facilities, and with Fund II’s institutional limited partners.

Accordingly, we have raised approximately $140 million in equity by selling common stock at an average price of $120 per share; we have started three mortgage applications with Freddie and Fannie which are expected to raise an additional $100 million before the end of the year; we have construction loans in place to fund approximately $100 million of the development commitments in Fund II or in joint ventures; and we have made the final capital call for Fund II institutional investors of over $30 million.

As highlighted in our press release, the new secured line facility of Freddie Mac will increase our borrowing capacity from $100 million to $150 million before the end of 2008. Currently we intend to exercise our option to extend the $200 million of secured bank facility so that it will mature in March 2010. As we plan for the 2010 debt maturities we have the ability to expand the new Freddie secured facility by $100 million to $250 million.

W e also have significant borrowing capacity from our 2009 and 2010 maturities. These secured loans that mature in 2009 and 2010 were originally underwritten with 1999 and 2000 rents and have had 10 years of principal payments. Using the current underwriting practices of Freddie and Fannie we expect that the refinancing proceeds from 2009 and 2010 maturities will generate enough additional funds to pay off the mortgage balance and also retire our exchangeable bond obligation.

We also have approximately $400 million in forward-starting swaps as a hedge in the event long-term interest rates are significantly higher when these mortgages are refinanced in 2010.

In summary, these capital activities are expected to leave us with close to $100 million in cash and marketable securities and over $300 million in line and construction loan capacity by year end with only $25 million in 2009 debt maturities. This capital plan provides us the needed resources to finance our active developments and provide sufficient flexibility to fund future opportunistic investments.

This concludes my remarks. I will turn the call back to the operator for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Dustin Pizzo - Banc of America Securities.

Dustin Pizzo - Banc of America Securities

John, can you just talk about where pricing is today on some of the land opportunities you’ve been looking at versus where say it was three to six months ago? And also, have there been any further changes to what you’d be targeting on the development side from a yield perspective or is the mid-6 range still a fair assessment there?

John D. Eudy

First on land prices, they probably peaked when the condo urban guys were active in the markets two and a half years ago maybe. At that time we were boxed out. We hadn’t contracted any land in our pipeline for well over three years. My range would be between $100,000 and $150,000 at door for land was being contracted at that time and up.

Currently there have not been a lot of transactions to look at so it’s difficult to gauge but I can tell you we are in negotiations on deals where we had fished around we’ll call it $1 and now we’re offering $0.50 and we’re getting a response. Where it all settles out I can’t say because we haven’t really done a deal yet in the range that makes sense. With that in combination with there’s going to be some retraction on these hard costs that we saw go up 100% over five to six years, we expect our development yields that we’re targeting are in the mid-7 range on current yield.

Dustin Pizzo - Banc of America Securities

Keith, as you guys look at where cap rates appear to be headed and the potential for additional stress in the market, have you moved any further down the path of considering a Fund III today?

Keith R. Guericke

Fund 3 is an ongoing conversation. We have not made any more commitment than we spoke about on the last call. It’s something that we’re very interested in. We are cognizant of the benefits of it. I think the reality is many of the potential investors out there are suffering from the denominator effect so the ability to go out and be aggressive to raise a fund is problematic. Having said that, it’s on our radar.

Dustin Pizzo - Banc of America Securities

Mike Dance, the equity you guys issued during the quarter, was that done through some sort of drip? I just don’t recall ever seeing any press releases or SEC filings about it or anything like that. Separately can you also just touch on the expected pricing of the mortgage applications you mentioned that are in with Fannie and Freddie?

Michael T. Dance

About a year and a half ago we had a prospectus supplement with a Cantor Fitzgerald control equity offering and that is the vehicle we used to raise the common equity. Current pricing from Freddie and Fannie continue between $115 and $120 debt service coverage and we’re seeing anywhere between $225 and $260 in spreads depending on the quality of the security.

Operator

Our next question comes from Analyst for Michael Bilerman - Citigroup Investment Research.

Analyst for Michael Bilerman - Citigroup Investment Research

Tenants. Can you provide a little bit more color in terms of any kind of consolidation you’re seeing? Do you have figures around any increases in unit occupancy?

Michael J. Schall

As I said on the call, it’s all anecdotal at this point in time. We don’t have that information. I know that historically we started tracking it in Northern California in the late 90s. That was the last time it was relevant and it’s not something we track on an ongoing basis. So I don’t have any hard statistical information. Anecdotally, again Southern California has more double ups. If it becomes a greater factor, if we think that our occupancies in general are suffering because of it, we will start tracking it but we haven’t seen that need at this point in time.

Analyst for Michael Bilerman - Citigroup Investment Research

Did you talk about delinquencies?

Michael J. Schall

I did and I noted that during the quarter our delinquencies are down year-over-year.

Analyst for Michael Bilerman - Citigroup Investment Research

Obviously there are some expenses that are fairly unpredictable going into next year, but what kind of initiatives are you taking to potentially control tax increases?

Michael J. Schall

Most of our taxes are already controlled by Prop 13. Most of our portfolio is in California and Prop 13 limits California reassessment to 2% in general. I think most of our property tax exposure is limited because of Prop 13. In Seattle less so but we think that we had a big increase in assessed value last year which resulted in the property tax increases that we saw go through the quarter or really all this year. So I think it’ll be less substantially next year.

Operator

Our next question comes from Jay Habermann - Goldman Sachs.

Jay Habermann - Goldman Sachs

I wanted to follow up on the question on distress opportunities. Given the competitive nature of capital and where returns are today in perhaps other areas whether it’s debt at large, but where do you think returns will have to go in order to again raise that capital that you mentioned in there today? A further question on that is, would you anticipate raising liquidity on your own balance sheet, meaning sell assets today because Freddie and Fannie are still providing capital and you can sell at low cap rates and would you deploy that 12 to 18 months down the road?

Keith R. Guericke

I think that the kinds of returns that investors are going to need in a front format are going to be in the high teens or low 20s, just expectations and alternative opportunities. I think that drives that. With respect to our own balance sheet, we sold the Cardiff by the Sea which was a very good asset and a very good market and basically it was an asset that we’d only held for a short time but the reasoning behind that was we were going to do a rehab project on it. Then about a year ago as you’ll recall our share price had dropped down to around $90 or just slightly under $90 and we thought it would be a better use of those proceeds to sell that asset and buy our shares back. As we all know, real estate’s not quite as liquid as our shares are so it took us about six or seven months to do that and by the time we got that transaction done our share prices were back up around $120. So we used those exchange dollars really to buy the property up in Seattle which was at a much better cap rate than we sold the Cardiff transaction by. Beyond that we’re sort of cleaning up some of our lesser projects down in San Diego that we acquired in the [Sachs] merger.

I think right now what’s happening is that people who are actually selling are those who are in distress and started to sell into a distressed market. Unless we thought we could do substantially better, it probably doesn’t make a lot of sense, and the other probably that we have is that many of our assets have low bases so we have to finalize in exchange a 1031 exchange within identification period within 45 days. So we don’t have the luxury of sitting on those proceeds for 18 months to wait for better times.

I think what we’re going to do is look at either joint ventures or hopefully a Fund III or if we have opportunities at $120 if we ever see that again to look at our own share price or our own equity. Those are the kinds of things I think we’re going to use to take advantage of the future.

Jay Habermann - Goldman Sachs

Switching back to markets, the Pacific Northwest is specifically Seattle and then I guess San Francisco, can you give us a sense of with NOI growth really having been stronger than expected year-to-date, how much of a deceleration are you anticipating perhaps over the next six to nine months? Are you looking for levels to drop in half from here? Do you think that they go flat similar to where Southern California is?

Keith R. Guericke

I think we’re in the process of analyzing our various submarkets and in the process of doing budgets. Clearly we’re not going to have the [effacle] growth we had this year but I think Northern California and Seattle are probably going to drop to the 3% to 4% range and so we’re still going to have decent positive growth in those two markets.

Jay Habermann - Goldman Sachs

Why do you think you’ve still got some modest growth versus say the period after 2001?

John D. Eudy

I can comment on that. The period after 2001 was extraordinary. I think we lost in terms of job losses 200,000 jobs approximately in Santa Clara County alone which was about 10% of the workforce. So those were incredible never-to-occur-again type of statistics. I don’t think that we see anything that’s remotely like that this time around. Again, there was a huge bubble you’ll recall Y2K, dot com explosion and then busting; those were extraordinary events. Again I don’t see any parallels to that at all.

John Lopez, do you agree with that?

John Lopez

That sounds right to me.

Jay Habermann - Goldman Sachs

On the concessions, I noticed that they were actually down in Southern California. Can you actually explain that given the pressures you’re seeing in that market?

Michael J. Schall

I did comment on that. The comment was that with respect to our pricing model since we’re using a price optimizer piece of software, it generates an array of net prices. Not to say we can’t offer a concession but it tends to focus on a net pricing type model as opposed to a gross plus a concession. It’s really a function of the price optimizer software. The offset to that obviously is that economic rents are lower because our economic rents don’t include the net effect of a concession so the tradeoffs were lower concessions but also lower economic rents.

Jay Habermann - Goldman Sachs

And at the same time, what are you seeing from your competitors? What are the concessions like in the market now?

Michael J. Schall

We’ll go to the new product of the market. There’s quite a bit of lease up activity throughout Southern California. We’re seeing in those transactions one to two months. That includes our downtown L.A. project as well. So pretty significant concession activity on all of the lease ups. Less so, typically half a month to a month on areas that do not have any lease up if any concession at all. Again, the net effect of rent sometimes does not include a concession. You just go with a lower coupon rent.

Operator

Our next question comes from [Michelle Coe] - UBS Securities.

[Michelle Coe] - UBS Securities

I believe you said earlier that you expect next year’s FFO will not have the same growth as in ’08. I just wanted to clarify a little bit about what you said earlier. Do you anticipate FFO to grow in ’09?

Michael T. Dance

What I said was we’re in the process of getting our budgets together and finalizing our projections for 2009. We aren’t in a position to give guidance. I was just signaling that you should not expect a 10% growth again. I will leave it at that but we aren’t in a position to give guidance at this moment.

[Michelle Coe] - UBS Securities

I was also wondering if you could talk some more about the sale process for Coral Gardens, what kind of cap rate it sold for and if you can give us a sense of how some of the cap rates have moved over the last three months for A versus ESS?

Michael J. Schall

It’s difficult to give you market information because there isn’t a very large market. As I’ve said, that asset is an asset that is sort of in a market that we’re not particularly happy with and the asset’s an older asset that we would like to just get rid of. The cap rate on that is probably about a 6 which is higher than we’ve seen in a long time. In fact it actually might be slightly higher than that. But it’s an asset that we think we can get rid of at this point and use the proceeds more productively somewhere else. There’s just not a lot of activity in those market places right now.

Operator

Our next question comes from Karin A. Ford - KeyBanc Capital Markets.

Karin A. Ford - KeyBanc Capital Markets

Just to follow up on Jay’s question regarding required returns. You said fund investors are looking for high teens to low 20s today. How does that compare to return expectations that you guys have when you’re buying today? Can you just talk about how you get to those returns given where you’re pricing you’re buying say the two assets you bought this quarter?

Michael J. Schall

It’s very similar. Frankly what we look from a REIT perspective is we try to three things when we buy or develop a new asset and then [inaudible]: Be accretive to FFO, be accretive to our growth rate and be accretive to NAV. We don’t spend as much time looking at IRRs as maybe our outside investors’ partners would.

Having said that, if you were to do the IRR calculations on the types of transactions, as you will notice last year we did almost $400 million of acquisitions. So far this year we’ve done about $80 million. So the reality is we’ve become much more selective and to find those kinds of returns is very difficult.

The answer is we’re trying to find very similar kinds of returns even though we’re looking at slightly different metrics and there are very few of those transactions in the market. We think that things will get better. I shouldn’t say get better because that’s a double-edged sword but we think that those opportunities will provide themselves in the near future and we will have some. What we’re doing internally is very consistent with that.

Karin A. Ford - KeyBanc Capital Markets

The next question is just regarding the Southern California submarkets. Did your ranking of the health of submarkets change at all? I think San Diego was near the top last quarter and Ventura was down the list. Is that still the same outlook?

Michael J. Schall

I would say that San Diego remains at the top. Ventura sort of started having its difficulties sooner and it has worked through many of those difficulties. As you’ll recall it had pretty significant layoffs at Am Gen and Countrywide so the market has worked through significant amounts of those. So I’d put them and L.A. County sort of number two and then I think Orange County is the weakest at this point.

Karin A. Ford - KeyBanc Capital Markets

The next question is on your dividend. I know you’ve got a pretty low payout ratio. Are you guys still hovering close to the minimum payout ratios to maintain your REIT status? Will you guys need to grow your dividend next year?

Michael T. Dance

No. We have some room. Taxable income is about $30 million less than our current dividend.

Karin A. Ford - KeyBanc Capital Markets

Final question on WaMu. I know you said it’s a little early to know what the impact is. Do you know what percentage of your residents are employed by WaMu?

Michael J. Schall

I don’t know. We have not tracked that historically.

Operator

Our next question comes from Michael Salinsky.

Michael Salinsky

Keith, I know you haven’t finished the budget for 2009 and I know you’re not giving guidance, but given what you’re seeing right now, what’s your gut feeling? Is this a shorter term pullback or is this more of a prolonged downturn here?

John Lopez

Given what’s going on our outlook is that it’s going to be a very difficult job formation in 2009 through at least the first three quarters. Probably the duration is [inaudible] to five quarters on weak economic growth.

Michael J. Schall

We think it will get better into the summer next year but we won’t really see strong improvement until the end of next year.

Mike Salinsky - RBC Capital Markets

I noticed on your development pipeline [90 Archer] is now marked for sale. Is that a fourth quarter transaction or is that a next year transaction?

John D. Eudy

[Inaudible] fourth quarter.

Mike Salinsky - RBC Capital Markets

Will there be any gains on that?

John D. Eudy

Yes.

Mike Salinsky - RBC Capital Markets

I believe your marketing an asset from the Fund. Is that a next year event?

John D. Eudy

We have put an asset out for the fund to market. At this point in time it’s not in contract so I don’t know that it will sell. If we don’t get a price that makes sense for us, we will pull it off the market.

Mike Salinsky - RBC Capital Markets

You talked in the past that you’re bias was still towards Northern California and Seattle. Just given what you’re seeing with the developments in Seattle, WaMu and the Boeing situation, has that changed in any way?

Michael J. Schall

I don’t think so. The reality is all these markets are cyclical and as Southern California continues to get beat up, John had talked earlier about some of the land prices that he’s seen come down. Some of that’s in Southern California so opportunities are going to come up. It’s difficult at this point in time to see which market is the best cyclical advantage but frankly if you look forward, Boeing is still going to be very strong. It’s got a hu8ge backlog on the Dreamliners. Microsoft is still going strong. We’re expecting Seattle to continue to be fairly strong at least through next year. Northern California as Mike said, this is very different than the 2001/2002 implosion we had here. We’ve lost very few jobs year-to-date compared to losing 200,000 jobs back there. So this market still has got legs. As I mentioned in my comments, we’ve got the formation of new ventures and new companies and we’ve got a great venture capital foundation here. So I think these are still the obvious markets but there’s going to be a point in time where things get so cheap in Southern California that it does open up and we continue to monitor that but frankly I haven’t seen it yet though

Operator

Your next question comes from Lindsey E. Yao – Robert W. Baird & Co.

Lindsey E. Yao – Robert W. Baird & Co.

Related to the commercial I guess employment, you mentioned something about the 2.2% occupied by Boeing employees. Do you have an idea of how much of the overall portfolio is leased with commercial or corporate contracts?

Michael J. Schall

We do not generally like the corporate business and so it’s not a big percentage, it’s less than 5% of the portfolio in general. It’s not something that we focus on and it’s a very small percentage.

Lindsey E. Yao – Robert W. Baird & Co.

I guess with that, it’s a very small percentage but have you seen any trends so far with employers coming back to you saying, “You know what we’re going to have to cut back?” at all.

Michael J. Schall

I know that’s a good leading indicator, we have not seen that yet. But again, I don’t think we have enough of those units to really be a good barometer on what is happening there.

Lindsey E. Yao – Robert W. Baird & Co.

Then just looking at the new supply in Seattle, sorry if I missed this but can you just give some more color on the nature of that supply that’s coming online?

John D. Eudy

There’s two nodes where the supply is coming on line. Over the next 18 months is downtown where there’s approximately 2,000 to 2,500 coming online. A majority of that is condo conversion and there’s a similar number in downtown Bellevue over the next 18 months and there’s two or three large high rise projects that have 500 plus that were originally intended to be condos. We think those will all go apartments. Those will probably burn off and supply will begin to decrease at the end of ‘010.

Keith R. Guericke

Those are high end units and they’re all going to be, the rents to make those things work and I frankly don’t know what the construction costs are because we didn’t do any of them but I know they’re high end and if they were being built in any normal market which that market is very similar to most of the California markets they’ve got to be $550,000 to $700,000 per unit so the rent that they have to get are very high.

Frankly, most of our product up there is B plus A minus kind of product so we don’t think it’s going to have any absolute direct competition with us.

Operator

Your next question comes from the line of Richard Anderson – BMO Capital Markets.

Richard Anderson – BMO Capital Markets

If you could explain this to me in just like a sentence or two because I still don’t know that I get it entirely. You raised your guidance or low end of your guidance to effectively raise your guidance and then you didn’t get the second half recovery that you originally planned. Could you just explain? Is it just that you had better than you expected performance in your core markets? What was it that made that happen or was it just sort of a wide range to begin with?

Michael J. Schall

Offsetting the not obtaining the second half growth in rents that we were expecting has been a windfall in short term interest rates. We’re really benefitting from the variable rate demand notes that we have on our low income where we have below market rate rents.

Richard Anderson – BMO Capital Markets

That got you $0.20 of guidance?

Michael J. Schall

Historically we’ve paid about 4.5% to 5% on those mortgages so take $250 million and we’re paying about 3.5% so almost 200 basis points on $250 million.

Richard Anderson – BMO Capital Markets

The next question is on the lack of transaction activity, Keith and I guess all of you kind of referenced, does that to you illustrate – I guess it does illustrate that there aren’t stressed sellers out there and that is good in a sense that there’s not this situation where you have sort of a problematic environment from a debt maturity or debt expiration perspective. But, do you see that on the horizon? Do you see mom and pop owners of real estate that are going to be faced with some debt maturity, debt expirations in the next couple of years? Are you monitoring those types of situations?

Keith R. Guericke

Yes, there’s sort of two issues, one is those properties that put five year bullets on essentially three to four years ago, that’s stuff we’re looking at and then sort of the other pocket that we think there’s going to be some opportunities in – well, there’s two other pockets, one pocket is there were a number of private rehabbers, they were fairly prominent and they were looking at pretty high octane transactions and used a lot of leverage.

I think a number of those guys are going to face IRR clocks or just loans that mature here the next couple of years that they’re going to have pain because they had way too much leverage. I don’t think the moms and pops are going to be in trouble because the guys that went out and just put on normal Fannie Mae loans at 50% and 60%, maybe even 70% had rent growth in those last few years. The only ones that are going to be in real trouble are the ones that way over levered.

I think that’s a potential opportunity. The last one is there are a number of condo developers that built projects that have sold nothing so we don’t have to look at a broken condo but they’re just upside down. They can’t sell, their equity is gone, maybe the mez is gone. We’re talking to construction lenders that might have to take a haircut to get out. I think there’s the opportunity and the issue is whether or not we can get the price to a point where it works as a rental.

Richard Anderson – BMO Capital Markets

So in ’09 in a period where it will be sort of tough fundamentally you can actually see a good chunk of acquisitions if things align themselves right?

Keith R. Guericke

Yes, I think that’s a true statement.

Richard Anderson – BMO Capital Markets

Just two quick follow ups, are you seeing any people materially going out and renting foreclosed homes in your markets?

John D. Eudy

Absolutely. It represents competition in several of our submarkets. Fortunately, we don’t have a lot of property in the inland empire, that would be ground zero for trying to compete, have a two bedroom unit competing against a three bedroom home at very reduced rents. Sacramento Valley, the same phenomena. So, it’s less the case in the coastal markets but still a factor in a number of places.

Richard Anderson – BMO Capital Markets

But it’s not the individual like one bedroom person that’s going to live in a tree line street and watch kids playing hopscotch, right?

John D. Eudy

No, no.

Richard Anderson – BMO Capital Markets

It’s a family?

John D. Eudy

It tends to be, even within the coastal market it tends to be the more outlying of the coastal markets. If someone in San Francisco doesn’t have that option, Palo Alto doesn’t have that option, Santa Clara County for the most part doesn’t. But, there are some properties, again not the core of our portfolio that are closer to the more outlying areas and they have a greater impact. Again, it goes right back to what Keith said which is look at where the foreclosure activity is the greatest and that is where you’re going to see the greatest impact from rental competition.

Richard Anderson – BMO Capital Markets

Lastly, are you seeing people move from Class A to your properties? Are you seeing that sort of type of traffic?

John D. Eudy

It’s hard to track that. We think anecdotally we think that is happening as people become more price sensitive and try to focus on improving their personal balance sheets, pay back a little bit of credit and they can obviously do so if they go in to more affordable properties. We also mentioned there’s a number of submarkets that there’s a significant amount of new product being delivered, it tends to be very high end and probably pushes that segment of the rental market beyond what it would have historically been pushed and as a result of that I think we are going to see pretty significant discounting of the As and that will inure to the benefit of the Bs.

Operator

Your next question comes from the line of [Hanwell St. Jess] – Green Street Advisors.

[Hanwell St. Jess] – Green Street Advisors

To follow up I guess on an unrelated question, are you seeing any pressure from your investors to sell assets given what’s going on with asset pricing in the market and the broader economy?

Keith R. Guericke

No, we’ve just had meetings with our investors this last summer and we talked about the markets and what’s going on and basically in the current fund we’ve got about three years left plus a couple of extensions so this downturn we don’t think it’s going to last forever and clearly we think we’ve got plenty of time coming out at the other end to still execute and make the right decisions.

[Hanwell St. Jess] – Green Street Advisors

Are you adjusting expectations, what I initially believe were high teens, return expectations?

Keith R. Guericke

We have not adjusted those expectations for the long term. I think that a number of those assets were bought early and we had good cap rates going in and we’ve gotten some great rental growth and great NOI growth in the assets that are in that fund. I think we’re going to be just fine if we sit tight and execute at the right time.

[Hanwell St. Jess] – Green Street Advisors

To follow up on an earlier question, I didn’t quite hear the answer and I guess I was just looking for more color on change in asset pricing that you feel has occurred specifically more in the last 30 to 60 days given your activity in the marketplace?

Keith R. Guericke

Again, I think you’re right, I didn’t answer that specifically and partly because I don’t know. There has not been a lot of transactions as somebody had mentioned earlier. We had a fund asset that was listed, as of today we haven’t received a price that is acceptable to us so clearly prices in the market place are down. I would guess that B product is in the 5.75 to 6.25 range in most of our markets today. A year ago that would have been at least 100 basis points less so I think that’s kind of the range of where things are at.

[Hanwell St. Jess] – Green Street Advisors

One last question, can you give us a sense or maybe quantify your pricing power between new leases, people coming in the door and renewals?

Michael J. Schall

I think in this world the two are becoming closer and closer to one because everyone does for example a lot of Craigslist type advertising and information, rental information is so available via the Internet that your ability to have significant difference between new pricing and renewal pricing is pretty limited. I guess it depends on the circumstance a bit but we’re seeing a sort of tightening of that relationship as time goes on. I think that continues. I don’t see a big difference between the two.

Operator

At this time there are no further questions in the queue. Ladies and gentlemen thank you for joining today’s conference. This concludes the presentation you may now disconnect and have a wonderful day.

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Source: Essex Property Trust, Inc. F3Q08 (Qtr End 9/30/08) Earnings Call Transcript
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