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Essex Property Trust 10-K 2006 Documents found in this filing:UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(MARK ONE)
[X]
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF
1934
For
the fiscal year ended December 31, 2005
OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF 1934
FOR
THE TRANSITION PERIOD FROM ___________ TO _____________
Commission
file number 1-13106
 Essex
Property Trust, Inc.
(Exact
name of Registrant as Specified in its Charter)
925
East Meadow Drive
Palo
Alto, California 94303
(Address
of Principal Executive Offices including Zip Code)
(650)
494-3700
(Registrant's
Telephone Number, Including Area Code)
Securities
registered pursuant to Section 12(b) of the Act:
Securities
registered pursuant to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined
in
Rule 405 of the Securities Act. Yes
[X]
No [ ]
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate
by check mark whether the registrant (1) has filed all reports required to
be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for
the past 90 days.
Yes
[X] No [ ]
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K, or any amendment to
this Form
10-K. [
]
Indicate
by check mark whether the registrant is a large accelerated filer, and
accelerated filer, or a non-accelerated filer.
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act).
Yes
[ ] No [X]
As
of
June 30, 2005, the aggregate market value of the voting stock held by
non-affiliates of the registrant was $1,880,817,368. The aggregate market value
was computed with reference to the closing price on the New York Stock Exchange
on such date. Shares of common stock held by executive officers, directors
and
holders of more than ten percent of the outstanding common stock have been
excluded from this calculation because such persons may be deemed to be
affiliates. This exclusion does not reflect a determination that such persons
are affiliates for any other purposes.
As
of
March 10, 2006, 22,881,621 shares of Common Stock ($.0001 par value) were
outstanding.
LOCATION
OF EXHIBIT INDEX: The index exhibit is contained in Part III, Item 15, on page
number 42.
DOCUMENTS
INCORPORATED BY REFERENCE:
The
following document is incorporated by reference in Part III of the Annual Report
on Form 10-K: Proxy statement for the annual meeting of stockholders of Essex
Property Trust, Inc. to be held May 9, 2006.
Essex
Property Trust, Inc.
2005
ANNUAL REPORT ON FORM 10-K
TABLE
OF CONTENTS
ii
PART
I
Forward
Looking Statements
This
Form
10-K contains forward-looking statement within the meaning of Section 27A of
the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1943.
Our actual results could differ materially from those set forth in each
forward-looking statement. Certain factors that might cause such a difference
are discussed in this report, including Item 1A, Risk Factors of this Form
10-K.
Item
1. Business
OVERVIEW
Essex
Property Trust, Inc. (“Essex”) is a Maryland corporation that operates as a
self-administered and self-managed real estate investment trust (“REIT”). Essex
owns all of its interest in its real properties directly or indirectly through
Essex Portfolio, L.P. (the “Operating Partnership”). Essex is the sole general
partner of the Operating Partnership and as of December 31, 2005 owns a 90.4%
general partnership interest. In this report, the terms “we”, “us” and “our”
refer to Essex Property Trust, it’s Operating Partnership and their
subsidiaries.
The
Company has elected to be treated as a real estate investment trust (“REIT”) for
federal income tax purposes, commencing with the year ended December 31, 1994
as
the Company completed an initial public offering on June 13, 1994. In order
to
maintain compliance with REIT tax rules, the Company utilizes taxable REIT
subsidiaries (“TRS”) for various revenue generating or investment activities.
The TRSs’ are consolidated by the Company.
We
are
engaged primarily in the ownership, operation, management, acquisition,
development and re-development of real estate. Our real estate consists
primarily of apartment communities. As of December 31, 2005, we owned or held
an
interest in 126 apartment communities, aggregating 26,587 units, located
predominantly along the West Coast (collectively, the “Properties”, and
individually, a “Property”). Our other properties included three recreational
vehicle parks (totaling 562 spaces), three office buildings (totaling
approximately 166,340 square feet), which the company primarily occupies and
uses as office space, and one manufactured housing community (containing 157
pads). We currently have three development projects, with 505 units in various
stages of development (together with the Properties, the
“Portfolio”).
The
Company’s website address is http://www.essexpropertytrust.com.
The
Company’s annual reports on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K and all amendments to those reports, and the Proxy Statement
for its Annual Meeting of Stockholders are available, free of charge, on our
website as soon as practicable after we file the reports with the Securities
and
Exchange Commission (“SEC”).
BUSINESS
OBJECTIVES AND STRATEGIES
The
following is a discussion of our business objectives and strategies with respect
to real estate investment and management. One or more of these criteria may
be
amended or rescinded from time to time without stockholder vote.
Business
Objectives
Our
primary business objectives are to increase shareholders’ value by investing in
properties located in supply constrained markets, improving operating results
and the value of our Properties while maintaining a conservative balance sheet.
We intend to achieve these objectives by:
We
can
not assure that we will achieve our business objectives.
1
Business
Strategies
Research
Driven Approach -
We
believe that successful real estate investment decisions and portfolio growth
begin with extensive regional economic research and local market knowledge.
Utilizing a proprietary research model that we have developed over the last
19
years, we continually assess markets where we currently operate, as well as
markets where we would consider future investment opportunities by evaluating:
Recognizing
that all real estate markets are cyclical, we regularly evaluate the results
of
our regional economic, as well as our local market research and adjust the
geographic focus of our portfolio accordingly. We seek to increase our portfolio
allocation in markets projected to have the strongest local economies and to
decrease such allocations in markets projected to have declining economic
conditions. Likewise, the Company also seeks to increase its portfolio
allocation in markets that have attractive property valuations and to decrease
such allocations in markets that have inflated valuations and low relative
yields.
Property
Operations
- We
manage our Properties by focusing on and marketing strategies that will generate
above-average rental growth, tenant retention/satisfaction and long-term asset
appreciation. We intend to achieve this by utilizing the strategies set forth
below:
CURRENT
BUSINESS ACTIVITIES
Acquisitions
Acquisitions
have been a significant growth component of our business. In 2005, we completed,
in addition to acquisitions by the Essex Apartment Value Fund II (“Fund II”)
discussed below, a series of acquisitions that added to our overall
portfolio.
In
January 2006, we acquired two apartment communities - Chimney Sweep and CBC,
aggregating 239 units, located in Isla Vista, California for a combined price
of
approximately $57.1 million.
2
Dispositions
As
part
of our strategic plan to own quality real estate in supply-constrained markets,
we continually evaluate our Properties and sell those which no longer meet
our
strategic criteria. We may use the capital generated from the dispositions
to
invest in higher-return Properties or repay debts. We believe that the sale
of
these Properties will not have a material impact on our future results of
operations or cash flows nor will their sale materially affect our ongoing
operations. Generally, any impact of earnings dilution resulting from these
dispositions will be offset by the positive impact of our acquisitions,
development and redevelopment activities.
Development
Development
communities are defined as new apartment properties that are being constructed
or are newly constructed and in a phase of lease-up and have not reached 95%
physical occupancy (stabilized operations). In the first quarter of 2005, we
stabilized the second phase of development at San Marcos, which is located
in
Richmond, California. Total construction costs for the 120 units were
approximately $23.9 million.
In
connection with the properties currently under development, we have entered
into
contractual construction-related commitments with unrelated third parties.
As of
December 31, 2005, we are committed to approximately $96.6 million in estimated
development expenditures to complete these projects.
As
of
December 31, 2005, we had three development projects in various stages of
construction and other pre-development costs in our pipeline with combined
estimated costs of $133.7 million. The following table sets forth information
regarding the Company’s development communities at December 31, 2005.
(1)
Includes incurred costs and estimated costs to complete the development
projects.
Redevelopment
Redevelopment
is defined as investment on existing Properties with the expectation of
increased financial returns through property improvement. During redevelopment
certain apartment units typically are not available for rent and, as a result,
may have less than stabilized operations. As of December 31, 2005, we had
ownership interests in six redevelopment communities aggregating 1,450 apartment
units with estimated redevelopment costs of $36.8 million, of which
approximately $23.5 million remains to be expended.
3
The
following table illustrates those redevelopment projects:
Debt
Transactions
On
February 1, 2005, we obtained a non-recourse mortgage on a previously
unencumbered property in the amount of $21.8 million with a 4.94% fixed interest
rate for a 9-year term, maturing in March 2014, with an option to extend the
maturity for one year thereafter at a floating rate of 2.4% over one month
LIBOR. During the extension period, the loan may be paid in full with no
prepayment penalty.
On
April
15, 2005, we obtained two non-recourse mortgage loans
on
previously unencumbered properties in the aggregate amount of $32.9 million
with
fixed interest rates of 5.44% that mature on May 1, 2014.
On
May
19, 2005, we obtained three non-recourse mortgage loans in the aggregate amount
of $12.9 million, secured by second deeds of trusts, with an average interest
rate of 5.32% and maturity dates ranging from May 1, 2009 to January 1,
2013.
On
July
14, 2005, we obtained a non-recourse mortgage loan on previously unencumbered
property in the aggregate amount of $40.3 million with a fixed interest rate
of
4.935% for a 10-year term that matures on August 1, 2015.
During
October and November 2005, the Operating Partnership raised
$225 million from the sale of exchangeable senior notes (the “Notes”) with a
coupon of 3.625% due 2025. On
or
after November 1, 2020, the Notes will be exchangeable at the option of the
holder into cash and, in certain circumstances at Essex’s option, shares of the
Company’s common stock at an initial exchange price of $103.25 per share subject
to certain adjustments. The Notes will also be exchangeable prior to November
1,
2020, but only upon the occurrence of certain specified events. On or after
November 4, 2010, the Operating Partnership may redeem all or a portion of
the
Notes at a redemption price equal to the principal amount plus accrued and
unpaid interest. Note holders may require the Operating Partnership to
repurchase all or a portion of the Notes at a purchase price equal to the
principal amount plus accrued and unpaid interest (including additional
interest, if any), on the Notes on November 1, 2010, November 1, 2015 and
November 1, 2020.
With
the
proceeds from the sale of the Notes, the Company repurchased $25 million in
common stock and paid down $135 million on the outstanding lines of credit.
In
part using proceeds from the sale of the Notes, in
the
fourth quarter of 2005, the Company paid-off ten mortgage notes payable totaling
$89 million with fixed rates ranging from 6.5% to 7.9%, and the Company
originated two new mortgage notes payable totaling $35 million with fixed rates
of 5.5% and 5.6%.
Derivative
Transactions
To
hedge
the cash flows associated with the refinancings of a portion of the debt that
matures in 2007 and 2008 the Company entered into the following
contracts:
4
We
believe that these transactions will be effective in offsetting changes in
future cash flows for forecasted transactions and qualify for hedge accounting.
The increase in the fair value of these derivatives during 2005 was
approximately $660,000 and is reflected in accumulated other comprehensive
income in the Company’s consolidated financial statements.
On
February 22, 2006, the Company entered into additional notional forward-starting
swaps. The first was for $25.0 million with a commercial bank at a fixed rate
of
5.082% and a settlement date on or before January 1, 2009. The second and third
swaps are for a total of $100.0 million with two commercial banks at a fixed
rate of 5.099% and a settlement date on or before January 1, 2011. These
derivatives will be used to economically hedge the cash flows associated with
the refinancing of debt that matures in 2008 and 2010, respectively
Equity
Transactions
The
Company repurchased $25 million of common stock in conjunction with our
exchangeable bond offering in the fourth quarter of 2005. The Company also
granted stock options and certain employees exercised their options pursuant
to
the Company’s Stock Incentive Plan.
ESSEX
APARTMENT VALUE FUNDS
Essex
and
several institutional partners formed Essex Apartment Value Fund (“Fund I”) to
broaden the Company’s capital alternatives. Essex is
a 1%
general partner and 20.4% limited partner in Fund I. Fund I was in the process
of liquidation as of December 31, 2005. Essex
Apartment Value Fund II (“Fund II”) was formed in 2004, and Essex is a 1%
general partner and 27.2% limited partner. Fund II is the Company’s investment
vehicle (subject to certain exceptions) until October 31, 2006, or when Fund
II’s capital has been invested, whichever occurs first.
Acquisitions
Dispositions
OFFICES
AND EMPLOYEES
The
Company is headquartered in Palo Alto, California, and has regional offices
in
Woodland Hills, California; Irvine, California; San Diego, California; Bellevue,
Washington; and Portland, Oregon. As of December 31, 2005, the Company had
approximately 820 employees.
INSURANCE
The
Company carries comprehensive liability, fire, extended coverage and rental
loss
insurance for each of the Properties. There are, however, certain types of
extraordinary losses, such as, for example, losses for terrorism or earthquake,
for which the Company may not have sufficient insurance coverage.
5
Substantially
all of the Properties are located in areas that are subject to earthquake
activity. The Company has obtained earthquake insurance for most the Properties.
Most of the Properties are included in an earthquake insurance program that
is
subject to an aggregate limit of $80.0 million payable upon a covered loss
in
excess of a $15.0 million self-insured retention amount and a 5% deductible.
In
the future, the Company may selectively exclude properties from being covered
by
earthquake insurance based on management's evaluation of the following factors:
(i) the availability of coverage on terms acceptable to the Company, (ii) the
location of the property and the amount of seismic activity affecting that
region, and, (iii) the age of the property and building codes in effect at
the
time of construction. Despite earthquake coverage on most of the Company's
Properties, should a property sustain damage as a result of an earthquake,
the
Company may incur losses due to deductibles, co-payments and losses in excess
of
applicable insurance, if any.
Although
the Company may carry insurance for potential losses associated with its
properties, employees, residents, and compliance with applicable laws, it may
still incur losses due to uninsured risks, deductibles, co-payments or losses
in
excess of applicable insurance coverage.
COMPETITION
There
are
numerous housing alternatives that compete with our multifamily properties
in
attracting residents. These include other multifamily rental apartments and
single-family homes that are available for rent in the markets in which the
properties are located. The properties also compete for residents with new
and
existing homes and condominiums that are for sale. If the demand for our
properties is reduced or if competitors develop and/or acquire competing
properties on a more cost-effective basis, rental rates and occupancy may drop,
which may have a material adverse affect on our financial condition and results
of operations.
We
face
competition from other real estate investment trusts, businesses and other
entities in the acquisition, development and operation of properties. Some
of
the competitors are larger and have greater financial resources than we do.
This
competition may result in increased costs of properties we acquire and/or
develop.
WORKING
CAPITAL
We
believe that cash flows generated by our operations, existing cash balances,
availability under existing lines of credit, access to capital markets and
the
ability to generate cash gains from the disposition of real estate are
sufficient to meet all of our reasonably anticipated cash needs during 2006.
The
timing, source and amounts of cash flows provided by financing activities and
used in investing activities are sensitive to changes in interest rates and
other fluctuations in the capital markets environment, which can affect our
plans for acquisitions, dispositions, development and redevelopment activities.
ENVIRONMENTAL
CONSIDERATIONS
See
the
discussion under the caption, “Possible
environmental liabilities”
in
Item
1A, Risk Factors, for information concerning the potential effect of
environmental regulations on our operations.
OTHER
MATTERS
Certain
Policies of the Company
We
intend
to continue to operate in a manner that will not subject us to regulation under
the Investment Company Act of 1940. The Company has in the past five years
and
may in the future (i) issue securities senior to its Common Stock, (ii) fund
acquisition activities with borrowings under its line of credit and (iii) offer
shares of Common Stock and/or units of limited partnership interest in the
Operating Partnership or affiliated partnerships as partial consideration for
property acquisitions. The Company from time to time acquires partnership
interests in partnerships and joint ventures, either directly or indirectly
through subsidiaries of the Company, when such entities' underlying assets
are
real estate. In general, the Company does not (i) underwrite securities of
other
issuers or (ii) actively trade in loans or other investments.
We
invest
primarily in multifamily properties that are located in predominantly coastal
markets within Southern California, the San Francisco Bay Area, and parts of
Pacific Northwest. The Company currently intends to continue to invest in
multifamily properties in such regions. However, these practices may be reviewed
and modified periodically by the Board of Directors and may change these
practices without shareholder approval.
6
Item
1A. Risk Factors
Our
business, operating results, cash flows and financial conditions are subject
to
various risks and uncertainties, including, without limitation, those set forth
below, any one of which could cause our actual results to vary materially from
recent results or form our anticipated future results.
We
depend on our key personnel
- Our
success depends on our ability to attract and retain executive officers, senior
officers and company managers. There is substantial competition for qualified
personnel in the real estate industry and the loss of several of our key
personnel could have an adverse effect on us.
Debt
financing
- At
December 31, 2005, we had approximately $1.35 billion of indebtedness (including
$186.7 million of variable rate indebtedness, of which $152.7 million is subject
to interest rate protection agreements). We are subject to the risks normally
associated with debt financing, including the following:
Uncertainty
of our ability to refinance balloon payments
- As of
December 31, 2005, we had approximately $1.35 billion of mortgage debt,
exchangeable bonds and line of credit borrowings, most of which are subject
to
balloon payments. We do not expect to have sufficient cash flows from operations
to make all of these balloon payments. These mortgages, bonds and lines of
credit borrowings have the following scheduled principal and balloon payments:
2006--$26.2
million;
2007--$82.0
million;
2008--$155.7
million;
2009--$34.4
million;
2010--$159.3
million;
Thereafter--$872.2
million.
We
may
not be able to refinance such mortgage indebtedness, bonds, or lines of credit.
The Properties subject to these mortgages could be foreclosed upon or otherwise
transferred to the lender. This could cause us to lose income and asset value.
We may be required to refinance the debt at higher interest rates or terms
of
such refinancing may not be as favorable as the terms of existing indebtedness.
Debt
financing on properties may result in insufficient cash
flow
- Where
possible, we intend to continue to use leverage to increase the rate of return
on our investments and to provide for additional investments that we could
not
otherwise make. There is a risk that the cash flow from the properties will
be
insufficient to meet both debt payment obligations and the distribution
requirements of the real estate investment trust provisions of the Internal
Revenue Code. We may obtain additional debt financing in the future, through
mortgages on some or all of the properties. These mortgages may be recourse,
non-recourse, or cross-collateralized.
As
of
December 31, 2005, Essex had 72 of its 120 consolidated multifamily properties
encumbered by debt. Of the 72 properties, 53 are secured by deeds of trust
relating solely to those properties. With respect to the remaining 19
properties, there are 4 cross-collateralized mortgages secured by 8 properties,
6 properties, 3 properties and 2 properties, respectively. The holders of this
indebtedness will have a claim against these properties and, to the extent
indebtedness is cross-collateralized, lenders may seek to foreclose upon
properties, which are not the primary collateral for their loan. This may
accelerate other indebtedness secured by properties. Foreclosure of properties
would reduce our income and asset value.
Risk
of rising interest rates
-
Current
interest rates are at historic lows and could potentially increase rapidly,
which could result in higher interest expense on our variable rate indebtedness.
Prolonged interest rate increases could negatively impact our ability to make
acquisitions and develop properties at economic returns on investment and our
ability to refinance existing borrowings at acceptable rates.
As
of December 31, 2005, we had approximately $186.7
million of long-term variable rate indebtedness bearing interest at floating
rates tied to the rate of short-term tax-exempt revenue bonds (which mature
at
various dates from 2020 through 2034), and $25.0 million of variable rate
indebtedness under our lines of credit, bearing interest at the Freddie Mac
Reference Rate plus from 0.55% to 0.59%.
7
Approximately
$152.7 million of the long-term indebtedness is subject to interest rate cap
protection agreements, which may reduce the risks associated with fluctuations
in interest rates. The remaining $34.0 million of long-term variable rate
indebtedness was not subject to any interest rate cap protection agreements
as
of December 31, 2005. An increase in interest rates may have an adverse effect
on our net income and results of operations.
Risk
of losses on interest rate hedging arrangement
-
Periodically, we have entered into agreements to reduce the risks associated
with increases in interest rates, and may continue to do so. Although these
agreements may partially protect against rising interest rates, they also may
reduce the benefits to us if interest rates decline. If a hedging arrangement
is
not indexed to the same rate as the indebtedness that is hedged, we may be
exposed to losses to the extent that the rate governing the indebtedness and
the
rate governing the hedging arrangement change independently of each other.
Finally, nonperformance by the other party to the hedging arrangement may
subject us to increased credit risks. In order to minimize counterparty credit
risk, our policy is to enter into hedging arrangements only with large financial
institutions.
Bond
compliance requirements may limit income from certain
properties
- At
December 31, 2005, we had approximately $186.7 million of variable rate
tax-exempt financing relating to the Inglenook Court Apartments, Wandering
Creek
Apartments, Treetops Apartments, Huntington Breakers Apartments, Camarillo
Oaks
Apartments, Fountain Park, Anchor Village and Parker Ranch Apartments. This
tax-exempt financing subjects these properties to certain deed restrictions
and
restrictive covenants. We expect to engage in tax-exempt financings in the
future. In addition, the Internal Revenue Code and rules and regulations
thereunder impose various restrictions, conditions and requirements excluding
interest on qualified bond obligations from gross income for federal income
tax
purposes. The Internal Revenue Code also requires that at least 20% of apartment
units be made available to residents with gross incomes that do not exceed
a
specified percentage, generally 50%, of the median income for the applicable
family size as determined by the Housing and Urban Development Department of
the
federal government. In addition to federal requirements, certain state and
local
authorities may impose additional rental restrictions. These restrictions may
limit income from the tax-exempt financed properties if we are required to
lower
rental rates to attract residents who satisfy the median income test. If Essex
does not reserve the required number of apartment homes for residents satisfying
these income requirements, the tax-exempt status of the bonds may be terminated,
the obligations under the bond documents may be accelerated and we may be
subject to additional contractual liability.
Adverse
effect to property income and value due to general real estate investment risks
-
Real
property investments are subject to a variety of risks. The yields available
from equity investments in real estate depend on the amount of income generated
and expenses incurred. If the properties do not generate sufficient income
to
meet operating expenses, including debt service and capital expenditures, cash
flow and the ability to make distributions to stockholders will be adversely
affected. The performance of the economy in each of the areas in which the
properties are located affects occupancy, market rental rates and expenses.
Consequently, the income from the properties and their underlying values may
be
impacted. The financial results of major local employers may have an impact
on
the cash flow and value of certain of the properties as well.
Income
from the properties may be further adversely affected by, among other things,
the following factors:
As
leases
on the properties expire, tenants may enter into new leases on terms that are
less favorable to us. Income and real estate values also may be adversely
affected by such factors as applicable laws (e.g., the Americans With
Disabilities Act of 1990 and tax laws), interest rate levels and the
availability and terms of financing. Real estate investments are relatively
illiquid and, therefore, our ability to vary our portfolio promptly in response
to changes in economic or other conditions may be quite limited.
Economic
environment and impact on operating results
- The
national economy and the economies of the western states in markets where we
operate can impact our operating results. Some of these markets are concentrated
in high-tech sectors, which have experienced economic downturns, and could
again
in the future. Our property type and diverse geographic locations provide some
degree of risk mitigation. However, we are not immune to prolonged economic
downturns. Although we believe we are well positioned to meet these challenges,
it is possible a reduction in rental rates, occupancy levels, property
valuations and increases in operating costs such as advertising, turnover and
repair and maintenance expense could occur in the event of economic
uncertainty.
8
Risk
of Inflation/Deflation
-
Substantial inflationary or deflationary pressures could have a negative effect
on rental rates and property operating expenses.
Risks
that acquisitions will fail to meet expectations
- We
intend to continue to acquire multifamily residential properties. However,
there
are risks that acquisitions will fail to meet our expectations. Our estimates
of
future income, expenses and the costs of improvements or redevelopment that
are
necessary to allow us to market an acquired property as originally intended
may
prove to be inaccurate. We expect to finance future acquisitions, in whole
or in
part, under various forms of secured or unsecured financing or through the
issuance of partnership units by the Operating Partnership or related
partnerships or additional equity by Essex. The use of equity financing, rather
than debt, for future developments or acquisitions could dilute the interest
of
Essex’s existing stockholders. If we finance new acquisitions under existing
lines of credit, there is a risk that, unless we obtain substitute financing,
Essex may not be able to secure further lines of credit for new development
or
such lines of credit may be not available on advantageous terms.
Risks
that development activities will be delayed, not completed, and/or not achieve
expected results
- These
risks may reduce the funds available for distribution to Essex’s stockholders.
Further, the development of properties is also subject to the general risks
associated with real estate investments. For further information regarding
these
risks, please see “Adverse Effect to Property Income and Value Due to General
Real Estate Investment Risks.”
We
pursue
multifamily residential property development projects and these projects
generally require various governmental and other approvals, which have no
assurance of being received. Our development activities generally entail certain
risks, including the following:
The
geographic concentration of our Properties and fluctuations in local markets
may
adversely impact our financial condition and operating
results
- We
generated significant amounts of rental revenues for the year ended December
31,
2005 from properties concentrated in Southern California (Los Angeles, Ventura,
Orange, San Diego and Riverside counties), Northern California (the San
Francisco Bay Area), and the Pacific Northwest (the Seattle, Washington and
Portland, Oregon metropolitan areas). As of December 31, 2005, more than half
(73%) of our Properties were located in California. This geographic
concentration could present risks if local property market performance falls
below expectations. The economic condition of these markets could affect
occupancy, market rental rates, and expenses, as well as impact the income
generated from the Properties and their underlying asset values. The financial
results of major local employers also may impact the cash flow and value of
certain of the Properties. This could have a negative impact on our financial
condition and operating results, which could affect our ability to pay expected
dividends to our stockholders.
Competition
in the multifamily residential market may adversely affect operations and the
rental demand for our Properties
- There
are numerous housing alternatives that compete with our multifamily properties
in attracting residents. These include other multifamily rental apartments
and
single-family homes that are available for rent in the markets in which the
Properties are located. The Properties also compete for residents with new
and
existing homes and condominiums that are for sale. If the demand for our
Properties is reduced or if competitors develop and/or acquire competing
properties on a more cost-effective basis, rental rates may drop, which may
have
a material adverse affect on our financial condition and results of operations.
We
also
face competition from other real estate investment trusts, businesses and other
entities in the acquisition, development and operation of properties. Some
of
the competitors are larger and have greater financial resources than we do.
This
competition may result in increased costs of properties we acquire and/or
develop.
Dividend
requirements as a result of preferred stock may lead to a possible inability
to
sustain dividends
- The
Company has approximately $25 million of Series F Cumulative Redeemable
Preferred Stock (“Series F Preferred Stock”) outstanding. The Series B Preferred
Units, the Series D Preferred Units, and the Series F Preferred Stock are
collectively referred to as the “Preferred Equity”. The terms of the Series F
Preferred Stock and of the preferred stock into which each series of Preferred
Units are exchangeable provide for certain cumulative preferential cash
distributions per each share of preferred stock.
9
These
terms also provide that while such preferred stock is outstanding, Essex cannot
authorize, declare, or pay any distributions on the Common Stock, unless all
distributions accumulated on all shares of such preferred stock have been paid
in full. The distributions payable on such preferred stock may impair Essex’s
ability to pay dividends on its Common Stock.
If
Essex
wishes to issue any Common Stock in the future (including, upon exercise of
stock options), the funds required to continue to pay cash dividends at current
levels will be increased. Essex’s ability to pay dividends will depend largely
upon the performance of the Properties and other properties that may be acquired
or developed in the future.
If
Essex
cannot pay dividends on its stock, Essex’s status as a real estate investment
trust may be jeopardized. Our ability to pay dividends on our common stock
is
further limited by the Maryland General Corporation Law. Under the Maryland
General Corporation Law, Essex may not make a distribution on stock if, after
giving effect to such distribution, either:
Resale
of shares pursuant to our effective registration statement may have an adverse
effect on the market price of the shares
-
Pursuant to the acquisition of John M. Sachs, Inc., a real estate company,
in
December 2002, we issued 2,719,875 shares of common stock, as partial
consideration for the acquisition, to the trusts that were the shareholders
of
that company. In connection with the acquisition, Essex entered into a
registration rights agreement with these trusts, pursuant to which in January
2003 we filed a registration statement on Form S-3 in order to enable the resale
of these shares of common stock. In an amendment to this registration statement
filed in April 2003, we also registered, pursuant to certain registration
rights, 50,000 shares of common stock which are issuable to the trusts in
connection with certain contractual obligations and 2,270,490 shares of common
stock which are issuable upon exchange of limited partnership interests in
the
Operating Partnership. These limited partnership interests are held by senior
members of our management, certain members of our Board of Directors and certain
outside investors, or the Operating Partnership holders, and comprise
approximately 9.6% of the limited partnership interests of the Operating
Partnership as of December 31, 2005. In the 2003 registration statement, we
registered, pursuant to certain registration rights, 1,473,125 shares of common
stock, which are issuable upon redemption of all of the limited partnership
interests in such real estate partnerships. In total, this 2003 registration
statement covers in aggregate 6,513,490 shares of our common stock. In January
2006, we filed registration statements that cover (1) the resale of up to
142,076 shares issuable in connection with our Waterford and Vista Belvedere
acquisitions and (2) the resale of shares issuable in connection with the
exchange rights of our 3.625% Senior Exchangeable Notes, as to which there
is a
principal amount of $225 million outstanding. The resale of the shares of common
stock pursuant to these various registration statements may have an adverse
effect on the market price of our shares.
The
exchange and repurchase rights of Exchangeable Senior Notes may be detrimental
to holders of common stock -
The
Operating Partnership has $225 million principal amount of 3.625% Exchangeable
Senior Notes (the “Notes”) outstanding which mature on November 1, 2025. The
Notes are exchangeable into the Company's common shares on or after November
1,
2020 or prior to November 1, 2020 under certain circumstances. The Notes are
redeemable at the Company's option for cash at any time on or after November
4,
2010 and are subject to repurchase for cash at the option of the holder on
November 1st
in the
years 2010, 2015 and 2020, or upon the occurrence of certain events. The Notes
are senior unsecured and unsubordinated obligations of the Company. The exchange
of Notes for common stock would dilute stockholder ownership in the Company,
and
could adversely affect the market price of our common stock and could impair
our
ability to raise capital through the sale of additional equity securities.
If
the Notes are not exchanged, the repurchase rights of holder of the Notes may
discourage or impede transactions that might otherwise be in the interest of
holders of common stock. Further, these repurchase rights might be triggered
in
situations where Essex needs to conserve its cash reserves, in which event
such
repurchase might adversely affect Essex and its common holders.
Our
Chairman is involved in other real estate activities and investments, which
may
lead to conflicts of interest - Our
Chairman, George M. Marcus is not an employee of Essex, and is involved in
other
real estate activities and investments, which may lead to conflicts of interest.
Mr. Marcus owns interests in various other real estate-related businesses and
investments. He is the Chairman of The Marcus & Millichap Company, or
“TMMC”, which is a holding company for certain real estate brokerage and
services companies. TMMC has an interest in Pacific Property Company, a company
that invests in West Coast multifamily residential properties. In 1999 we sold
an office building to TMMC, which Essex previously occupied as its corporate
headquarters.
Mr.
Marcus has agreed not to divulge any information that may be received by him
in
his capacity as Chairman of Essex to any of his affiliated companies and that
he
will abstain his vote on any and all resolutions by the Essex Board of Directors
regarding any proposed acquisition and/or development of a multifamily property
where it appears that there may be a conflict of interest with any of his
affiliated companies.
10
Notwithstanding
this agreement, Mr. Marcus and his affiliated entities may potentially compete
with us in acquiring and/or developing multifamily properties, which competition
may be detrimental to us. In addition, due to such potential competition for
real estate investments, Mr. Marcus and his affiliated entities may have a
conflict of interest with us, which may be detrimental to the interests of
Essex’s stockholders.
The
influence of executive officers, directors and significant stockholders may
be
detrimental to holders of common stock
- As of
December 31, 2005, George M. Marcus, the Chairman of our Board of Directors,
wholly or partially owned 1,752,111 shares of common stock (including shares
issuable upon exchange of limited partnership interests in the Operating
Partnership and certain other partnerships and assuming exercise of all vested
options). This represents approximately 7.6% of the outstanding shares of our
common stock. Mr. Marcus currently does not have majority control over us.
However, he currently has, and likely will continue to have, significant
influence with respect to the election of directors and approval or disapproval
of significant corporate actions. Consequently, his influence could result
in
decisions that do not reflect the interests of all our stockholders.
Under
the
partnership agreement of the Operating Partnership, the consent of the holders
of limited partnership interests is generally required for any amendment of
the
agreement and for certain extraordinary actions. Through their ownership of
limited partnership interests and their positions with us, our directors and
executive officers, including Mr. Marcus and Mr. William A. Millichap, a
director of Essex, have substantial influence on us. Consequently, their
influence could result in decisions that do not reflect the interests of all
stockholders.
The
voting rights of preferred stock may allow holders of preferred stock to impede
actions that otherwise benefit holders of common stock
- In
general, the holders of Series F Preferred stock and of the preferred stock
into
which our preferred units are exchangeable do not have any voting rights.
However, if full distributions are not made on any outstanding preferred stock
for six quarterly distributions periods, the holders of preferred stock who
have
not received distributions, voting together as a single class, will have the
right to elect two additional directors to serve on Essex’s Board of Directors.
These voting rights continue until all distributions in arrears and
distributions for the current quarterly period on the preferred stock have
been
paid in full. At that time, the holders of the preferred stock are divested
of
these voting rights, and the term and office of the directors so elected
immediately terminates.
These
voting rights of the preferred stock may allow holders of preferred stock to
impede or veto actions that would otherwise benefit the holders of Essex’s
Common Stock. While any shares of Series F Preferred Stock or shares of
preferred stock into which the preferred units are exchangeable are outstanding,
Essex may not, without the consent of the holders of two-thirds of the
outstanding shares of each series of preferred stock, each voting separately
as
a single class;
The
redemption rights of the Series B preferred units, Series D preferred units
and
Series F preferred stock may be detrimental to holders of Essex common
stock
- Upon
the occurrence of one of the following events, the terms of the Operating
Partnership’s Series B and D Preferred Units require it to redeem all of such
units and the terms of Essex’s Series F Preferred Stock provide the holders of
the majority of the outstanding Series F Preferred Stock the right to require
Essex to redeem all of such stock:
The
aggregate redemption price of the Series B Preferred Units would be $80 million,
the aggregate redemption price of the Series D Preferred Units would be $50
million and the aggregate redemption price of the Series F Preferred Stock
would
be $25 million, plus, in each case, any accumulated distributions.
11
These
redemption rights may discourage or impede transactions that might otherwise
be
in the interest of holders of common stock. Further, these redemption rights
might trigger situations where Essex needs to conserve its cash reserves, in
which event such redemption might adversely affect Essex and its common
holders.
Maryland
business combination law may not allow certain transactions between Essex and
its affiliates to proceed without compliance with such
law
- The
Maryland General Corporation Law establishes special requirements for “business
combinations” between a Maryland corporation and “interested stockholders”
unless exemptions are applicable. An interested stockholder is any person who
beneficially owns ten percent or more of the voting power of the
then-outstanding voting stock.
The
law
also requires a supermajority stockholder vote for such transactions. This
means
that the transaction must be approved by at least:
However,
as permitted by the statute, the Board of Directors of Essex irrevocably has
elected to exempt any business combination by us, George M. Marcus, William
A.
Millichap, who are the chairman and a director of Essex, respectively, and
TMMC
or any entity owned or controlled by Messrs. Marcus and Millichap and TMMC.
Consequently, the super-majority vote requirement described above will not
apply
to any business combination between us and Mr. Marcus, Mr. Millichap, or TMMC.
As a result, we may in the future enter into business combinations with Messrs.
Marcus and Millichap and TMMC, without compliance with the super-majority vote
requirements and other provisions of the Maryland General Corporation Law.
Anti-takeover
provisions contained in the Operating Partnership agreement, charter, bylaws,
and certain provisions of Maryland law could delay, defer or prevent a change
in
control
- While
Essex is the sole general partner of the Operating Partnership, and generally
has full and exclusive responsibility and discretion in the management and
control of the Operating Partnership, certain provisions of the Operating
Partnership agreement place limitations on Essex’s ability to act with respect
to the Operating Partnership. Such limitations could delay, defer or prevent
a
transaction or a change in control that might involve a premium price for our
stock or otherwise be in the best interest of the stockholders or that could
otherwise adversely affect the interest of Essex’s stockholders. The partnership
agreement provides that if the limited partners own at least 5% of the
outstanding units of limited partnership interest in the Operating Partnership,
Essex cannot, without first obtaining the consent of a majority-in-interest
of
the limited partners in the Operating Partnership, transfer all or any portion
of our general partner interest in the Operating Partnership to another entity.
Such limitations on Essex’s ability to act may result in our being precluded
from taking action that the Board of Directors believes is in the best interests
of Essex’s stockholders. As of December 31, 2005, George M. Marcus held or
controlled more than 50% of the outstanding units of limited partnership
interest in the Operating Partnership, allowing such actions to be blocked
the
limited partner.
Essex’s
Charter authorizes the issuance of additional shares of common stock or
preferred stock and the setting of the preferences, rights and other terms
of
such preferred stock without the approval of the holders of the common stock.
We
may establish one or more series of preferred stock that could delay, defer
or
prevent a transaction or a change in control. Such a transaction might involve
a
premium price for our stock or otherwise be in the best interests of the holders
of common stock. Also, such a class of preferred stock could have dividend,
voting or other rights that could adversely affect the interest of holders
of
common stock.
Essex’s
Charter, as well as Essex’s stockholder rights plan, contains other provisions
that may delay, defer or prevent a transaction or a change in control that
might
be in the best interest of Essex’s stockholders. Essex’s stockholder rights plan
is designed, among other things, to prevent a person or group from gaining
control of us without offering a fair price to all of Essex’s stockholders. The
Bylaws may be amended by the Board of Directors to include provisions that
would
have a similar effect, although Essex presently has no such intention. The
Charter contains ownership provisions limiting the transferability and ownership
of shares of capital stock, which may have the effect of delaying, deferring
or
preventing a transaction or a change in control. For example, subject to
receiving an exemption from the Board of Directors, potential acquirers may
not
purchase more than 6% in value of the stock (other than qualified pension trusts
which can acquire 9.9%). This may discourage tender offers that may be
attractive to the holders of common stock and limit the opportunity for
stockholders to receive a premium for their shares of common stock.
The
Maryland General Corporations Law restricts the voting rights of shares deemed
to be “control shares.”
12
Under
the
Maryland General Corporations Law, “control shares” are those which, when
aggregated with any other shares held by the acquirer, entitle the acquirer
to
exercise voting power within specified ranges. Although the Bylaws exempt Essex
from the control share provisions of the Maryland General Corporations Law,
the
Board of Directors may amend or eliminate the provisions of the Bylaws at any
time in the future. Moreover, any such amendment or elimination of such
provision of the Bylaws may result in the application of the control share
provisions of the Maryland General Corporations Law not only to control shares
which may be acquired in the future, but also to control shares previously
acquired. If the provisions of the Bylaws are amended or eliminated, the control
share provisions of the Maryland General Corporations Law could delay, defer
or
prevent a transaction or change in control that might involve a premium price
for the stock or otherwise be in the best interests of Essex’s stockholders.
Essex’s
joint ventures and joint ownership of properties and partial interests in
corporations and limited partnerships could limit Essex’s ability to control
such Properties and partial interests
-
Instead
of purchasing properties directly, we have invested and may continue to invest
as a co-venturer. Joint venturers often have shared control over the operation
of the joint venture assets. Therefore, it is possible that the co-venturer
in
an investment might become bankrupt, or have economic or business interests
or
goals that are inconsistent with our business interests or goals, or be in
a
position to take action contrary to our instructions or requests, or our
policies or objectives. Consequently, a co-venturer’s actions might subject
property owned by the joint venture to additional risk. Although we seek to
maintain sufficient influence of any joint venture to achieve its objectives,
we
may be unable to take action without our joint venture partners’ approval, or
joint venture partners could take actions binding on the joint venture without
consent. Should a joint venture partner become bankrupt, we could become liable
for such partner’s share of joint venture liabilities.
From
time
to time, we, through the Operating Partnership, invest in corporations, limited
partnerships, limited liability companies or other entities that have been
formed for the purpose of acquiring, developing or managing real property.
In
certain circumstances, the Operating Partnership’s interest in a particular
entity may be less than a majority of the outstanding voting interests of that
entity. Therefore, the Operating Partnership’s ability to control the daily
operations of such an entity may be limited. Furthermore, the Operating
Partnership may not have the power to remove a majority of the board of
directors (in the case of a corporation) or the general partner or partners
(in
the case of a limited partnership) of such an entity in the event that its
operations conflict with the Operating Partnership’s objectives. The Operating
Partnership may not be able to dispose of its interests in such an entity.
In
the event that such an entity becomes insolvent, the Operating Partnership
may
lose up to its entire investment in and any advances to the entity. We have
and
in the future may enter into transactions that could require us to pay the
tax
liabilities of partners, which contribute assets into joint ventures or the
Operating Partnership, in the event that certain taxable events, which are
within our control, occur. Although we plan to hold the contributed assets
or
defer recognition of gain on their sale pursuant to the like-kind exchange
rules
under Section 1031 of the Internal Revenue Code, we can provide no assurance
that we will be able to do so and if such tax liabilities were incurred they
can
expect to have a material impact on our financial position.
Dedicated
investment activities and other factors specifically related to Fund
II.
- Fund
II involves risks to us such as the following:
We
will,
however, generally seek to maintain sufficient influence over Fund II to permit
it to achieve its business objectives.
Investments
in mortgages and other real estate securities
- We may
invest in securities related to real estate, which could adversely affect our
ability to make distributions to stockholders. We may purchase securities issued
by entities, which own real estate and invest in mortgages or unsecured debt
obligations. These mortgages may be first, second or third mortgages that may
or
may not be insured or otherwise guaranteed. In general, investments in mortgages
include the following risks:
13
If
any of
the above were to occur, cash flows from operations and our ability to make
expected dividends to stockholders could be adversely affected.
Possible
environmental liabilities
- Under
various federal, state and local laws, ordinances and regulations, an owner
or
operator of real estate is liable for the costs of removal or remediation of
certain hazardous or toxic substances on, in, to or migrating from such
property. Such laws often impose liability without regard as to whether the
owner or operator knew of, or was responsible for, the presence of such
hazardous or toxic substances. The presence of such substances, or the failure
to properly remediate such substances, may adversely affect the owner’s or
operator’s ability to sell or rent such property or to borrow using such
property as collateral. Persons exposed to such substances, either through
soil
vapor or ingestion of the substances may claim personal injury damages. Persons
who arrange for the disposal or treatment of hazardous or toxic substances
or
wastes also may be liable for the costs of removal or remediation of such
substances at the disposal or treatment facility to which such substances or
wastes were sent, whether or not such facility is owned or operated by such
person. Certain environmental laws impose liability for release of
asbestos-containing materials (“ACMs”) into the air, and third parties may seek
recovery from owners or operators of real properties for personal injury
associated with ACMs. In connection with the ownership (direct or indirect),
operation, management and development of real properties, the Company could
be
considered an owner or operator of such properties or as having arranged for
the
disposal or treatment of hazardous or toxic substances and, therefore, may
be
potentially liable for removal or remediation costs, as well as certain other
costs, including governmental fines and costs related to injuries of persons
and
property.
Investments
in real property create a potential for environmental liabilities on the part
of
the owner of such real property. We carry certain limited insurance coverage
for
this type of environmental risk. We have conducted environmental studies which
revealed the presence of groundwater contamination at certain properties. Such
contamination at certain of these properties was reported to have migrated
on-site from adjacent industrial manufacturing operations. The former industrial
users of the properties were identified as the source of contamination. The
environmental studies noted that certain properties are located adjacent to
any
possible down gradient from sites with known groundwater contamination, the
lateral limits of which may extend onto such properties. The environmental
studies also noted that at certain of these properties, contamination existed
because of the presence of underground fuel storage tanks, which have been
removed. In general, in connection with the ownership, operation, financing,
management and development of real properties, we may be potentially liable
for
removal or clean-up costs, as well as certain other costs and environmental
liabilities. We may also be subject to governmental fines and costs related
to
injuries to persons and property.
Recently
there has been an increasing number of lawsuits against owners and managers
of
multifamily properties alleging personal injury and property damage caused
by
the presence of mold in residential real estate. Some of these lawsuits have
resulted in substantial monetary judgments or settlements. Essex has been sued
for mold related matters and has settled some, but not all, such matters, which
matters remain unresolved and pending. Insurance carriers have reacted to mold
related liability awards by excluding mold related claims from standard policies
and pricing mold endorsements at prohibitively high rates. Essex has, however,
purchased pollution liability insurance, which includes limited coverage for
mold, although the insurance may not cover all pending or future mold claims.
Essex has adopted programs designed to manage the existence of mold in its
properties as well as guidelines for promptly addressing and resolving reports
of mold to minimize any impact mold might have on residents or the property.
Essex cannot assure you that it will not be sued in the future for mold related
matters not can it assure you that the liabilities resulting from such current
or future mold related matters will not be substantial. The costs of carrying
insurance to address potential mold related claims may also be
substantial.
California
has enacted legislation commonly referred to as “Proposition 65” requiring that
“clear and reasonable” warnings be given to consumers who are exposed to
chemicals known to the State of California to cause cancer or reproductive
toxicity, including tobacco smoke. Although we have sought to comply with
Proposition 65 requirements, we cannot assure you that we will not be adversely
affected by litigation relating to Proposition 65.
Methane
gas is a naturally-occurring gas that is commonly found below the surface in
several areas, particularly in the Southern California coastal areas.
Methane is a non-toxic gas, but can be ignitable in confined spaces.
Although naturally-occurring, methane gas is not regulated at the state or
federal level, some local governments, such as the County of Los Angeles, have
imposed requirements that new buildings install detection systems in areas
where
methane gas is known to be located.
14
Methane
gas is also associated with certain industrial activities, such as former
municipal waste landfills. Radon is also a naturally-occurring gas that is
found
below the surface. Essex cannot assure you that it will not be adversely
affected by costs related to its compliance with methane gas related
requirements or litigation costs related to methane or radon gas.
Except
with respect to three Properties, the Company has no indemnification agreements
from third parties for potential environmental clean-up costs at its Properties.
The Company has no way of determining at this time the magnitude of any
potential liability to which it may be subject arising out of unknown
environmental conditions or violations with respect to the properties formerly
owned by the Company. No assurance can be given that existing environmental
studies with respect to any of the Properties reveal all environmental
liabilities, that any prior owner or operator of a Property did not create
any
material environmental condition not known to the Company, or that a material
environmental condition does not exist as to any one or more of the Properties.
The Company has limited insurance coverage for the types of environmental
liabilities described above.
General
uninsured losses
- We
have a comprehensive insurance program covering our property and operating
activities. There are, however, certain types of extraordinary losses for which
we may not have insurance. Accordingly, we may sustain uninsured losses due
to
insurance deductibles, self-insured retention, uninsured claims or casualties,
or losses in excess of applicable coverage.
Changes
in real estate tax and other laws
-
Generally we do not directly pass through costs resulting from changes in real
estate tax laws to residential property tenants. We also do not generally pass
through increases in income, service or other taxes, to tenants under leases.
These costs may adversely affect funds from operations and the ability to make
distributions to stockholders. Similarly, compliance with changes in (i) laws
increasing the potential liability for environmental conditions existing on
properties or the restrictions on discharges or other conditions or (ii) rent
control or rent stabilization laws or other laws regulating housing may result
in significant unanticipated expenditures, which would adversely affect funds
from operations and the ability to make distributions to
stockholders.
Changes
in financing policy; no limitation on debt -
We have
adopted a policy of maintaining a debt-to-total-market-capitalization ratio
of
less than 50%. The calculation of debt-to-total-market-capitalization is as
follows: total property indebtedness divided by the sum of total property
indebtedness plus total equity market capitalization. As used in this
calculation, total equity market capitalization is equal to the aggregate market
value of the outstanding shares of common stock (based on the greater of current
market price or the gross proceeds per share from public offerings of the
outstanding shares plus any undistributed net cash flow), assuming the
conversion of all limited partnership interests in the Operating Partnership
into shares of common stock and the gross proceeds of the preferred units.
Based
on this calculation (including the current market price and excluding
undistributed net cash flow), our debt-to-total-market-capitalization ratio
was
approximately 35% as of December 31, 2005.
Our
organizational documents do not limit the amount or percentage of indebtedness
that may be incurred. Accordingly, the Board of Directors of Essex could change
current policies and the policies of the Operating Partnership regarding
indebtedness. If we changed these policies, we could incur more debt, resulting
in an increased risk of default on our obligations and the obligations of the
Operating Partnership, and an increase in debt service requirements that could
adversely affect our financial condition and results of operations. Such
increased debt could exceed the underlying value of the Properties.
We
are subject to certain tax risks
- Essex
has
elected to be taxed as a REIT under the Internal Revenue Code. Essex’s
qualification as a REIT requires it to satisfy numerous requirements (some
on an
annual and quarterly basis) established under highly technical and complex
Internal Revenue Code provisions for which there are only limited judicial
or
administrative interpretations, and involves the determination of various
factual matters and circumstances not entirely within Essex’s control. Although
Essex intends that its current organization and method of operation enable
it to
qualify as a REIT, it cannot assure you that it so qualifies or that it will
be
able to remain so qualified in the future. Future legislation, new regulations,
administrative interpretations or court decisions (any of which could have
retroactive effect) could adversely affect Essex’s ability to qualify as a REIT
or adversely affect its stockholders. If it fails to qualify as a REIT in any
taxable year, Essex would be subject to U.S. federal income tax (including
any
applicable alternative minimum tax) on its taxable income at corporate rates,
and would not be allowed to deduct dividends paid to its shareholders in
computing its taxable income. Essex may also be disqualified from treatment
as a
REIT for the four taxable years following the year in which it failed to
qualify. The additional tax liability would reduce its net earnings available
for investment or distribution to stockholders, and it would no longer be
required to make distributions to its stockholders. Even if Essex continues
to
qualify as a REIT, it will continue to be subject to certain federal, state
and
local taxes on its income and property.
15
Essex
has
established several taxable REIT subsidiaries. Despite Essex’s qualification as
a REIT, its taxable REIT subsidiaries must pay U.S. federal income tax on their
taxable income. While Essex will attempt to ensure that its dealings with its
taxable REIT subsidiaries will not adversely affect its REIT qualification,
it
cannot provide assurance that it will successfully achieve that result.
Furthermore, Essex may be subject to a 100% penalty tax, or its taxable REIT
subsidiaries may be denied deductions, to the extent its dealings with its
taxable REIT subsidiaries are not deemed to be arm’s length in nature. No
assurances can be given that Essex’s dealings with its taxable REIT subsidiaries
will be arm’s length in nature.
From
time
to time, we may transfer or otherwise dispose of some of our Properties. Under
the Internal Revenue Code, any gain resulting from transfers of Properties
that
we hold as inventory or primarily for sale to customers in the ordinary course
of business would be treated as income from a prohibited transaction subject
to
a 100% penalty tax. Since we acquire properties for investment purposes, we
do
not believe that our occasional transfers or disposals of property are
prohibited transactions. However, whether property is held for investment
purposes is a question of fact that depends on all the facts and circumstances
surrounding the particular transaction. The Internal Revenue Service may contend
that certain transfers or disposals of properties by us are prohibited
transactions. If the Internal Revenue Service were to argue successfully that
a
transfer or disposition of property constituted a prohibited transaction, then
Essex would be required to pay a 100% penalty tax on any gain allocable to
Essex
from the prohibited transaction and Essex’s ability to retain future gains on
real property sales may be jeopardized. Income from a prohibited transaction
might adversely affect Essex’s ability to satisfy the income tests for
qualification as a REIT for U.S. federal income tax purposes. Therefore, no
assurances can be given that Essex will be able to satisfy the income tests
for
qualification as a REIT.
Item
1B. Unresolved Staff Comments.
None.
Item
2. Properties
Our
core
apartment portfolio as of December 31, 2005 (including partial ownership
interests) was comprised of 126 multifamily properties (comprising 26,587
apartment units), of which 13,382 units are located in Southern California,
6,557 units are located in the San Francisco Bay Area, 5,471 units are located
in the Seattle Metropolitan Area, and 875 units are located in the Portland
Metropolitan Area. The Company’s multifamily properties accounted for 99% of the
Company’s property revenues for the year ended December 31, 2005.
Occupancy
Rates
The
126
apartment communities had an average Same-Properties occupancy (as defined
in
Item 7), based on “financial occupancy,” during the year ended December 31,
2005, of approximately 96.9%. With respect to stabilized multifamily properties
with sufficient operating history, occupancy figures are based on financial
occupancy (the percentage resulting from dividing actual rental revenue by
total
possible rental revenue). Actual rental revenue represents contractual revenue
pursuant to leases without considering delinquency and concessions. Total
possible rental revenue represents the value of all apartment units, with
occupied units valued at contractual rental rates pursuant to leases and vacant
units valued at estimated market rents. We believe that financial occupancy
is a
meaningful measure of occupancy because it considers the value of each vacant
unit at its estimated market rate. Financial occupancy may not completely
reflect short-term trends in physical occupancy and financial occupancy rates
as
disclosed by other REITs may not be comparable to our calculation of financial
occupancy.
As
of
December 31, 2005, the headquarters building was 100% occupied by the Company
and the Southern California office building was 99% occupied, based on physical
occupancy. With respect to office buildings, occupancy figures are based on
“physical occupancy” which refers to the percentage resulting from dividing
leased and occupied square footage by rentable square footage. With respect
to
recreational vehicle parks, manufactured housing communities, or multifamily
properties which have not yet stabilized or have insufficient operating history,
occupancy figures are based on “physical occupancy” which refers to the
percentage resulting from dividing leased and occupied units by rentable units.
For
the
year ended December 31, 2005, none of the Company’s Properties had book values
equal to 10% or more of total assets of the Company or gross revenues equal
to
10% or more of aggregate gross revenues of the Company.
Multifamily
Residential Properties
Our
apartment communities are generally suburban garden apartments and town homes
comprising multiple clusters of two and three story buildings situated on three
to fifteen acres of land.
16
The
multifamily properties have on average 210 units, with a mix of studio, one,
two
and some three-bedroom units. A wide variety of amenities are available at
each
apartment community, including covered parking, fireplaces, swimming pools,
clubhouses with complete fitness facilities, volleyball and playground areas
and
tennis courts.
We
select, train and supervise a full team of on-site service and maintenance
personnel. We believe that the following primary factors enhance our ability
to
retain tenants:
Office
Buildings
The
Company’s corporate headquarters is located in a two-story office building with
approximately 17,400 square feet located at 925 East Meadow Drive, Palo Alto,
California. The Company acquired this property in 1997. The Company also owns
an
office building in Southern California (Woodland Hills), comprised of
approximately 38,940 square feet building, of which the Company occupies
approximately 11,200 square feet at December 31, 2005. The building has nine
third party tenants occupying approximately 27,400 feet. The largest single
tenant occupies approximately 10,900 square feet. The Company acquired this
property in 2001. The Company has a mortgage loan receivable on an office
building with approximately 110,000 square feet located in Irvine, California,
which is consolidated under FIN 46R.
Recreational
Vehicle Parks and Manufactured Housing Community
The
Company owns three recreational vehicle parks (comprising of 562 spaces),
acquired in the Company’s December 2002 acquisition of John M. Sachs, Inc.,
located in El Cajon and San Jaciento, California.
The
Company owns one manufactured housing community (containing 157 sites), acquired
in the Company’s December 2002 acquisition of John M. Sachs, Inc., located in
Vista, California.
17
The
following tables describe the Company’s Properties as of December 31, 2005. The
first table describes the Company’s multifamily residential properties and the
second table describes the Company’s other real estate assets.
18
19
20
21
Item
3. Legal Proceedings
In
April
2004, an employee lawsuit entitled Chance Nelson and Douglas Korte, et al vs.
Essex Property Trust, as filed against the Company in the California Superior
Court in the County of Alameda. In this lawsuit, two former Company maintenance
employees seek unpaid wages, associated penalties and attorneys’ fees on behalf
of a putative class of the Company’s current and former maintenance employees
who were required to wear a pager while they were on call during evening and
weekend hours. In June 2005, the Company recorded $1.5 million for legal
settlement costs. There has been no change to the settlement amount since the
second quarter of 2005. However, litigation is subject to inherent
uncertainties, and such amount represents management’s best estimate of the
total cost of the litigation at this time.
Recently
there has been an increasing number of lawsuits against owners and managers
of
multifamily properties alleging personal injury and property damage caused
by
the presence of mold in residential real estate. Some of these lawsuits have
resulted in substantial monetary judgments or settlements. The Company has
been
sued for mold related matters and has settled some, but not all, of such
matters. Insurance carriers have reacted to mold related liability awards by
excluding mold related claims from standard policies and pricing mold
endorsements at prohibitively high rates. The Company has, however, purchased
pollution liability insurance, which includes coverage for mold. The Company
has
adopted programs designed to manage the existence of mold in its properties
as
well as guidelines for promptly addressing and resolving reports of mold to
minimize any impact mold might have on residents or the property. Liabilities
resulting from such mold related matters and the costs of carrying insurance
to
address potential mold related claims may also be substantial.
The
Company is subject to various other lawsuits in the normal course of its
business operations. Accordingly, such lawsuits, as well as the class action
lawsuit described above, could result in substantial costs and diversion of
resources and could have a material adverse effect on the Company’s financial
condition, results of operations or cash flows.
During
the fourth quarter of 2005, no matters were submitted to a vote of security
holders.
22
Part
II
The
shares of the Company’s common stock are traded on the New York Stock Exchange
(“NYSE”) under the symbol ESS.
Market
Information
The
Company’s common stock has been traded on the NYSE since June 13, 1994. The
high, low and closing price per share of common stock reported on the NYSE
for
the quarters indicated are as follows:
The
closing price as of March 10, 2006 was $105.50.
Holders
The
approximate number of holders of record of the shares of the Company’s common
stock was 208 as of March 10, 2006. This number does not include stockholders
whose shares are held in trust by other entities. The actual number of
stockholders is greater than this number of holders of record.
Return
of Capital
Under
provisions of the Internal Revenue Code of 1986, as amended, the portion of
the
cash dividend, if any, that exceeds earnings and profits is considered a return
of capital. The return of capital is generated due to a variety of factors,
including the deduction of non-cash expenses, primarily depreciation, in the
determination of earnings and profits.
The
status of the cash dividends distributed for the years ended December 31, 2005,
2004 and 2003 for tax purposes is as follows:
23
Dividends
and Distributions
Since
its
initial public offering on June 13, 1994, the Company has paid regular quarterly
dividends to its stockholders. From inception, the Company has paid the
following dividends per share of common stock:
Future distributions by the Company will be at the discretion of the Board of Directors and will depend on the actual funds from operations of the Company, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code, applicable legal restrictions and such other factors as the Board of Directors deems relevant. There are currently no contractual restrictions on the Company’s present or future ability to pay dividends. On
February 23, 2006, the Company announced the Board of Directors approved a
$0.12
per share annual increase to the quarterly cash dividend. Accordingly, the
first
quarter dividend distribution, payable on April 17, 2006 to stockholders as
of
record as of March 31, 2006, will be $0.84 per share.
Dividend
Reinvestment and Share Purchase Plan
The
Company has adopted a dividend reinvestment and share purchase plan designed
to
provide holders of Common Stock with a convenient and economical means to
reinvest all or a portion of their cash dividends in shares of Common Stock
and
to acquire additional shares of Common Stock through voluntary purchases.
Computershare, LLC, which serves as the Company’s transfer agent, administers
the dividend reinvestment and share purchase plan. For a copy of the plan,
contact Computershare, LLC at (312)
360-5354.
Stockholder
Rights Plan
In
1998,
the Company adopted a stockholder rights plan that is designed to enhance the
ability of all of the Company’s stockholders to realize the long-term value of
their investment. The rights plan is designed, in part, to prevent a person
or
group from gaining control of the Company without offering a fair price to
all
of the Company’s stockholders.
On
October 13, 1998, the Board declared a one for one preferred share purchase
right (a “Right”) for each outstanding share of Common Stock. Each Right
entitles the registered holder to purchase from the Company one one-hundredth
of
a share of Series A Junior Participating Preferred Stock, par value $.0001
per
share, of the Company, at a price of $99.13 per one-hundredth of a share,
subject to adjustment. The description and terms of the Rights are set forth
in
a Rights Agreement dated as of November 11, 1998, as amended between the Company
and Computershare, LLC as Rights Agent.
Securities
Authorized for Issuance under Equity Compensation
Plans
See
our
disclosure in the 2006 Proxy Statement under the heading “Equity Compensation
Plan Information”, which disclosure is incorporated herein by
reference.
Issuer
Purchases of Equity Securities
In
October and November 2005, the Operating Partnership raised $225 million from
the sale of exchangeable senior notes. In conjunction with the sale of the
notes, on October 28, 2005 the Operating Partnership repurchased an aggregate
of
286,073 shares at a cost of approximately $25 million.
24
Item
6. Selected Financial Data
The
following tables set forth summary financial and operating information for
the
Company from January 1, 2001 through December 31, 2005.
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