Essex Property Trust (NYSE: ESS) is a real estate investment trust that owns and rents apartment communities in southern California, the San Francisco Bay Area, and metro areas in the Pacific Northwest. With 27,248 apartment units across 133 apartment communities, five office buildings (totaling approximately 215,840 square feet), and four active development projects with 581 units in various stages of development, Essex focuses on metropolitan areas in which supply is constrained and demand is driven by strong population and employment growth. The company pursues a strategy of operating in high barrier-to-entry markets in which obtaining proper regulatory approval and obtaining properties on favorable terms is difficult. ESS generally operates in proximity to businesses, transportation, employment and recreation centers in each of its markets, in order to help target employees in these areas who have a propensity to rent rather than purchase a home elsewhere.
During 2009, the Company completed the acquisition of two communities. In December 2009, the Company acquired Axis 2300 (formerly DuPont Lofts), a 115 unit condominium development project in Irvine. In December 2009, the Company acquired Regency at Encino, a 75 unit community located in Encino, California. In November 2009, the Company acquired a 3.6 acre site in Dublin, California. The land parcel is located adjacent to the Dublin Bay Area Rapid Transit station.
Essex's performance is tied to interest rates, which have several important effects. While the company competes for tenants with other apartment operators, it also competes on the relative attractiveness of owning a home versus renting an apartment. When home prices are high, renting becomes more attractive (and vice versa). Interest rates determine the attractiveness of mortgage financing. When interest rates are high, renting becomes more appealing as financing a mortgage becomes more expensive. It is also important to note that Essex operates as a real estate investment trust (REIT). As such, the company must distribute at least 90% of its cash flow to shareholders every year in the form of a dividend. When interest rates rise, so do demands for investment yields on dividends, which can depress a REIT's stock price.
Second Quarter 2010 Results
During the second quarter, Essex Property Trust reported revenues decreased by $4.3 million or 4.4% to $92.3 million from $96.6 million in the second quarter of 2009. The decrease was primarily attributable to a decrease in scheduled rents of $5.5 million as reflected in a decrease of 5.8% in average rental rates from $1,375 per unit in the second quarter of 2009 to $1,295 per unit in the second quarter of 2010. Scheduled rents decreased by 4.2%, 6.0%, and 10.6% in Southern California, Northern California, and Seattle Metro, respectively. The Company has experienced a decrease in scheduled rents due to the slowdown in the economy coupled with job losses during 2009.
During 2009 through the second quarter of 2010, the Company experienced a decrease in gross revenue in comparison to the prior year in the Company s markets from the reduction in rents from leases entered during those periods. The decrease in scheduled rents was partially offset by an increase of occupancy of 40 basis points or $0.6 million, from 96.8% for the second quarter of 2009 to 97.2% for the second quarter of 2010.
Depreciation expense increased by $2.4 million or 8.2% for the second quarter of 2010 compared to the second quarter of 2009, due to the acquisition of two communities, the completion of four development properties, and the capitalization of approximately $19.0 million in additions to rental properties for the six months ended June 30, 2010 and the capitalization of approximately $55.6 million in additions to rental properties, including $26.7 million spent on redevelopment and revenue generating capital expenditures during 2009.
The strength of the labor market has important implications for the company. Jobs fuel demand for all types of housing, including multi-family/apartment dwellings. Strong job growth can drive higher occupancy rates and lead to increased unit rental revenue. High unemployment and slow job growth, on the other hand, can hamper the apartment rental market and, when job growth is negative, the company can experience falling occupancy rates and lower revenue per unit, which leads to less efficient apartment buildings as the utilization of the complex falls.
Factors driving the non-apartment, alternative housing market can have a substantial impact on the company. Throughout 2007, falling housing prices in the company’s key markets, coupled with decreasing new home construction and the rising cost of financing mortgages increased demand for apartments relative to houses and other living alternatives. However, if housing prices continue to fall, houses can become more attractive to purchasers, and they may substitute away from apartments and opt for single-family housing instead.
The attractiveness of mortgage financing for home purchasers has important ramifications for the apartment REITs. If mortgage rates fall and credit is plentiful, buying a home becomes more attractive than renting an apartment, thus stifling demand for the company’s rental units. On the other hand, if the availability and attractiveness of mortgages declines, as did during the fallout from the subprime lending crisis, renting an apartment becomes more appealing, so occupancy rates and rental revenue per apartment increase.
The rate of population growth in the company's operating regions is another key determinant of the company's success. In towns whose populations are rapidly increasing, limited housing supply and/or the lag time in building houses leads to greater demand for the company's apartment units. The growth in local population is also closely correlated to the rate of job growth.
All of the company's properties are located in either southern Californian cities, the San Francisco Bay area, Portland, OR, or Seattle, WA. As compared to competitor AIV, a REIT that is widely geographically diversified, the company is exposed more heavily to risks of the local economies of these three states. The rate of job growth, property taxes, zoning requirements and regulations, and other factors within these states can have important effects on the company's bottom line. The lack of geographic diversity exposes the company more heavily to real estate cycles in its operating areas, as real estate values move in tandem within a given city.
Southern California is at greater risk of earthquakes than most other areas in the United States. Since a substantial portion of the company's properties are located in earthquake prone cities, the company must manage the risk of potential earthquake damage. While the company is insured up to around $150 million, a fat-tail event such as a severe earthquake could cause substantial damage over and above the company's coverage limits.
The company competes against a wide array of other apartment rental owner/operators. The National Multi Housing Council estimates that around 17 million apartment units exist nationwide. The median rental income per unit is around $650 per month. In the company's core market, California, there are an estimated 2.5 million apartment units, and, given the attractive demographic and economic characteristics of the state's coastal cities, competition is intense. As partly evidenced by the chart to the left, for instance, all of the company's major publicly traded competitors have operations in California.
The market for multi-family housing is highly fragmented geographically as well as within any given region. To the left are industry statistics for each of the major markets of publicly traded apartment REITs.
Below is a table of relevant competitive data as compared to rival or comparable companies:
|Company||Apt. Units||Addressable Market (Units)||Local Market Share||National Market Share||Occupancy Rate||Operating Margin||Revenue/unit|