Essex Property Trust Inc

NYSE:ESS

Earnings Call Transcript 2018-Q4

[Operator]

Good day and welcome to the Essex Property Trust Fourth Quarter 2018 Earnings Call. As a reminder, today’s conference call is being recorded. Statements made in this conference call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made based on current expectations, assumptions and beliefs as well as information available to the company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found in the company’s filings with the SEC. When we get to the question-and-answer portion, management asks that you be respectful of everyone’s time and limit yourself to one question and one follow-up.

It is now my pleasure to introduce your host, Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you. You may begin.

[Michael Schall, President and Chief Executive Officer]

Thank you and welcome to the ESS fourth quarter earnings call. John Burkart and Angela Kleiman will follow me with comments and John Eudy is here for Q&A. Today I will review our 2018 results, summarize our expectations for 2019 and provide an update on the West Coast investment markets. Before beginning, I would like to recognize John Eudy whose retirement was announced last month for his many contributions to the company’s success over the past 30 plus years.

Turning to the first topic, 2018 was another solid year for Essex with 5.5% core FFO per share growth and 2.9% same property NOI growth both slightly better than anticipated at the start of the year. To put 2018 results into a broader perspective, ESS has generated a 16% compounded annual total return to shareholders since its IPO 24 years ago ranking us number 1 in total shareholder return for the REIT industry since the IPO. Over that period, we achieved an 8.5% compounded annual growth rate in FFO per share and a dividend that has grown for 24 consecutive years. Next month, our board will consider increasing our dividend for the 25th year, placing us among a select group of company known as Dividend Aristocrats. Achieving these results was as much about discipline as it was about being opportunistic, especially as it relates to capital allocation. We have found that avoiding major mistakes and understanding the local real estate markets has led to winning formula. To use a baseball analogy, our goal is to get many base hits while minimizing unforced errors. Although 2018’s 5.5% FFO growth is below our historical average, it is consistent with later phases of an economic cycle and the challenges in finding investments that add to per share, core FFO and NAV.

While we are proud of our nearly 25-year track record as a public company, our team remains focused on continuous improvement of our platform for the next 25 years as it relates to residents, colleagues and shareholders. Setting the stage for 2019, we continue to see strong levels of housing demand relative to the national average across our West Coast footprint. We ended 2018 with trailing 3-month job growth in the Essex metros of 2.1%, which exceeded our initial expectations. The primary drivers of the out-performance were the tech markets of San Jose and Seattle, where we saw a strong increase in high-quality jobs during the quarter compared to 1 year ago. We believe this trend will continue as tech firms continue to expand in our markets.

Over the past year, job openings in California and Washington at the top 10 public tech firms all of which are located in Essex markets grew 49% to over 23,000 open positions, the highest level we have seen since we started tracking this data several years ago. While considerable recent attention has focused on the announced expansion of large tech companies in other areas of the country, we would like to note that these very same companies were pursuing nearly twice as much growth in their West Coast markets during the same time period as demonstrated on Page S-16.1 of the supplemental.

Turning to 2019, we continue to expect the tight labor markets and low unemployment will continue to push wages upward. In 2018, personal income growth was estimated at 6% in our markets compared to 3.9% for the U.S. We believe this outperformance will continue into 2019. As a result of wages growing faster than rents, we continue to see rent to income ratios decline in nearly all of our markets as compared to a year ago leading to improved rental affordability. Our supply estimates for 2019 have not changed from what we published in our third quarter supplemental. Overall, we expect a similar level of supply deliveries in 2019 as compared to 2018 although there are significant differences by market such as large increases in apartment deliveries in downtown LA and CBD Oakland offset by reduced apartment deliveries in Orange County and San Diego.

Last quarter, we discussed the change in methodology for estimating apartment supply by factoring construction delays into our forecast. This resulted in pushing the delivery of 3,000 multifamily units from 2018 to 2019 resulting in a supply delivery estimate of roughly 35,000 units for 2018. Looking back to our original supply estimates at the beginning of 2018, we overestimated multifamily supply by 8% primarily due to construction delays while third-party providers overestimated 2018 supply by as much as 65%. The improved accuracy of our multifamily supply estimates reflect several process improvements implemented by our research team who track and frequently visit apartment communities under development. Although we are monitoring several macro related risks to the economy, steady supply levels and healthy job growth support our expectation that rent growth will be mostly consistent with long-term averages for the Essex markets in 2019.

Turning to investment market conditions, a review of transactions on our West Coast markets since the last quarterly call suggests no change to cap rates. The heightened market volatility in December resulted in a few deals being dropped. However, conditions have since stabilized. Generally, cap rates do not move quickly and the first indication of changing conditions is often lower transaction volumes. With plenty of capital still looking to buy apartments and tempered Fed expectations for interest rates, we expect little change to cap rates in the near future. We continue to view the best risk adjusted returns on our investment dollars will be found in the preferred equity market and we expect to close a few more deals in 2019 given our current pipeline. That concludes my comments.

I will turn the call over to John Burkart.

[John Burkart, Senior Executive Vice President]

Thank you, Mike. For the full year, we achieved 2.8% year-over-year same-store revenue growth exceeding our original guidance. I would like to thank all our associates for their hard work and focus on achieving these results.

Overall, our markets are stronger today than 1 year ago. In the fourth quarter, market rents were 3.5% higher at the end of 2018 compared to 2017. Consistent with my comments last quarter related to the strengthening of the market and our related operating strategy, we expect to continue emphasizing market rent over higher occupancy in 2019. Our 2019 guidance contemplates a reduction of occupancy of about 20 basis points to 96.6% for the full year.

Regarding expenses, we continue to see pressure in 2019 in utilities, taxes and wages with offsets in other categories largely controllables leading to operating expense guidance of 3% year-over-year for 2019 at the midpoint. The operating team continues to do a great job of identifying opportunities to increase efficiencies in the operating platform. In 2018, they had held controllable expenses to 1.6% year-over-year growth and in 2019 they are expected to do about the same. Office leasing activity provides insight into future rental demand. We are encouraged by the robust office leasing environment and continued office construction announcements in the second half of 2018, which we have illustrated for the major public tech companies on Page S-16.1 of the supplemental. I will provide more regional detail on this leasing activity in my market commentary.

In terms of supply, the focus of new apartment deliveries continues to be in the downtown locations. Overall in 2019, we expect that supply deliveries as a percentage of stock will be 2.8% in the downtown markets versus 60 basis points in the suburban areas surrounding the CBDs of the largest coastal cities. Essex’s portfolio is not concentrated in the downtown locations and therefore should be less impacted by new supply.

Now, I will provide an update on our markets. For the full year of 2018, Seattle had its strongest year since 2000 with 3.4% year-over-year job growth. Although Amazon announced the second and third headquarter location, Amazon’s open positions for Washington have increased over 150% from Q4 2017. In Q4 2018, there were almost 9,000 openings at Amazon and Washington. Other major employers in the Pacific Northwest hit major milestones in their continued plans to expand the Pacific Northwest offices, including Microsoft breaking ground on their 2.5 million square foot expansion in Redmond; Costco receiving city approval for their 1.2 million square foot expansion in Issaquah; and Facebook’s new lease of over 1 million square feet in South Lake Union. Additionally, Amazon and Facebook continue to expand outside of Downtown Seattle pre-leasing 750,000 square feet office in Bellevue, Washington.

Moving to Northern California, job growth in the San Francisco Bay Area averaged 2.3% year-over-year in Q4 led by San Jose with 3.2% growth the vast majority of which occurred in high paying industries such as professional and business services and information. Tech companies, Google, Facebook and DoorDash, expanded their downtown San Francisco presence by over 2 million square feet. In the South Bay, Google was active in purchasing over $1 billion worth of land and property while expanding their Sunnyvale and Mountain View footprint by over 400,000 square feet. Our year-over-year same-store revenue growth for the same period was led by our San Mateo and San Jose submarkets with 4.2% and 3.2% growth respectively, followed by Fremont at 2.9%, Oakland at 2.1% and San Francisco with 1.7% growth for the same period. Supply in the San Francisco and San Jose MDs is slightly lower in 2019 compared to 2018. However, we see supply in the Oakland MD increasing to 3,500 units, of which 3,000 units will be delivered in downtown Oakland. Although the total supply in the Bay Area is still relatively low at 70 basis points, it will be impactful in downtown Oakland.

Continuing South, Southern California job growth for our markets averaged 1.2% in Q4, which was negatively impacted by Orange County. Los Angeles remained consistent with the region posting 1.4% growth for the period. Netflix continues to solidify their presence in the market pre-leasing an additional 355,000 square feet in Hollywood. Google and Facebook both completed deals to expand a combined 860,000 square feet in West LA. Year-over-year revenue growth for the fourth quarter of 2018 was led by our Woodland Hills and West LA submarkets, with 4.7% and 4.3% growth respectively trailed by Long Beach with 2.8% growth and Tri-Cities with 2.4% growth, while LA CBD remains flat.

Regarding supply, I have had similar comment for downtown LA as in Oakland. Although the supply overall in LA County is relatively low at 60 basis points, the concentration in downtown LA is significant. We expect deliveries in downtown LA to increase from about 2,000 units in 2018 to about 4,000 units in 2019. In Orange County, jobs in the fourth quarter grew 30 basis points year-over-year and actually turned negative when looking at December 2018 over the prior year’s period. A similar situation occurred in the numbers last year and it was revised with the annual benchmarking in March, which we will review closely this year.

Finally, in San Diego year-over-year job growth was 1.9% for the fourth quarter of 2018. Most of the job growth is attributed to jobs added in high paying industries. In addition to tech giant Apple’s plan for a campus in Austin, the company also announced goals to add over 1,000 employees in San Diego as well as Culver City and Seattle. Military activity will have a moderate impact in the market on the margins with one carrier having departed at the beginning of the year and the potential of two inbound carriers arriving later in the year, each carrier strike group has an estimated 7,500 crew members. Year-over-year revenue growth in the fourth quarter of 2018 was 4.2% for our North City submarket, 3.9% for Oceanside, and 2.4% in Chula Vista. Currently, our portfolio is at 97% occupancy and our availability 30 days out is at 4%. Thank you.

And I will now turn the call over to our CFO, Angela Kleiman.

[Angela Kleiman]

Thank you, John. Today, I will focus on our 2019 guidance followed by an update on capital markets and the balance sheet. The key assumptions supporting our 2019 forecast starts on Page 4 of the press release and S-14 of the supplemental. We are guiding to a midpoint of 3% for both same property revenue and expense growth. The revenue growth assumptions is primarily driven by our expectation of a steady market rent growth near the long-term average and for our West Coast markets to continue to outperform the U.S. average.

On core FFO guidance, we are expecting a growth rate of 3.7% at the midpoint. You mentioned on the third quarter call that there are two key headwinds impacting this growth rate. First is debt refinancing as the effective rate on the debt coming due is below current rates in the marketplace. Second is the lease up of our development pipeline. When a building first opens, even though it is vacant, we recognize the operating and associated interest expense. This effect creates a temporary drag on cash flow. Since over 85% of our development pipeline will start lease up this year, we anticipate a more meaningful FFO per share drag of between $0.05 to $0.10 in 2019. Once the buildings are stabilized which typically takes 12 to 18 months per phase, we expect the drag to become a tailwind.

Turning to capital markets activities, for the year, Essex was a net seller of assets as we arbitrage between private market yields and our cost of capital. During the fourth quarter, we sold 8th & Hope in Downtown Los Angeles for $220 million, which represents a cap rate close to mid 3%. We purchased this property over 3 years ago for $200 million which we funded with common stock when we were trading at a large premium to net asset value. Recently, using the proceeds from the sale of this property, we have repaid debt and repurchased stock, because we have been trading at a discount to net asset value. Since the beginning of 2018, we have repurchased $108 million of stock at an average price of $243.44. Currently, our 2019 guidance does not assume any additional stock repurchase other than what has been completed through January. As always, we remain disciplined capital allocators and are ready to adjust our plan depending on market conditions to maximize shareholder returns.

Lastly, on the balance sheet, we plan to repay about $880 million of debt in 2019. This includes pre-paying a $290 million secured loan that matures in 2020 without incurring any prepayment fees. We generally favor refinancing on maturities with long term unsecured debt subject to relative pricing of course. As for the $290 million loan prepayment, we had discussed on our previous call that the average pay rates on this debt is 5.7%, while the effective rate used to calculate GAAP interest expense is 3.8%. So, even though the FFO impact will be negative, we will generate annual cash savings of approximately $3 million.

In summary, our balance sheet remains strong, with only 25% leverage, 5.4x debt to EBITDA, and over $1.5 billion of liquidity. We are well-positioned to take advantage of any opportunities that may arise in 2019. That concludes my comments. And I will now turn the call back to the operator for questions.

[Operator]

Thank you. [Operator Instructions] Our first question comes from Nick Joseph with Citi. Please proceed with your question.

[Nick Joseph, Citi]

Thanks. Wondering if you can talk about the same-store revenue growth throughout 2019 given difficult occupancy comps seen at least in the first quarter and probably for the first half of the year?

[John Burkart, Senior Executive Vice President]

Yes, sure. This is John. The first quarter is going to be a little bit tougher and part of it because of some noise that we had from other income, the benefit of other income last year. So the year-over-year comps are a little tougher. For example, in January, our rental revenue on preliminary numbers is 3%, but the actual revenue, overall revenue is 2.6%. So, it will come out looking less than desirable, but the reality is the market is actually stronger this year than it was last year. So overall, we are in a better position, but the first quarter numbers would be lighter and then it will pickup throughout the year.

[Nick Joseph, Citi]

Thanks. And then just on development, it looks like two of the projects were delayed by a quarter and I recognize that that could be a shift of only a few weeks. So are these projects actually seeing delays or is it more normal quarterly shift?

[John Eudy]

This is John Eudy. The labor issue delayed a couple of our deals. They are actually only pushed out about a 1.5 month, but it pushed it into the next quarter, so that was the reason behind it.

[Nick Joseph, Citi]

Thanks.

[Operator]

Our next question comes from Trent Trujillo with Scotiabank. Please proceed with your question.

[Trent Trujillo, Scotiabank]

Hi, good morning and thanks for taking the questions. I appreciate the commentary on supply in different markets, but it looks like there is a lot of supply that’s scheduled to deliver in the Bay Area. So, how are you thinking about your ability to retain residents, perhaps maintain occupancy and drive rent growth, because I believe one of your peers cited recently that the new assets could have rents that are at 15% to 20% discounts to existing products? So do you think that will be a drawing point or do you see enough demand that it may not be much of an ultimate impact?

[Michael Schall, President and Chief Executive Officer]

Hi, Trent, this is Mike. Thanks for your question. Yes, we continue to see the Bay Area as the area that has the strongest job growth and the strongest economy. And if you look at overall levels of supply, we think 2019 will be somewhere around 1% of stock on the apartment side and 0.7% of stock on total supply in the Bay Area. So obviously we are growing jobs at 2%. Those numbers do not appear to be concerning. And the other point I would make is there is sort of a trend toward fewer for-sale units being built and a few more apartments being built and the for-sale component is impacted by higher mortgage rates and higher prices. I think California had a median home price increase of somewhere around 5% over the past year. So, the for-sale side is getting more expensive and I think that, that benefits the rental. But when we look basically at supply and demand, we think demand significantly outstrips supply as it relates to all housing and apartments as well.

[Trent Trujillo, Scotiabank]

Okay, great. And then maybe one for John Eudy, this might be one of the last times we can ask about this with your transition, but you took a lead role in the Prop 10 campaign. So maybe can you provide your latest thoughts on affordability measures and maybe let us know about the efforts you have seen and been involved in and what you think could be a potential resolution to the housing shortage and affordability issues in California?

[John Eudy]

Well, that is a very long-winded question I’ll do my best to answer it first off, as you know, Prop 10 was defeated handsomely 60/40 by 20 points and I think the leadership of the legislature and our new governor understand that repealing Costa-Hawkins was not good for California and California housing so that’s good as far as all the measures that are out there to create more housing, it gets back to the economic drivers and how we’re going to make it work I can’t speak to how some of the affordable housing solutions that have been bantered around at the legislature are actually going to get done, but there is discussion but as you well know, the economics have to work for anything to be built, and it’s been tough the last couple of years to even keep up with the supply demands that we’ve had so I don’t see it blowing up, if you will, meaning unabated amount of construction beginning to occur it is going to be a long struggle in California and a deep hole for housing shortage, if you will, and it’s going to take a long time to get out of it there is a lot of focus on post Prop 10, what can we do if anything and I think that’s being discussed if there are any amendments to or call it reform to Costa-Hawkins, they would be very minor is my expectation.

[Trent Trujillo, Scotiabank]

Okay, thank you very much.

[Operator]

Our next question comes from Shirley Wu with Bank of America/Merrill Lynch. Please proceed with your question.

[Shirley Wu, Bank of America/Merrill Lynch]

Hey, guys. Thanks for taking the question. So going back to your revenue guidance of 2.5% to 3.5%, how comfortable are you with that range? And what do you think it will take to get to the upper versus the lower end range in terms of rents and occupancy?

[John Burkart, Senior Executive Vice President]

Sure. This is John speaking. We are very comfortable with our range and obviously with our midpoint at this point in time the markets right now are stronger than they were a year ago we mentioned at the last call, we had a better loss to lease position, which puts us in a good spot we shifted our strategy where we’re favoring market rent as opposed to occupancy so all those things lead to a stronger market at the same time though there are some headwinds, because of the occupancy headwinds I mentioned about 20 basis points of occupancy headwind that will work against us what would make things better or worse is really jobs I would say if the jobs we’re watching that Orange County jobs I mentioned that and if that turns out unfavorable that will hurt that market. It’s not a huge market but will hurt that we are seeing some stronger job growth certainly in Seattle and the Bay Area so that would be the upside and the downside would be Orange County jobs does that answer your question?

[Shirley Wu, Bank of America/Merrill Lynch]

Yes. So actually also on supply, you mentioned that right now you have a good slippage into ’19 but it seems as if slippage is a consistent theme, so have you accounted for slippage from ‘19 into ‘20 into your projection?

[John Burkart, Senior Executive Vice President]

Yes, this is John. What we made shift last year because you’re right, it is a fairly consistent theme where we go out and we drive all of the assets and look and make an assessment as to where they’re at, come up with our best judgment as to the timing but even then, there is errors just because of the labor shortage and the slippage so what we adjusted is we continued that process of driving every asset, but then we made a more of a macro adjustment based on our experience that we have over the last several years to modify that so we’re more confident this year than in the past as it relates to our supply expectations, but, yeah, I acknowledge it’s the last couple of years have been tough because of the delays.

[Shirley Wu, Bank of America/Merrill Lynch]

Got it. Thank you.

[Operator]

Our next question is from Austin Wurschmidt with KeyBanc Capital Markets. Please proceed with your question.

[Austin Wurschmidt, KeyBanc Capital Markets]

Hi there. Question, when you look at your forecasts for supply versus third-party forecasts for 2019 are there still material differences? And do you think they’ve got a handle on the timing of completions at this point?

[Michael Schall, President and Chief Executive Officer]

Hi Austin, it’s Mike Schall. As John just alluded to, we spent a lot of time on the supply estimates and that’s largely because there are such a high degree of variation out there in terms of estimates as I noted in my comments that some of the vendors had 65% more supply in 2018 than was actually delivered and typically that just moves into the next year and then the next year appears to be overstated so without making a systematic adjustment, like the one we made, to move 3,000 units from this year to next year and then do the same thing from ‘19 to ‘20, you end up with these huge numbers that are out there that are well beyond reality in our opinion so we think that similar to ‘17 and ‘18, there’ll be around 35,000 units per year that are delivered in our West Coast markets unless something changes in the construction labor market, which candidly we don’t see, it was the point we made last time on last quarter’s call, that I don’t know how you could expect a significant increase in the amount of supply when the labor market hasn’t fundamentally changed and in fact, I would say that there are demographic issues within the construction labor market, because there are more people retiring and going into the trade and you also have, maybe as an anecdote, people, construction workers diverted to some of these fire destroyed areas that are taking people out of the labor markets in some of the metro areas and moving them into the areas that had these fires so without a fundamental change in construction labor, I don’t see how you could possibly produce a tremendous number of more homes makes sense?

[Austin Wurschmidt, KeyBanc Capital Markets]

Yes, that’s an interesting anecdote. Thanks for that. Do you think once we pass peak construction or peak supply deliveries in a specific quarter and that pipeline begins to slow that there is I don’t know if you call it a greater risk or greater likelihood that projects are completed on time?

[Michael Schall, President and Chief Executive Officer]

Yes, I think I’d go back to what John Eudy just said, it’s all about the economics so for the past couple of years we’ve had rents growing at somewhere around 3%, 2% to 3%, and construction costs have been growing at the high single digit to low double-digit rate and so the net effect of those two numbers is to compress development yields and this is why I think it’s unlikely that you’re going to have a significant increase in the number of units developed from a from the perspective of just economics in terms of development economics and really this underlies our switch from direct development where we’re buying land and for future start and concern therefore about that construction cost increase between when we commit to land and when we start and rather than that focus on our preferred equity portfolio where we’re financing someone else’s development deal and we are coming in at the point that we know the cost because they have a construction loan, they are signing a contract with the general contractor etcetera. so, we think that’s a low risk, more appropriate way to approach development at this point in time.

[Austin Wurschmidt, KeyBanc Capital Markets]

I appreciate the thoughts, Mike. And then last one for me is, you talked about downtown LA significant concentration of supply doubling in ‘19 versus ’18 can you just speak to the concession trends you’re seeing as well as what your guys’ exposure is in the market now following the sale of 8th and Hope?

[Michael Schall, President and Chief Executive Officer]

John, do you want to do that? [indiscernible]

[John Burkart, Senior Executive Vice President]

Sure, I’ll grab that. Yes, so what we are seeing now as far as concessions in that market is it’s pretty consistent with what we typically see in the fourth quarter because again reminding everybody that it’s the lower point in the season so concessions are up a couple of weeks, they are now roughly 6, 6 to 8 weeks in the downtown LA market, specifically as it relates to lease-ups, not same-store but lease-ups and that’s fairly normal we one might expect with the new supply coming on this year that it might get more aggressive, we’ll watch that carefully as it relates to our exposure in the downtown market for LA, our exposure is pretty small. It’s right now, a couple of percent of the whole portfolio, it’s really not very big at this point after that sale does that answer your question?

[Austin Wurschmidt, KeyBanc Capital Markets]

Yes, absolutely. That was very helpful. Thank you.

[Operator]

Our next question comes from Alexander Goldfarb with Sandler O’Neill. Please proceed with your question.

[Alexander Goldfarb, Sandler O’Neill]

Yes, good morning out there. So two questions. First, on the operating expense, you guys talked about your ability to really make headway on the controllables to offset the payroll utility and taxes, but it certainly seems Mike to your comments on labor shortage, seems like payroll wages is going to be a continuing pressure point so can you just talk ongoing you said that you could manage it this year do you think that’s sustainable or do you think that expenses are going to rise in the future if you guys are unable to further control the controllables?

[John Burkart, Senior Executive Vice President]

Yes, Alex, this is John. I will take a stab at it. I know you said, Mike, but I’ve got the controllables in my bucket here so as it relates to wages, you’re right, there is significant pressure out there let’s not forget that one of our issues is affordability and so as wages go up, it does help the overall picture much, much more so if this was a long-term trend that would actually be very beneficial for affordability and therefore rents but getting back to your specific question, sure, in the end of the day it goes up forever, we will run out of potentially run out of opportunities but we continue to find ways to leverage the asset collections that we have with sharing of personnel to reduce total labor while we are still paying our people significantly more so everybody is winning in that equation we are also finding opportunities to leverage technology to automate various processes and in doing so improving the customer experience, making things much faster as well as our employee experience and again reducing labor or vendor costs so what we see for the foreseeable future is a lot of opportunity, but a tremendous amount of work with change management to try to implement the different things that we’re looking at.

[Michael Schall, President and Chief Executive Officer]

Does that answer your question there?

[Alexander Goldfarb, Sandler O’Neill]

Yes, yes, it does and I was referencing Mike’s comments on wage with construction labor but actually now I am going to turn to Angela on the guidance page it looks like capitalized interest is expected to be higher, if I’m reading the guidance page correctly, and it so if you could just talk, are you guys anticipating increasing the development pipeline? I mean, it didn’t sound that way, but if you could just walk through why capitalized interest looks to be higher in ‘19 than ‘18?

[Angela Kleiman]

Oh, sure and I am happy to Alex that’s really just a function of our current development pipeline we still have about $250 million a little over $250 million of spend this year and because of that capitalized interest is going to naturally increase so it’s nothing more than just how those numbers work out.

[Alexander Goldfarb, Sandler O’Neill]

Okay, thanks Angela.

[Michael Schall, President and Chief Executive Officer]

Thanks, Alex.

[Operator]

Our next question comes from John Kim with BMO Capital Markets. Please proceed with your question.

[John Kim, BMO Capital Markets]

Good morning. I think Mike in your prepared remarks, you mentioned preferred equity as your most attractive risk-adjusted returns for your dollar spend yet your guidance for this year anticipates only $50 million to $100 million which is less than what you’ve invested last year and on top of that you expect to be a net seller this year. So just wondering if we should read into that that most investment opportunities are getting pricy?

[Michael Schall, President and Chief Executive Officer]

Yes, John, it’s a good observation. Thanks for that. I think it has to do with the other point I made a minute ago which is construction cost increasing faster than rents and a lot of these deals are being pushed back in fact, most of our pipeline in 2019 represents the deals that we thought were going to close in 2018 and it just essentially has been pushed back so they require typically more equity than some of the sponsors originally thought they would and otherwise need to be reworked so basically it’s taken us a longer period of time to get the preferred equity deals to the closing table and so we remain optimistic in 2019 we actually have a very good pipeline right now and so perhaps just a little bit of upside to the guidance assumption but again, given the inherent uncertainty, we are we want to make sure we had a level that we could for sure close.

[John Kim, BMO Capital Markets]

Okay. And then John mentioned Orange County and the slight loss of jobs that occurred in December, it doesn’t sound like you’re concerned about it too much at this point, but you’re still maintaining your 20,000 jobs forecast for the year I’m just wondering if you had to reduce that job forecast, how sensitive would that be to your market trend forecast?

[Michael Schall, President and Chief Executive Officer]

Yes, John, this is Mike and John will follow me. Job growth there is 1.2% and job growth in Southern California is about 1.3% so I don’t think that we have been aggressive on jobs I think we’re being thoughtful and realistic so all of these assumptions can vary to some degree and but I think if you look back historically, we have been pretty close on virtually everything and if anything maybe a little bit conservative.

[John Burkart, Senior Executive Vice President]

Yes. And I would just add, you remember last year with Orange County, the jobs were pretty flat and then the revisions came through and they revised back a whole bunch of jobs. We’re watching that situation. I’m not sure if that’ll happen again or not, but we’re watching that closely. We’re not seeing signs that the market is having great struggles. I just want to bring it up on the call so people are aware and seeing what we see that there was a negative print in jobs in December.

[John Kim, BMO Capital Markets]

Got it. Okay, thank you.

[Operator]

Our next question comes from Drew Babin with Robert W. Baird. Please proceed with your question.

[Drew Babin, Robert W. Baird]

Hey, good morning.

[Michael Schall, President and Chief Executive Officer]

Hi, Drew.

[Drew Babin, Robert W. Baird]

A question – hey, going into next year, obviously, there were quite a few markets where you had a pickup in kind of the second derivative of leasing in 2018. In your guidance, are you assuming that any markets has another second derivative improvement in pricing power for 2019 guidance purposes?

[John Burkart, Senior Executive Vice President]

I wouldn’t say it that way. I would look at it and say, we expect the markets to continue to stay strong. We had a – really a shift in the market and it goes all the way back to ‘17 when things were slow in the first half of ‘18 and then they shifted – clearly shifted. We see a continued strength in the market, but not necessarily something really taking off, but we do see continued strength in the market and we look at factors like the Northern California job growth, the Seattle job growth and consistency in the SoCal region again with the exception of Orange County and expect that things will continue pretty good over the next year, again, with supplies generally in check overall in the larger markets.

[Drew Babin, Robert W. Baird]

Okay, that’s helpful. And I guess kind of converting that over to loss to lease language, it would seem based on your market rent forecast for ‘19, as well as some of the comments on loss to lease, towards the end of ‘18 that revenue growth would maybe be a bit higher than implied by the midpoint of guidance. I know you talked about the 20 basis points of occupancy decline. I guess, can you quantify the piece of that kind of caused by overall deceleration in property fee income growth or kind of what’s the drag being created by that?

[John Burkart, Senior Executive Vice President]

Let me kind of walk through big picture the way I look at it. Typically, again, and thank you for referencing loss to lease, to Essex it’s one of the key metrics along with market rent and of course occupancy adjustment, that’s how we look at it. And so, when looking at loss to lease, we typically like to look at it in September. It’s after peak leasing and before things slow down in the normal seasonal slowdown. So, at that point we had about 1.6% for the portfolio loss to lease, and again, on average with 12 month leases, you’re going to figure, you’re going to get all of that over the next year. Then, if you look at our rent in S-16, it’s 3.1% and if you look at that and say we’re going to take a mid-year convention on how that hits the market, that gets you about another 155 basis points. And then if you take the 20 basis points of occupancy and subtract that out, that gets you into about the 2.95% range for revenue and we’re pretty darn close to that at 3%. So that big picture how we kind of look at it and see it the year, so I think we are pretty spot on with our 3% midpoint guidance.

[Drew Babin, Robert W. Baird]

Okay. The explanation is very helpful. And lastly just in Seattle, it would seem based on some of the data out there and some commentary that supply is beginning to kind of directionally shift from downtown out more towards the East side and also some news about tech firms possibly getting behind the creation of additional kind of lower and middle income housing out on the East side. I guess are you seeing anything in the market at this point in time any kind of disruption and what kind of visibility can you provide about some of those East side submarkets around Seattle?

[Michael Schall, President and Chief Executive Officer]

Well, yes, I think you’re right, Drew. There is more development on the East side than there have been in West. It was – development was very focused on Downtown Seattle first and then Downtown Bellevue and then now it’s moving more into the suburban areas of Seattle. And – but we see an overall trend of reduced supply in the Seattle area more broadly. So in ‘18, we had 9,750 units in Seattle being delivered 9,019 and then about little over 6,000 in 2020. So, we think actually that the supply side is actually going in the right direction. And then the other side is, obviously the demand side, which continues to be very robust. So – and maybe the other piece, which is affordability, which we were bit concerned about more in the California markets, Seattle is much more affordable. So, we still view Seattle as being an appropriate area to invest. And as you can tell from our 2019 expectation, it’s just a small bit below our expectation for market rent growth compared to Southern Cal and Northern Cal.

[Drew Babin, Robert W. Baird]

Great. Appreciate the explanation. Thank you.

[Operator]

Our next question comes from Wes Golladay with RBC Capital Markets. Please proceed with your question.

[Wes Golladay, RBC Capital Markets]

Yes, good morning to everyone. Go and look at that 8th and Hope transaction, it was described as an arbitrage, and I’m just wondering – it looks like you bought all the stock in the last week of the quarter. Is it – was it conceivable that you guys could actually sell the asset and buy the stock in a one-week period or were you contemplating that maybe throughout the entire quarter?

[Michael Schall, President and Chief Executive Officer]

Yes, hey Wes, it’s Mike. Yes, I guess we hope to buy the stock if we could. If we didn’t buy the stock, we thought that debt rates could increase to a point that there was still positive arbitrage just kind of smaller refinance for example. So, it was going to be positive arbitrage no matter what happened in our view. But obviously the opportunity to buy the stock back was the better outcome and we’re pretty excited about it.

[Wes Golladay, RBC Capital Markets]

Yes. Well, congrats on buying the bottom. Big picture though when you’re selling assets at a 3.5% cap rate, which I believe you cited, do you think eventually if there’s more transactions like that developers will start to lower their hurdle and then maybe this whole low interest rate environment could just be maybe negative long-term for overall rent growth?

[Michael Schall, President and Chief Executive Officer]

Well, it’s pretty challenging on this side to respond to hypothetical type of questions, but because our view is, it’s all a matter of looking at the landscape, a variety of different points of view. So, in that case, I guess what you’re talking about is higher valuations of apartments are going to increase. The next question I would ask you is, hey, does that mean that the stock price is going to increase too and our cost of capital is going to decline, because again, we are constantly looking at what’s better. The real estate portfolio or the value implied in the stock and trying to understand that so we make good capital allocation decisions. So, to ask a question that just focuses on one variable without the other variable is challenging to answer. Does that make sense?

[Wes Golladay, RBC Capital Markets]

No, that’s fair point. And I definitely agree with the way you look at it from the relative value of your stock. That’s it for me. Thanks.

[Michael Schall, President and Chief Executive Officer]

Okay, thank you.

[Operator]

Our next question comes from Hardik Goel with Zelman & Associates. Please proceed with your question.

[Hardik Goel, Zelman & Associates]

Hey, guys. Thanks for taking my question. I was just wondering on the supply and adjustment there, obviously, you guys have the best view into the market, you guys drive around, you view these assets, I’m just wondering, what’s causing the delay beyond just the labor issues. So, if you look at assets that are maybe high-rise versus something that’s more mid-rise, is the high-rise more likely to be delayed than the mid-rise, are there certain kinds of projects that are more likely to be delayed? What kind of color can you add on the delays, specifically?

[John Eudy]

This is John Eudy. I’ll try to answer that. The more complicated the structure obviously, the higher likelihood that there could be more delays as everything stacks up on itself. The general labor issues that the industry has faced over the last year specifically has been the driver and the out-migration of the older construction folks that are no longer there like they were 10 years ago as part of the answer. So, it’s a little bit of everything, Hardik, but yes, the more complex the construction, the higher likelihood there would be delays in this environment for the next 12 months, say.

[Hardik Goel, Zelman & Associates]

And is that just on a construction basis or also complexity on the capital structure side that you notice?

[John Eudy]

Well, I was just referring to construction, but on the capital, obviously, the numbers have to work to want to do a deal, but you’ve already committed once you start it, so it’s in the pipeline. So, I was only referring to the pipeline when I responded.

[Hardik Goel, Zelman & Associates]

Well, thanks so much, John, and best of luck as you retire.

[John Eudy]

Well, I’ll never retire, but I’m not going to be working 24/7.

[Michael Schall, President and Chief Executive Officer]

We’re not going to let John go that easy.

[John Eudy]

Yes.

[Operator]

Our next question comes from John Guinee with Stifel. Please proceed with your question.

[John Guinee, Stifel]

Great, thank you. First, John, we’re going to miss you, it’s been a great 30 years, boy.

[John Eudy]

34, just to be exact, not that I’m counting.

[John Guinee, Stifel]

34, wow. You have started there when you were 16, wow. Any 1031 Exchange requirements on 8th and Hope? And then other two questions, any promote income identified in 2019 and then refresh our memory and if you already did this and I missed it, I apologize, how you handle the Costa-Hawkins costs that you incurred in 2018?

[Angela Kleiman]

Sure. Thanks, John. On the 8th and Hope, there is a small piece of 1031 exchange, but it’s not such a meaningful impact on the gains, because we had – we had sold back then. It was the last piece of share gain. So just a small piece. So really doesn’t impact the ultimate gain numbers in a material way and we certainly have the ability to absorb that without impacting a dividend. And as far as the Costa-Hawkins and the G&A impact we pulled that off core and we actually disclosed it separately, and I think it’s on Page 5 or 6 in the press release. But in any event the total cost, which is also public information for Costa-Hawkins is about $5.8 million for the full-year. And we don’t expect, of course, such a significant one-time item to reoccur in 2019, and so we don’t have a forecasted number.

[John Guinee, Stifel]

Angela, any promote income expected in 2019?

[Angela Kleiman]

At this point, not yet, we’re still reevaluating the platform because that involves conversations with the joint venture and market conditions and there’s a lot more conversations that goes into just factoring getting a promote.

[John Guinee, Stifel]

Great. Thank you.

[Angela Kleiman]

So, we certainly have a good embedded pipeline on the promote.

[John Guinee, Stifel]

Great, thank you very much. Thank you.

[Michael Schall, President and Chief Executive Officer]

Thanks, John.

[Operator]

Our next question comes from Tayo Okusanya with Jefferies. Please proceed with your question.

[Tayo Okusanya, Jefferies]

Hi, yes, good morning over there on the West Coast. Let me also add my congratulations John on your semi-retirement and Adam also congrats on the promotion. A couple of things from our end. I think we’ve talked about the cap rate on 8th and Hope. Could you just give us a sense of kind of some of the other cap rates of some of the other acquisitions you did during the quarter, as well as disposition?

[Michael Schall, President and Chief Executive Officer]

Sure, this is Mike. As I mentioned in the prepared remarks, I don’t think cap rates have changed a whole heck of a lot for A quality property and locations, it’s around a 4% cap rate. Sometimes you have very well located very high quality, let’s say, A plus, A plus plus type property that will go sub-4 cap rates. And then for B quality or let’s say, from A minus to B minus, you have a – you would add probably from 30 basis points to 60 basis points to the A cap rate. So again, very consistent with what we’ve said in the past.

[Tayo Okusanya, Jefferies]

Okay. That’s helpful. And the second question, given the viewpoint on cap rates, is that one of the main reasons why you still forecast being the net seller of assets in 2019 similar to 2018?

[Michael Schall, President and Chief Executive Officer]

Yes, again it’s what I said earlier, it really is the relationships between the stock price and net asset value of the Company and the different components that go into each of those. Notably, for example, our debt on balance sheet is lower cost and if we go and incur debt tomorrow, which gives our balance sheet a reason to buy it versus just transact in the marketplace. So, we’re looking for the appropriate arbitrage and add value on – from the transactional side. We also need to fund our development pipeline.

[Tayo Okusanya, Jefferies]

Got it. Okay. That’s it from my end. Congrats. Thank you.

[Michael Schall, President and Chief Executive Officer]

Thank you.

[Operator]

Our next question comes from John Pawlowski with Green Street Advisors. Please proceed with your question.

[John Pawlowski, Green Street Advisors]

Thanks. Let’s say, go back to Orange County a bit and contrast it to I think it was a year ago in the Bay Area where you saw similar scary BLS job growth trajectories and that were restated. So, I understand the concern with restatements. Is it that your on-the-ground trends, which I’m guessing could be better predictors of job growth and BLS. Those on-the-ground trends a year-ago corroborated BLS type numbers, at least as I stated and this time they’re kind of telling you a different answer that on-the-ground trends and Orange County are actually a lot stronger than the BLS numbers?

[John Burkart, Senior Executive Vice President]

No, this is John. So last year, it really wasn’t the Bay Area, it was Orange County that was revised up pretty substantially. And last year we saw market rent growth in the context of everything that’s going on in the sense of supply being delivered and everything else, which was pretty good. And so, it was not consistent with BLS and I would go back and say, this year it’s a similar situation. We are seeing Orange County, say, the fourth quarter rents in Orange County were 2.9% year over prior year, yet the BLS has basically flat job growth for that quarter. We also expect lower supply deliveries going forward. So, the BLS is one number that’s out there and we watch it but we look at many numbers and we’re trying to make sense of it. Right now, on-the-ground, we’re not seeing a significant deterioration. And so, we’ll watch the revisions, but we’ll continue to stay more focused on what’s really going on in the rental market.

[John Pawlowski, Green Street Advisors]

Okay. Could you share that 2.9% growth in 4Q? What it will look like in January and what was that trend? What’s the trajectory of the trend into this year?

[John Burkart, Senior Executive Vice President]

Sure. The – that is up from where it was earlier in the year and in January it’s down a little bit from there as is San Diego. Both of those markets are down a little bit, but that’s not unusual at this point in time. That’s why I quoted the fourth quarter number as a whole because one-month there is a movement that can go on within our portfolio and certainly it’s the low demand period. So not really a good reference point. That’s why I use the whole quarter, but we only have January, so January is down a little bit from there.

[John Pawlowski, Green Street Advisors]

Okay. John Eudy on the Governor Newsom’s recent steps or planned steps to address the regional housing need allocations in certain cities. From your experience if he is successful and he does have bipartisan support, big yes, how quickly could we see starts starting to pick up in some of these cities that are forced to increase their allocation?

[John Burkart, Senior Executive Vice President]

Well, as you know John in California, not taking that into consideration that 4 years to 7 years is the cycle from identification of site till you actually have a stabilized asset. And some of the ambitious things that he has said sound good, but the execution in reality by the time you go through the process and sequel even if there is some sequel reform, you’re not really going to accelerate the timing that much and the economics drive the decision anyway. So, I don’t see a near-term over the next 3 years to 5 years massive increase from what we’re expecting to see.

[Michael Schall, President and Chief Executive Officer]

Hey John, John, it’s Mike. I just have one more thing to add to that. And I don’t know if you saw a strike in the backyard. But I think it’s notable that the City of Huntington Beach is suing the state over some of these new requirements SB-35. So, I think that’s something that we’re going to be keeping our eye on as it relates to these matters.

[John Pawlowski, Green Street Advisors]

Right. Okay. Thanks, guys.

[John Burkart, Senior Executive Vice President]

Nimby attitudes in California are not going to change easily is what I think Mike says.

[Michael Schall, President and Chief Executive Officer]

That’s the point, yes, exactly.

[Operator]

We will take our last question from Karin Ford with MUFG Securities. Please proceed with your question.

[Karin Ford, MUFG Securities]

Oh, hey, good morning out there. It doesn’t sound like you’re underwriting a recession in your 2019 outlook, but if we do end up going into one nationwide this year, how do you think the West Coast will fare and what do you think the downside risk could be to your job growth and market rent growth forecasts?

[Michael Schall, President and Chief Executive Officer]

Hi, Karin, it’s Mike. I am not sure exactly how to respond to that, because obviously it depends on what type of recession, how deep it is what happens to employment, etcetera. So, I have a hard time responding to it exactly. I would expect at the end of the cycle, conditions continue to change, jobs will trail off, the development pipelines will continue to be delivered, because once you turn a stated work, they will be finished and you’ll end up with a supply demand mismatch, but quantifying how that looks and exactly what that means I think it is virtually impossible to do at this point.

[Karin Ford, MUFG Securities]

Okay, fair enough. And then my second question is just on the preferred equity pipeline and book, you said in the third quarter press release that you had originated, I think an $18 million or $19 million investment in Burlingame, but the number of investments stayed at $17 million from September to December. Just I was wondering did something get paid off or did that deal just not happen?

[Michael Schall, President and Chief Executive Officer]

Yes. So, the typical duration of these preferred equity deals are 3 to 4 years. So yes, we are constantly having redemptions or repayments.

[Karin Ford, MUFG Securities]

Okay. Can you just give us a sense for what was repaid and what was the rate on it?

[Angela Kleiman]

Yes, it was a small deal, $6 million and the pay rate, I am just from memory was around 11%. But at this point, if you look at our total preferred equity commitment, it’s still pretty darn close to what we had disclosed last time it’s close to $400 million. So there is some inflows, there is some outflows, but net-net, we are still around that $400 million and we are well under our maximum capacity of $900 million.

[Karin Ford, MUFG Securities]

And is there anything – any new investment that you think is imminent in the first phase closing in the first quarter?

[Angela Kleiman]

That’s really hard to say, because we do as Mike said, have a good pipeline and that we are working through, but the timing of the close is just difficult to predict.

[Karin Ford, MUFG Securities]

Okay, thank you.

[Michael Schall, President and Chief Executive Officer]

Thank you, Karen.

[Operator]

At this time, I would like to turn the call back to Michael Schall for closing comments.

[Michael Schall, President and Chief Executive Officer]

Thank you, operator and thanks everyone for your participation on the call today. We look forward to seeing many of you at the Citigroup conference in March. Have a great day. Thank you.

[Operator]

This concludes today’s conference. You may disconnect your lines at this time and we thank you for your participation.