filings.toolsItem 1. Business
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Item 1. Business
OVERVIEW
Essex Property Trust, Inc. ("Essex"), a Maryland corporation, is an S&P 500 company that operates as a self-administered and self-managed real estate investment trust ("REIT"). Essex owns all of its interest in its real estate and other investments directly or indirectly through Essex Portfolio, L.P. (the "Operating Partnership" or "EPLP"). Essex is the sole general partner of the Operating Partnership and as of December 31, 2019, had an approximately 96.6% general partnership interest in the Operating Partnership. In this report, the terms the "Company," "we," "us," and "our" also refer to Essex Property Trust, Inc., the Operating Partnership and those entities/subsidiaries owned or controlled by Essex and/or the Operating Partnership.
Essex has elected to be treated as a REIT for federal income tax purposes, commencing with the year ended December 31, 1994. Essex completed its initial public offering on June 13, 1994. In order to maintain compliance with REIT tax rules, the Company utilizes taxable REIT subsidiaries for various revenue generating or investment activities. All taxable REIT subsidiaries are consolidated by the Company for financial reporting purposes.
The Company is engaged primarily in the ownership, operation, management, acquisition, development and redevelopment of predominantly apartment communities, located along the West Coast of the United States. As of December 31, 2019, the Company owned or had ownership interests in 250 operating apartment communities, aggregating 60,570 apartment homes, excluding the Company's ownership in preferred equity co-investments, loan investments, one operating commercial building, and a development pipeline comprised of five consolidated projects and two unconsolidated joint venture projects aggregating 1,960 apartment homes (collectively, the "Portfolio").
The Company’s website address is http://www.essex.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 its website as soon as practicable after the Company files the reports with the U.S. Securities and Exchange Commission ("SEC").
BUSINESS STRATEGIES
The following is a discussion of the Company’s business strategies in regards to real estate investment and management.
Business Strategies
Research Driven Approach to Investments – The Company believes that successful real estate investment decisions and portfolio growth begin with extensive regional economic research and local market knowledge. The Company continually assesses markets where the Company operates, as well as markets where the Company considers future investment opportunities by evaluating markets and focusing on the following strategic criteria:
| • | Major metropolitan areas that have regional population in excess of one million; |
| • | Constraints on new supply driven by: (i) low availability of developable land sites where competing housing could be economically built; (ii) political growth barriers, such as protected land, urban growth boundaries, and potential lengthy and expensive development permit processes; and (iii) natural limitations to development, such as mountains or waterways; |
| • | Rental demand enhanced by affordability of rents relative to costs of for-sale housing; and |
| • | Housing demand based on job growth, proximity to jobs, high median incomes and the quality of life including related commuting factors. |
Recognizing that all real estate markets are cyclical, the Company regularly evaluates the results of its regional economic, and local market research, and adjusts the geographic focus of its portfolio accordingly. The Company seeks to increase its portfolio
allocation in markets projected to have the strongest local economies and to decrease 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 allocations in markets that have inflated valuations and low relative yields.
Property Operations – The Company manages its communities by focusing on activities that may generate above-average rental growth, tenant retention/satisfaction and long-term asset appreciation. The Company intends to achieve this by utilizing the strategies set forth below:
| • | Property Management – Oversee delivery and quality of the housing provided to our tenants and manage the properties financial performance. |
| • | Capital Preservation – The Company's asset management services are responsible for the planning, budgeting and completion of major capital improvement projects at the Company’s communities. |
| • | Business Planning and Control – Comprehensive business plans are implemented in conjunction with significant investment decisions. These plans include benchmarks for future financial performance based on collaborative discussions between on-site managers, the operations leadership team, and senior management. |
| • | Development and Redevelopment – The Company focuses on acquiring and developing apartment communities in supply constrained markets, and redeveloping its existing communities to improve the financial and physical aspects of the Company’s communities. |
CURRENT BUSINESS ACTIVITIES
Acquisitions of Real Estate Interests
Acquisitions are an important component of the Company’s business plan, and during 2019, the Company acquired ownership interests in eight communities comprised of 2,007 apartment homes for a total contract price of $856.5 million.
The following is a summary of 2019 acquisitions ($ in millions):
| Property Name | Location | Apartment Homes | Essex Ownership Percentage | Ownership | Quarter in 2019 | Purchase Price | |||||||||||
| One South Market(1) | San Jose, CA | 312 | 100 | % | EPLP | Q1 | $ | 80.6 | |||||||||
| Brio(2) | Walnut Creek, CA | 300 | N/A | EPLP | Q2 | 164.9 | (3) | ||||||||||
| The Courtyards at 65th Street | Emeryville, CA | 331 | 50 | % | WESCO V | Q3 | 178.0 | (3) | |||||||||
| 777 Hamilton | Menlo Park, CA | 195 | 50 | % | BEX IV | Q3 | 148.0 | (3) | |||||||||
| Township | Redwood City, CA | 132 | 100 | % | EPLP | Q3 | 88.7 | ||||||||||
| Velo and Ray | Seattle, WA | 308 | 50 | % | WESCO V | Q4 | 133.0 | (3) | |||||||||
| Pure Redmond | Redmond, WA | 105 | 100 | % | EPLP | Q4 | 39.1 | ||||||||||
| Hidden Valley(4) | Simi Valley, CA | 324 | 100 | % | EPLP | Q4 | 24.2 | ||||||||||
| Total 2019 | 2,007 | $ | 856.5 |
| (1) | In March 2019, the Company purchased the joint venture partner's 45% membership interest in the One South Market co-investment based on an estimated property valuation of $179.0 million. In conjunction with the acquisition, $86.0 million of mortgage debt that encumbered the property was repaid. |
| (2) | In June 2019, the Company acquired Brio for a total contract price of $164.9 million in a DownREIT transaction. As part of the acquisition, the Company assumed $98.7 million of mortgage debt in the community. |
| (3) | Contract prices represent the total contract price at 100%. |
| (4) | In December 2019, the Company purchased the joint venture partner's 25% ownership interest in Hidden Valley, a consolidated community, based on an estimated property valuation of $97.0 million and an encumbrance of $29.7 million of mortgage debt. |
Dispositions of Real Estate
As part of its strategic plan to own quality real estate in supply-constrained markets, the Company continually evaluates all of its communities and sells those which no longer meet its strategic criteria. The Company may use the capital generated from the dispositions to invest in higher-return communities or other real estate investments, or to repay debts. The Company believes that the sale of these communities will not have a material impact on its future results of operations or cash flows nor will their sale materially affect its ongoing operations. Generally, the Company seeks to have any impact of longer-term earnings dilution resulting from these dispositions offset by the positive impact from reinvesting proceeds.
In October 2019, a Canada Pension Plan Investment Board ("CPPIB" or "CPP") joint venture, in which the Company had a 55.0% ownership interest at the time, sold Mosso, a 463 unit apartment home community located in San Francisco, CA, for $311.0 million, resulting in a gain of $50.2 million for the Company.
In October 2019, the Company sold a land parcel adjacent to the Mylo development community located in Santa Clara, CA, for $10.8 million and recorded an immaterial gain.
In December 2019, the Company sold land located in San Mateo, CA, that had been held for future development for $12.5 million and recorded a loss of $3.2 million.
Development Pipeline
The Company defines development projects as new communities that are being constructed, or are newly constructed and are in a phase of lease-up and have not yet reached stabilized operations. As of December 31, 2019, the Company's development pipeline was comprised of five consolidated projects under development and two unconsolidated joint venture projects under development aggregating 1,960 apartment homes, with total incurred costs of $1.0 billion, and estimated remaining project costs of approximately $222.0 million, $193.0 million of which represents the Company's estimated remaining costs, for total estimated project costs of $1.3 billion.
The Company defines predevelopment projects as proposed communities in negotiation or in the entitlement process with an expected high likelihood of becoming entitled development projects. As of December 31, 2019, the Company had various consolidated predevelopment projects. The Company may also acquire land for future development purposes or sale.
The following table sets forth information regarding the Company’s development pipeline ($ in millions):
| As of | |||||||||||||||
| 12/31/2019 | |||||||||||||||
| Essex | Estimated | Incurred | Estimated | ||||||||||||
| Development Pipeline | Location | Ownership% | Apartment Homes | Project Cost (1) | Project Cost**(1)** | ||||||||||
| Development Projects - Consolidated | |||||||||||||||
| Station Park Green - Phase II | San Mateo, CA | 100% | 199 | $ | 135 | $ | 141 | ||||||||
| Station Park Green - Phase III | San Mateo, CA | 100% | 172 | 119 | 134 | ||||||||||
| Station Park Green - Phase IV | San Mateo, CA | 100% | 107 | 16 | 94 | ||||||||||
| Mylo (2) | Santa Clara, CA | 100% | 476 | 197 | 226 | ||||||||||
| Wallace on Sunset (3) | Hollywood, CA | 100% | 200 | 70 | 105 | ||||||||||
| Total Development Projects - Consolidated | 1,154 | 537 | 700 | ||||||||||||
| Development Projects - Joint Venture | |||||||||||||||
| Patina at Midtown (4) | San Jose, CA | 50% | 269 | 115 | 136 | ||||||||||
| 500 Folsom (5) | San Francisco, CA | 50% | 537 | 377 | 415 | ||||||||||
| Total Development Projects - Joint Venture | 806 | 492 | 551 | ||||||||||||
| Predevelopment Projects - Consolidated | |||||||||||||||
| Other Projects | Various | 100% | — | 20 | 20 | ||||||||||
| Total - Consolidated Predevelopment Projects | — | 20 | 20 | ||||||||||||
| Grand Total - Development and Predevelopment Pipeline | 1,960 | $ | 1,049 | $ | 1,271 |
| (1) | Includes costs related to the entire project, including both the Company's and joint venture partners' costs. Includes incurred costs and estimated costs to complete these development projects. For predevelopment projects, only incurred costs are included in estimated costs. |
| (2) | Mylo was previously named Gateway Village. |
| (3) | Wallace on Sunset was previously named Essex Hollywood. |
| (4) | Patina at Midtown was previously named Ohlone. |
| (5) | Estimated project cost for this development is net of a projected value for low-income housing tax credit proceeds and the value of the tax exempt bond structure. |
Redevelopment Pipeline
The Company defines the redevelopment pipeline as existing properties owned or recently acquired, which have been targeted for additional investment by the Company with the expectation of increased financial returns through property improvement. During redevelopment, apartment homes may not be available for rent and, as a result, may have less than stabilized operations. As of December 31, 2019, the Company had ownership interests in four major redevelopment communities aggregating 1,327 apartment homes with estimated redevelopment costs of $132.7 million, of which approximately $14.9 million remains to be expended.
Long Term Debt
During 2019, the Company made regularly scheduled principal payments and loan payoffs of $951.6 million of its secured mortgage notes payable at an average interest rate of 4.2%.
In February 2019, the Company issued $350.0 million of senior unsecured notes due on March 1, 2029, with a coupon rate of 4.000% per annum (the "2029 Notes"), which are payable on March 1 and September 1 of each year, beginning on September 1, 2019. The 2029 Notes were offered to investors at a price of 99.188% of the principal amount thereof. The 2029 Notes are general unsecured senior obligations of the Operating Partnership, rank equally in right of payment with all other senior
unsecured indebtedness of the Operating Partnership and are unconditionally guaranteed by Essex Property Trust, Inc. In March 2019, the Company issued an additional $150.0 million of the 2029 Notes at a price of 100.717% of the principal amount thereof. These additional notes have substantially identical terms as the 2029 Notes issued in February 2019. The Company used the net proceeds of these offerings to repay indebtedness under its unsecured lines of credit and for other general corporate and working capital purposes.
In August 2019, the Company issued $400.0 million of senior unsecured notes due on January 15, 2030, with a coupon rate of 3.000% per annum (the "2030 Notes"), which are payable on January 15 and July 15 of each year, beginning on January 15, 2020. The 2030 Notes were offered to investors at a price of 98.632% of the principal amount thereof. The 2030 Notes are general unsecured senior obligations of the Operating Partnership, rank equally in right of payment with all other senior unsecured indebtedness of the Operating Partnership and are unconditionally guaranteed by Essex Property Trust, Inc. In October 2019, the Company issued an additional $150.0 million of the 2030 notes at a price of 101.685% of the principal amount thereof. These additional notes have substantially identical terms as the 2030 Notes issued in August 2019. The Company used the net proceeds of these offerings to prepay certain secured indebtedness under outstanding mortgage notes, to repay indebtedness under its unsecured lines of credit and for other general corporate and working capital purposes.
Bank Debt
As of December 31, 2019, Fitch Ratings, Moody’s Investor Service, and Standard and Poor's ("S&P") credit agencies rated Essex Property Trust, Inc. and Essex Portfolio, L.P. BBB+/Stable, Baa1/Stable, and BBB+/Stable, respectively.
At December 31, 2019, the Company had two unsecured lines of credit aggregating $1.24 billion. The Company's $1.2 billion credit facility had an interest rate of the London Interbank Offered Rate ("LIBOR") plus 0.825%, with a scheduled maturity date in December 2022 with one 18-month extension, exercisable at the Company's option. In January 2020, the line of credit facility was amended such that the scheduled maturity date was extended to December 2023 with one 18-month extension, exercisable at the Company's option. The underlying interest rate on the amended line is based on a tiered rate structure tied to the Company's corporate ratings and is currently at LIBOR plus 0.825%. The Company's $35.0 million working capital unsecured line of credit had an interest rate of LIBOR plus 0.825%, with a scheduled maturity date in February 2021.
Equity Transactions
During the year ended December 31, 2019, the Company issued 228,271 shares of common stock through its equity distribution program at an average price of $321.56 per share for proceeds of $73.4 million. As of December 31, 2019, there were no outstanding forward sale agreements, and $826.6 million of shares remain available to be sold under this program.
In January 2019, the Company repurchased and retired 234,061 shares of its common stock totaling $57.0 million, including commissions, at an average price of $243.48 per share. In February 2019, the board of directors approved the replenishment of the stock repurchase plan such that, as of such date, the Company had $250.0 million of purchase authority remaining under the replenished plan. The Company did not repurchase any additional shares during the year ended December 31, 2019, such that as of December 31, 2019, the Company had $250.0 million of purchase authority remaining under the stock repurchase plan.
Co-investments
The Company has entered into, and may continue in the future to enter into, joint ventures or partnerships (including limited liability companies) through which we own an indirect economic interest in less than 100% of the community or land or other investments owned directly by the joint venture or partnership. For each joint venture the Company holds a non-controlling interest in the venture and earns customary management fees and may earn development fees, asset property management fees, and a promote interest.
The Company has also made, and may continue in the future to make, preferred equity investments in various multifamily development projects. The Company earns a preferred rate of return on these investments.
OFFICES AND EMPLOYEES
The Company is headquartered in San Mateo, CA, and has regional offices in Woodland Hills, CA; Irvine, CA; San Diego, CA and Bellevue, WA. As of December 31, 2019, the Company had 1,822 employees.
INSURANCE
The Company purchases general liability and property insurance coverage, including loss of rent, for each of its communities. The Company also purchases limited earthquake, terrorism, environmental and flood insurance. There are certain types of losses which may not be covered or could exceed coverage limits. The insurance programs are subject to deductibles and self-insured retentions in varying amounts. The Company utilizes a wholly owned insurance subsidiary, Pacific Western Insurance LLC ("PWI") to self-insure certain earthquake and property losses. As of December 31, 2019, PWI had cash and marketable securities of approximately $78.4 million, and is consolidated in the Company's financial statements.
All of the Company's communities are located in areas that are subject to earthquake activity. The Company evaluates its financial loss exposure to seismic events by using actuarial loss models developed by the insurance industry and in most cases property vulnerability analysis based on structural evaluations by seismic consultants. The Company manages this exposure, where considered appropriate, desirable, and cost-effective, by upgrading properties to increase their resistance to forces caused by seismic events, by considering available funds and coverages provided by PWI and/or by purchasing seismic insurance. In most cases the Company also purchases limited earthquake insurance for certain properties owned by the Company's co-investments.
In addition, the Company carries other types of insurance coverage related to a variety of risks and exposures.
Based on market conditions, the Company may change or potentially eliminate insurance coverages, or increase levels of self-insurance. Further, the Company may incur losses, which could be material, due to uninsured risks, deductibles and self-insured retentions, and/or losses in excess of coverage limits.
COMPETITION
There are numerous housing alternatives that compete with the Company’s communities in attracting tenants. These include other apartment communities, condominiums and single-family homes. If the demand for the Company’s communities is reduced or if competitors develop and/or acquire competing housing, rental rates and occupancy may drop which may have a material adverse effect on the Company’s financial condition and results of operations.
The Company faces competition from other REITs, businesses and other entities in the acquisition, development and operation of apartment communities. Some competitors are larger and have greater financial resources than the Company. This competition may result in increased costs of apartment communities the Company acquires and/or develops.
WORKING CAPITAL
The Company believes that cash flows generated by its operations, existing cash and cash equivalents, marketable securities balances, availability under existing lines of credit, access to capital markets and the ability to generate cash from the disposition of real estate are sufficient to meet all of its reasonably anticipated cash needs during 2020.
The timing, source and amounts of cash flows provided by financing activities and used in investing activities are sensitive to changes in interest rates, stock price, and other fluctuations in the capital markets environment, which can affect the Company’s plans for acquisitions, dispositions, development and redevelopment activities.
ENVIRONMENTAL CONSIDERATIONS
See the discussion under the caption, "Risks Related to Real Estate Investments and Our Operations - The Company’s Portfolio may have environmental liabilities" in Item 1A, Risk Factors, for information concerning the potential effect of environmental regulations on its operations, which discussion under the caption "The Company’s Portfolio may have environmental liabilities" is incorporated by reference into this Item 1.
OTHER MATTERS
Certain Policies of the Company
The Company intends to continue to operate in a manner that will not subject it to regulation under the Investment Company Act of 1940. The Company 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.
The Company invests primarily in apartment communities that are located in predominantly coastal markets within Southern California, Northern California, and the Seattle metropolitan area. The Company currently intends to continue to invest in apartment communities in such regions. However, these practices may be reviewed and modified periodically by management.
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