filings.toolsItem 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
60K characters. Original on sec.gov ·
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature.
OVERVIEW
Essex is a self-administered and self-managed REIT that acquires, develops, redevelops, and manages apartment communities in selected residential areas located on the West Coast of the United States. Essex owns all of its interests in its real estate investments, directly or indirectly, through the Operating Partnership. Essex is the sole general partner of the Operating Partnership and, as of December 31, 2019, had an approximately 96.6% general partner interest in the Operating Partnership.
The Company’s investment strategy has two components: constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth. The Company’s strong financial condition supports its investment strategy by enhancing its ability to quickly shift acquisition, development, redevelopment, and disposition activities to markets that will optimize the performance of the Company's portfolio.
As of December 31, 2019, the Company owned or had ownership interests in 250 operating apartment communities, comprising 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.
The Company’s apartment communities are predominately located in the following major regions:
Southern California (primarily Los Angeles, Orange, San Diego, and Ventura counties)
Northern California (the San Francisco Bay Area)
Seattle Metro (Seattle metropolitan area)
As of December 31, 2019, the Company’s development pipeline was comprised of five consolidated projects under development, two unconsolidated joint venture projects under development, and various predevelopment projects 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.
As of December 31, 2019, the Company also had an ownership interest in one operating commercial building (totaling approximately 106,716 square feet).
By region, the Company's operating results for 2019 and 2018 and projection for 2020 new housing supply (defined as new multifamily apartment homes and single family homes, excluding developments with fewer than 50 apartment homes as well as student, senior and 100% affordable housing), projection for 2020 job growth, and 2020 estimated Same-Property revenue growth are as follows:
Southern California Region: As of December 31, 2019, this region represented 45% of the Company’s consolidated operating apartment homes. Revenues for "2019 Same-Properties" (as defined below), or "Same-Property revenues," increased 3.0% in 2019 as compared to 2018. In 2020, the Company projects new residential supply of 31,400 apartment homes and single family homes, which represents 0.5% of the total housing stock. The Company projects an increase of 91,850 jobs or 1.2%, and an increase in 2020 Same-Property revenues of between 2.2% to 3.2% in 2020.
Northern California Region: As of December 31, 2019, this region represented 35% of the Company’s consolidated operating apartment homes. Same-Property revenues increased 3.8% in 2019 as compared to 2018. In 2020, the Company projects new residential supply of 17,950 apartment homes and single family homes, which represents 0.8% of the total housing stock. The Company projects an increase of 72,350 jobs or 2.0%, and an increase in 2020 Same-Property revenues of between 2.6% to 3.6% in 2020.
Seattle Metro Region**:** As of December 31, 2019, this region represented 20% of the Company’s consolidated operating apartment homes. Same-Property revenues increased 3.8% in 2019 as compared to 2018. In 2020, the Company projects new residential supply of 13,400 apartment homes and single family homes, which represents 1.0% of the total housing stock. The
Company projects an increase of 43,200 jobs or 2.4%, and an increase in 2020 Same-Property revenues of between 3.5% to 4.5% in 2020.
In total, the Company projects an increase in 2020 Same-Property revenues of between 2.6% to 3.6%, as renewal and new leases are signed at higher rents in 2020 than 2019. Same-Property operating expenses are projected to increase in 2020 by 2.5% to 3.5%.
The Company’s consolidated operating communities are as follows:
| As of | As of | ||||||||||
| December 31, 2019 | December 31, 2018 | ||||||||||
| Apartment Homes | % | Apartment Homes | % | ||||||||
| Southern California | 22,674 | 45 | % | 22,674 | 46 | % | |||||
| Northern California | 17,556 | 35 | % | 16,136 | 33 | % | |||||
| Seattle Metro | 10,343 | 20 | % | 10,238 | 21 | % | |||||
| Total | 50,573 | 100 | % | 49,048 | 100 | % |
Co-investments, including Wesco I, Wesco III, Wesco IV, Wesco V, LLC, CPPIB, BEXAEW, BEX II, BEX III, and BEX IV communities, developments under construction, and preferred equity interest co-investment communities are not included in the table presented above for both periods.
RESULTS OF OPERATIONS
Comparison of Year Ended December 31, 2019 to the Year Ended December 31, 2018
The Company’s average financial occupancy for the Company’s stabilized apartment communities or "2019 Same-Property" (stabilized properties consolidated by the Company for the years ended December 31, 2019 and 2018) decreased 10 basis points to 96.6% in 2019 from 96.7% in 2018. Financial occupancy is defined as the percentage resulting from dividing actual rental income by total potential rental income. Actual rental income represents contractual rental income pursuant to leases without considering delinquency and concessions. Total potential rental income represents the value of all apartment homes, with occupied apartment homes valued at contractual rental rates pursuant to leases and vacant apartment homes valued at estimated market rents. The Company believes that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant apartment home at its estimated market rate.
Market rates are determined using the recently signed effective rates on new leases at the property and are used as the starting point in the determination of the market rates of vacant apartment homes. The Company may increase or decrease these rates based on a variety of factors, including overall supply and demand for housing, concentration of new apartment deliveries within the same submarket which can cause periodic disruption due to greater rental concessions to increase leasing velocity, and rental affordability. Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates, and the Company's calculation of financial occupancy may not be comparable to financial occupancy disclosed by other REITs.
The Company does not take into account delinquency and concessions to calculate actual rent for occupied apartment homes and market rents for vacant apartment homes. The calculation of financial occupancy compares contractual rates for occupied apartment homes to estimated market rents for unoccupied apartment homes, and thus the calculation compares the gross value of all apartment homes excluding delinquency and concessions. For apartment communities that are development properties in lease-up without stabilized occupancy figures, the Company believes the physical occupancy rate is the appropriate performance metric. While an apartment community is in the lease-up phase, the Company’s primary motivation is to stabilize the property, which may entail the use of rent concessions and other incentives, and thus financial occupancy, which is based on contractual income is not considered the best metric to quantify occupancy.
The regional breakdown of the Company’s 2019 Same-Property portfolio for financial occupancy for the years ended December 31, 2019 and 2018 is as follows:
| Years ended December 31, | |||||
| 2019 | 2018 | ||||
| Southern California | 96.6 | % | 96.7 | % | |
| Northern California | 96.7 | % | 96.8 | % | |
| Seattle Metro | 96.6 | % | 96.5 | % |
The following table provides a breakdown of revenue amounts, including the revenues attributable to 2019 Same-Properties.
| Number of Apartment | Years Ended December 31, | Dollar | Percentage | |||||||||||||||
| Property Revenues ($ in thousands) | Homes | 2019 | 2018 | Change | Change | |||||||||||||
| 2019 Same-Properties: | ||||||||||||||||||
| Southern California | 21,979 | $ | 590,943 | $ | 573,658 | $ | 17,285 | 3.0 | % | |||||||||
| Northern California | 15,685 | 530,970 | 511,679 | 19,291 | 3.8 | % | ||||||||||||
| Seattle Metro | 10,238 | 245,398 | 236,525 | 8,873 | 3.8 | % | ||||||||||||
| Total 2019 Same-Property revenues | 47,902 | 1,367,311 | 1,321,862 | 45,449 | 3.4 | % | ||||||||||||
| 2019 Non-Same Property Revenues | 83,317 | 69,008 | 14,309 | 20.7 | % | |||||||||||||
| Total property revenues | $ | 1,450,628 | $ | 1,390,870 | $ | 59,758 | 4.3 | % |
2019 Same-Property Revenues increased by $45.4 million or 3.4% to $1.4 billion for 2019 compared to $1.3 billion in 2018. The increase was primarily attributable to an increase of 3.4% in average rental rates from $2,242 per apartment home for 2018 to $2,318 per apartment home for 2019.
2019 Non-Same Property Revenues increased by $14.3 million or 20.7% to $83.3 million in 2019 compared to $69.0 million in 2018. The increase was primarily due to revenues generated from One South Market, which was consolidated in March 2019, Brio, which was acquired in June 2019, Marquis, which was consolidated in December 2018, and Station Park Green - Phase I, a development community that began producing rental income during the first quarter of 2018. These increases were partially offset by the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018.
Management and other fees from affiliates increased by $0.3 million or 3.3% to $9.5 million in 2019 from $9.2 million in 2018. The increase is primarily due to the addition of The Courtyards at 65th Street, 777 Hamilton, and Velo and Ray communities to the Company's joint venture portfolio in 2019, offset slightly by the disposition of Mosso joint venture community in the fourth quarter of 2019.
Property operating expenses, excluding real estate taxes increased by $8.7 million or 3.7% to $242.5 million in 2019 compared to $233.8 million in 2018, primarily due to an increase of $3.8 million in utilities expenses as well as an increase of $3.2 million in administrative expenses. 2019 Same-Property operating expenses, excluding real estate taxes, increased by $6.5 million or 2.9% to $232.5 million in 2019 compared to $226.0 million in 2018, primarily due to increases of $2.7 million in both administrative expenses and utilities expenses.
Real estate taxes increased by $3.6 million or 2.4% to $155.2 million in 2019 compared to $151.6 million in 2018, primarily due to increases in property valuations in Southern and Northern California and property tax expenses for Brio, which was acquired in the second quarter of 2019, offset by favorable tax assessments in the Seattle Metro region. 2019 Same-Property real estate taxes increased by $1.9 million or 1.3% to $145.3 million in 2019 compared to $143.4 million in 2018 primarily due to increases in property valuations in Southern and Northern California, offset by favorable tax assessments in the Seattle Metro region.
Corporate-level property management expenses increased by $1.8 million or 5.8% to $32.9 million in 2019 compared to $31.1 million in 2018, primarily due to an increase in corporate-level property management and staffing costs supporting the communities.
Depreciation and amortization expense increased by $3.9 million or 0.8% to $483.8 million in 2019 compared to $479.9 million in 2018, primarily due to the completion of the Station Park Green - Phase I development during the first and second quarters of 2018, consolidation of Marquis in the fourth quarter of 2018, consolidation of One South Market in the first quarter of 2019, and the acquisition of Brio in the second quarter of 2019. The increase was partially offset by the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018.
Impairment loss of $7.1 million in 2019 related to a consolidated CPPIB co-investment that owned land held for future development in Moorpark, CA. The impairment charge resulted from the Company’s offer to acquire the joint venture partner’s 45% interest in the co-investment of the land parcel at an amount lower than the carrying value.
Loss on sale of real estate and land of $3.2 million in 2019 was primarily attributable to the sale of land in San Mateo, CA that had been held for future development. The Company's $61.9 million gain in 2018 was attributable to the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018, which resulted in gains of $22.3 million and $39.6 million, respectively, for the Company.
Interest expense decreased by $3.2 million or 1.5% to $217.3 million in 2019 compared to $220.5 million in 2018*,* primarily due to various debt that was paid off or matured and regular principal amortization during and after 2018, which resulted in a decrease in interest expense of $30.0 million for 2019. Additionally, there was a $5.5 million increase in capitalized interest during 2019, which was due to an increase in development costs as compared to 2018. These decreases in interest expense were partially offset by an increase in average outstanding debt primarily as a result of the issuance of $300.0 million of senior unsecured notes due March 15, 2048 in March 2018, $500.0 million of senior unsecured notes due March 1, 2029 in February and March 2019, and $550.0 million of senior unsecured notes due January 15, 2030 in August 2019 and October 2019, which resulted in an increase of $32.3 million interest expense for 2019 as compared to 2018.
Total return swap income of $8.4 million in 2019 consists of monthly settlements related to the Company's total return swap contracts that were entered into during 2015, in connection with issuing $257.3 million of fixed rate tax-exempt mortgage notes. The decrease of $0.3 million or 3.4% from $8.7 million in 2018 was due to less favorable interest rates in 2019.
Interest and other income increased $23.3 million or 101.3% to $46.3 million in 2019 compared to $23.0 million in 2018, primarily due to an increase from unrealized gains (losses) on marketable securities of $10.9 million, $7.0 million of accelerated interest income from the maturity of a mortgage backed security investment recognized in 2019, and an increase of $5.1 million in marketable securities and other income.
Equity income from co-investments increased by $23.0 million or 25.8% to $112.1 million in 2019 compared to $89.1 million in 2018, primarily due to an increase in gains from the sale of co-investment communities of $40.5 million from sale of the Mosso co-investment community in 2019, an increase of $7.3 million in income from preferred equity investments, and a net unrealized gain of $4.4 million from an unconsolidated co-investment during the third quarter of 2019. The increase was partially offset by a decrease of $19.7 million in promote income and an $11.5 million other-than-temporary impairment charge on an unconsolidated CPPIB co-investment recognized in the fourth quarter of 2019.
Deferred tax expense on unrealized gain on unconsolidated co-investment of $1.5 million in 2019 resulted from a net unrealized gain of $4.4 million from an unconsolidated co-investment during the third quarter of 2019.
Gain on early retirement of debt, net of $3.7 million in 2019 was primarily due to early repayment of a $289.1 million secured mortgage note payable in September 2019, offset slightly by early repayment of approximately $122.5 million of secured mortgage notes in the fourth quarter of 2019.
Gain on remeasurement of co-investment of $31.5 million in 2019 resulted from the purchase of the Company's joint venture partner's 45.0% membership interest in the One South Market co-investment in March 2019. Gain on remeasurement of $1.3 million in 2018 resulted from the purchase of the Company's joint venture partner's 49.9% membership interest in the Marquis co-investment in December 2018.
Comparison of Year Ended December 31, 2018 to the Year Ended December 31, 2017
The Company’s average financial occupancy for the Company’s stabilized apartment communities or "2018 Same-Property" (stabilized properties consolidated by the Company for the years ended December 31, 2018 and 2017) increased 10 basis points to 96.7% in 2018 from 96.6% in 2017. The regional breakdown of the Company's 2018 Same-Property portfolio for financial occupancy for the years ended December 31, 2018 and 2017 is as follows:
| Years ended December 31, | |||||
| 2018 | 2017 | ||||
| Southern California | 96.7 | % | 96.6 | % | |
| Northern California | 96.8 | % | 96.8 | % | |
| Seattle Metro | 96.5 | % | 96.4 | % |
The following table provides a breakdown of revenue amounts, including the revenues attributable to 2018 Same-Properties:
| Number of Apartment | Years Ended December 31, | Dollar | Percentage | |||||||||||||||
| Property Revenues ($ in thousands) | Homes | 2018 | 2017 | Change | Change | |||||||||||||
| 2018 Same-Properties: | ||||||||||||||||||
| Southern California | 21,979 | $ | 573,658 | $ | 556,630 | $ | 17,028 | 3.1 | % | |||||||||
| Northern California | 14,356 | 469,457 | 458,241 | 11,216 | 2.4 | % | ||||||||||||
| Seattle Metro | 10,238 | 236,525 | 229,872 | 6,653 | 2.9 | % | ||||||||||||
| Total 2018 Same-Property revenues | 46,573 | 1,279,640 | 1,244,743 | 34,897 | 2.8 | % | ||||||||||||
| 2018 Non-Same Property Revenues | 111,230 | 109,582 | 1,648 | 1.5 | % | |||||||||||||
| Total property revenues | $ | 1,390,870 | $ | 1,354,325 | $ | 36,545 | 2.7 | % |
2018 Same-Property Revenues increased by $34.9 million or 2.8% to $1.3 billion for 2018 compared to $1.2 billion in 2017. The increase was primarily attributable to an increase of 2.5% in average rental rates from $2,177 per apartment home for 2017 to $2,231 per apartment home for 2018.
2018 Non-Same Property Revenues increased by $1.6 million or 1.5% to $111.2 million in 2018 compared to $109.6 million in 2017. The increase was primarily due to revenue generated by Station Park Green - Phase I, a development community, which began producing rental income during the first quarter of 2018, and Sage at Cupertino, which was consolidated in March 2017, offset by the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018.
Management and other fees from affiliates decreased by $0.4 million or 4.2% to $9.2 million in 2018 from $9.6 million in 2017. The decrease is primarily due to lower asset management fees caused by the amendment of the Wesco I joint venture operating agreement in October 2017.
Property operating expenses, excluding real estate taxes increased by $4.7 million or 2.1% to $233.8 million in 2018 compared to $229.1 million in 2017, primarily due to an increase of $2.4 million in maintenance and repairs expenses as well as an increase of $2.3 million in utilities expenses. 2018 Same-Property operating expenses excluding real estate taxes, increased by $4.2 million or 2.0% to $218.7 million in 2018 compared to $214.5 million in 2017, primarily due to a $2.2 million increase in maintenance and repairs expenses as well as an increase of $2.2 million in utilities expenses.
Real estate taxes increased by $5.3 million or 3.6% to $151.6 million in 2018 compared to $146.3 million in 2017, primarily due to the acquisition of Marquis and increases in tax rates and property valuations, offset by the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018. 2018 Same-Property real estate taxes increased by $4.9 million or 3.7% to $138.4 million in 2018 compared to $133.5 million in 2017 due to increases in tax rates and property valuations.
Corporate-level property management expenses increased by $0.9 million or 3.0% to $31.1 million in 2018 compared to $30.2 million in 2017, primarily due to an increase in corporate-level property management and staffing costs supporting the communities.
Depreciation and amortization expense increased by $11.0 million or 2.3% to $479.9 million in 2018 compared to $468.9 million in 2017, primarily due to the completion of the Station Park Green - Phase I development during the first and second quarters of 2018, the consolidation of Sage at Cupertino in March 2017, as well as an increase in redevelopment activity in 2018 versus 2017, partially offset by a decrease due to the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018.
Gain on sale of real estate and land increased by $35.5 million or 134.5% to $61.9 million in 2018 compared to $26.4 million in 2017. The Company's 2018 gain was attributable to the sales of Domain in the second quarter of 2018 and 8th & Hope in the fourth quarter of 2018, which resulted in a gain of $22.3 million and $39.6 million, respectively, for the Company. The Company's 2017 gain was primarily attributable to the sale of Jefferson at Hollywood, which resulted in a gain of $26.2 million.
Interest expense decreased by $2.4 million or 1.1% to $220.5 million in 2018 compared to $222.9 million in 2017*,* primarily due to debt that was paid off or matured and regular principal amortization during and after 2017, which resulted in a decrease in interest expense of $16.2 million for 2018. Additionally, there was a $4.8 million increase in capitalized interest during 2018, which was due to an increase in development costs as compared to 2017. These decreases in interest expense were partially offset by an increase in average outstanding debt primarily as a result of the issuance of $350.0 million senior unsecured notes due May 1, 2027 in April 2017 and $300.0 million senior unsecured notes due March 15, 2048 in March 2018, which resulted in an increase of $18.6 million interest expense for 2018 as compared to 2017.
Total return swap income of $8.7 million in 2018 consists of monthly settlements related to the Company's total return swap contracts that were entered into during 2015, in connection with issuing $257.3 million of fixed rate tax-exempt mortgage notes payable. The decrease of $1.4 million or 13.9% from $10.1 million in 2017 was due to less favorable interest rates in 2018.
Interest and other income decreased by $1.6 million or 6.5% to $23.0 million in 2018 compared to $24.6 million in 2017, primarily due to unrealized losses on marketable securities of $5.2 million that were recognized through income during 2018, partially offset by an increase in marketable securities and other interest income of $4.2 million.
Equity income from co-investments increased by $2.7 million or 3.1% to $89.1 million in 2018 compared to $86.4 million in 2017, primarily due to $20.5 million of co-investment promote income from the BEXAEW joint venture recognized during the first quarter of 2018, an increase in income from preferred equity investments of $11.8 million, and a gain on early retirement of debt from an unconsolidated co-investment of $3.7 million in the third quarter of 2018, partially offset by a decrease in gains on sales of co-investment communities of $34.3 million.
Gain on remeasurement of co-investment of $1.3 million in 2018 resulted from the purchase of the Company's joint venture partner's 49.9% membership interest in the Marquis co-investment in December 2018. Gain on remeasurement of $88.6 million in 2017 resulted from the purchase of the Company's joint venture partner's 50% membership interest in the Palm Valley co-investment in January 2017.
Liquidity and Capital Resources
The following table sets forth the Company’s cash flows for 2019, 2018 and 2017 ($ in thousands):
| For the year ended December 31, | ||||||||||||
| 2019 | 2018 | 2017 | ||||||||||
| Cash flow provided by (used in): | ||||||||||||
| Operating activities | $ | 919,079 | $ | 826,554 | $ | 769,607 | ||||||
| Investing activities | $ | (527,691 | ) | $ | (59,893 | ) | $ | (567,940 | ) | |||
| Financing activities | $ | (461,689 | ) | $ | (676,392 | ) | $ | (310,843 | ) |
Essex’s business is operated primarily through the Operating Partnership. Essex issues public equity from time to time, but does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses from operating as a public company which are fully reimbursed by the Operating Partnership. Essex itself does not hold any indebtedness, and its only material asset is its ownership of partnership interests of the Operating Partnership. Essex’s principal funding requirement is the payment of dividends on its common stock and preferred stock. Essex’s sole source of funding for its dividend payments is distributions it receives from the Operating Partnership.
As of December 31, 2019, Essex owned a 96.6% general partner interest and the limited partners owned the remaining 3.4% interest in the Operating Partnership.
The liquidity of Essex is dependent on the Operating Partnership’s ability to make sufficient distributions to Essex. The primary cash requirement of Essex is its payment of dividends to its stockholders. Essex also guarantees some of the Operating Partnership’s debt, as discussed further in Notes 7 and 8 to our consolidated financial statements included in Part IV, Item 15 of this Annual Report on Form 10-K. If the Operating Partnership fails to fulfill certain of its debt requirements, which trigger Essex’s guarantee obligations, then Essex will be required to fulfill its cash payment commitments under such guarantees. However, Essex’s only significant asset is its investment in the Operating Partnership.
For Essex to maintain its qualification as a REIT, it must pay dividends to its stockholders aggregating annually at least 90% of its REIT taxable income, excluding net capital gains. While historically Essex has satisfied this distribution requirement by making cash distributions to its stockholders, it may choose to satisfy this requirement by making distributions of other property, including, in limited circumstances, Essex’s own stock. As a result of this distribution requirement, the Operating Partnership cannot rely on retained earnings to fund its ongoing operations to the same extent that other companies whose parent companies are not REITs can. Essex may need to continue to raise capital in the equity markets to fund the Operating Partnership’s working capital needs, acquisitions and developments.
At December 31, 2019, the Company had $70.1 million of unrestricted cash and cash equivalents and $144.2 million in marketable securities, of which $71.5 million were equity securities or available for sale debt securities. 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 the Company’s 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 and other fluctuations in the capital markets environment, which can affect the Company’s plans for acquisitions, dispositions, development and redevelopment activities.
As of December 31, 2019, the Company had $200.0 million of private placement unsecured bonds outstanding at an average interest rate of 4.4% with maturity dates ranging from April 2021 through August 2021.
As of December 31, 2019, the Company had $4.3 billion of fixed rate public bonds outstanding at an average interest rate of 3.8% with maturity dates ranging from 2021 to 2048.
As of December 31, 2019, the Company had $350.0 million outstanding on its unsecured term loan. The unsecured term loan bears a variable interest rate of LIBOR plus 0.95%. The Company has five interest rate swap contracts, with an aggregate notional balance of $175.0 million, which effectively converts the interest rate on $175.0 million of the unsecured term loan to a fixed rate of 2.3%.
As of December 31, 2019, the Company’s mortgage notes payable totaled $1.0 billion, net of unamortized premiums and debt issuance costs, which consisted of $0.7 billion in fixed rate debt at an average interest rate of 4.7% and maturity dates ranging from 2020 to 2028 and $254.2 million of tax-exempt variable rate demand notes with a weighted average interest rate of 2.3%. The tax-exempt variable rate demand notes have maturity dates ranging from 2027 to 2046. $255.4 million is subject to total return swaps.
As of December 31, 2019, the Company had two unsecured lines of credit aggregating $1.24 billion, including a $1.2 billion unsecured line of credit and a $35.0 million working capital unsecured line of credit. As of December 31, 2019, there was $55.0 million outstanding on the $1.2 billion unsecured line of credit. The interest rate is based on a tiered rate structure tied to the Company's credit ratings and was LIBOR plus 0.825% as of December 31, 2019. In January 2020 this line of credit 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 interest rate on the amended line is based on a tiered rate structure tied to the Company's credit ratings and is currently at LIBOR plus 0.825%. As of December 31, 2019, there was no amount outstanding on the Company's $35.0 million working capital unsecured line of credit. The interest rate on the line is based on a tiered rate structure tied to the Company's credit ratings and was LIBOR plus 0.825% as of December 31, 2019 with a scheduled maturity date in February 2021.
The Company’s unsecured lines of credit and unsecured debt agreements contain debt covenants related to limitations on indebtedness and liabilities and maintenance of minimum levels of consolidated earnings before depreciation, interest and amortization. The Company was in compliance with the debt covenants as of December 31, 2019 and 2018.
The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Company primarily in investment grade securities held available for sale or is used by the Company to reduce balances outstanding under its lines of credit.
Derivative Activity
The Company uses interest rate swaps, interest rate caps, and total return swap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps and total return swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements.
The Company has entered into interest rate swap contracts with an aggregate notional amount of $175.0 million that effectively fixed the interest rate on the $175.0 million of the $350.0 million unsecured term loan at 2.3%. These derivatives qualify for hedge accounting.
The Company has four total return swap contracts, with an aggregate notional amount of $255.4 million, that effectively converts $255.4 million of mortgage notes payable to a floating interest rate based on the Securities Industry and Financial Markets Association Municipal Swap Index ("SIFMA") plus a spread. The total return swaps provide fair market value protection on the mortgage notes payable to our counterparties during the initial period of the total return swap until the Company's option to call the mortgage notes at par can be exercised. The Company can currently call all four of the total return swaps, with $255.4 million of the outstanding debt at par. These derivatives do not qualify for hedge accounting.
As of December 31, 2019, the Company had no interest rate caps. As of December 31, 2018, the Company had interest rate caps, which were not accounted for as hedges, totaling a notional amount of $9.9 million that effectively limited the Company’s exposure to interest rate risk by providing a ceiling on the variable interest rate for $9.9 million of the Company’s tax exempt variable rate debt. These interest rate caps matured in December 2019.
As of December 31, 2019 and 2018, the aggregate carrying value of the interest rate swap contracts was an asset of $1.0 million and $5.8 million, respectively, and is included in prepaid expenses and other assets on the consolidated balance sheets, and a liability of $0.2 million and zero, respectively, and is included in other liabilities on the consolidated balance sheets. The aggregate carrying value of the interest rate caps was zero on the balance sheets as of both December 31, 2019 and 2018. The aggregate carrying and fair value of the total return swaps was zero at both December 31, 2019 and 2018.
Hedge ineffectiveness related to cash flow hedges, which is reported in current year income as interest expense, net was a loss of $0.2 million, a loss of $0.1 million, and a gain of $0.1 million, for the years ended December 31, 2019, 2018, and 2017, respectively.
Issuance of Common Stock
In September 2018, the Company filed a new shelf registration statement with the SEC, allowing the Company to sell an undetermined number or amount of certain equity and debt securities of the Company, as defined in the prospectus contained in the shelf registration statement.
Also in September 2018, the Company entered into a new equity distribution agreement pursuant to which the Company may offer and sell shares of its common stock having an aggregate gross sales price of up to $900.0 million (the "2018 ATM Program"). In connection with the 2018 ATM Program, the Company may also enter into related forward sale agreements whereby, at the Company’s discretion, it may sell shares of its common stock under the 2018 ATM Program under forward sale agreements. The use of a forward sale agreement would allow the Company to lock in a share price on the sale of shares of its common stock at the time the agreement is executed, but defer receiving the proceeds from the sale of shares until a later date. The Company anticipates using the net proceeds, which are contributed to the Operating Partnership, to acquire, develop, or redevelop properties, which primarily will be apartment communities, to make other investments and for working capital or general corporate purposes, which may include the repayment of indebtedness.
For the year ended December 31, 2019, the Company issued 228,271 shares of common stock through the 2018 ATM Program at an average price of $321.56 per share for proceeds of $73.4 million. For the year ended December 31, 2018, the Company did not sell any shares of its common stock through the 2018 ATM Program or through the previous equity distribution agreement. For the year ended December 31, 2017, the Company issued 345,444 shares of common stock through the previous equity distribution agreement at an average price of $260.38 per share for total proceeds of $89.9 million. As of December 31, 2019, $826.6 million of shares remains available to be sold under the 2018 ATM Program.
Capital Expenditures
Non-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property. For the year ended December 31, 2019, non-revenue generating capital expenditures totaled approximately $1,764 per apartment home. These expenditures do not include the improvements required in connection with the origination of mortgage loans, expenditures for deferred maintenance on acquisition properties, expenditures for property renovations and improvements which are expected to generate additional revenue or cost savings, and do not include expenditures incurred due to changes in government regulations that the Company would not have incurred otherwise, or expenditures for which the Company expects to be reimbursed. The Company expects that cash from operations and/or its lines of credit will fund such expenditures.
Development and Predevelopment 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, two unconsolidated joint venture projects under development and various consolidated predevelopment projects, 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. The Company may also acquire land for future development purposes or sale.
The Company expects to fund the development and predevelopment pipeline by using a combination of some or all of the following sources: its working capital, amounts available on its lines of credit, construction loans, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of assets, if any.
Redevelopment Pipeline
The Company defines redevelopment communities 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.
Alternative Capital Sources
The Company utilizes co-investments as an alternative source of capital for acquisitions of both operating and development communities. As of December 31, 2019, the Company had an interest in 806 apartment homes in communities actively under development with joint ventures for total estimated costs of $0.6 billion. Total estimated remaining costs total approximately $0.1 billion, of which the Company estimates that its remaining investment in these development joint ventures will be approximately $29.5 million. In addition, the Company had an interest in 10,672 apartment homes in operating communities with joint ventures for a total book value of $0.7 billion.
Contractual Obligations and Commercial Commitments
The following table summarizes our obligations at December 31, 2019 ($ in thousands):
| For the Fiscal Years Ending | ||||||||||||||||||||
| 2020 | 2021 and 2022 | 2023 and 2024 | Thereafter | Total | ||||||||||||||||
| Mortgage notes payable | $ | 288,057 | $ | 74,841 | $ | 6,054 | $ | 618,383 | $ | 987,335 | ||||||||||
| Unsecured debt | — | 1,150,000 | 1,000,000 | 2,650,000 | 4,800,000 | |||||||||||||||
| Lines of credit | — | — | 55,000 | — | 55,000 | |||||||||||||||
| Interest on indebtedness (1) | 209,711 | 343,462 | 254,353 | 622,817 | 1,430,343 | |||||||||||||||
| Ground leases | 3,506 | 7,012 | 7,012 | 124,991 | 142,521 | |||||||||||||||
| Operating leases | 3,349 | 6,753 | 6,433 | 21,682 | 38,217 | |||||||||||||||
| $ | 504,623 | $ | 1,582,068 | $ | 1,328,852 | $ | 4,037,873 | $ | 7,453,416 |
| (1) | Interest on indebtedness for variable debt was calculated using interest rates as of December 31, 2019. |
We have a commitment, which is not reflected in the table above, to make additional capital contributions to a limited partnership in which we hold an equity interest. The capital contributions may be called by the general partner at any time until September 2022 after giving appropriate notice. As of December 31, 2019, we had committed to make additional capital contributions totaling up to $8.1 million if and when called by the general partner of the limited partnership until September 2022.
Real Estate Commitments
The following table summarizes the Company's real estate commitment at December 31, 2019 ($ in thousands):
| Number of Properties | Investment | Remaining Commitment | |||||||||
| Joint ventures: | |||||||||||
| Preferred equity investments | 7 | $ | 166,500 | $ | 20,300 | ||||||
| Real estate under development (1) | 2 | 245,825 | 29,500 | ||||||||
| Consolidated: | |||||||||||
| Real estate under development | 5 | 557,415 | 162,900 | ||||||||
| $ | 969,740 | $ | 212,700 |
| (1) | Estimated project cost for development of the Company's 500 Folsom project is net of a projected value for low-income housing tax credit proceeds and the value of the tax exempt bond structure. |
Variable Interest Entities
In accordance with accounting standards for consolidation of variable interest entities ("VIEs"), the Company consolidates the Operating Partnership, 17 DownREIT entities (comprising nine communities) and six co-investments as of December 31, 2019. As of December 31, 2018, the Company consolidated the Operating Partnership, 16 DownREIT entities (comprising eight communities), and eight co-investments. The Company consolidates these entities because it is deemed the primary beneficiary. Essex has no assets or liabilities other than its investment in the Operating Partnership. The consolidated total assets and liabilities related to the above consolidated co-investments and DownREIT entities, net of intercompany eliminations, were approximately $1.0 billion and $364.3 million, respectively, as of December 31, 2019, and $849.8 million and $261.7 million, respectively, as of December 31, 2018. Noncontrolling interests in these entities were $122.5 million and $64.5 million as of December 31, 2019 and 2018, respectively. The Company's financial risk in each VIE is limited to its equity investment in the VIE. As of December 31, 2019, the Company did not have any other VIEs of which it was deemed to be the primary beneficiary and did not have any VIEs of which it was not deemed to be the primary beneficiary.
Critical Accounting Policies and Estimates
The preparation of consolidated financial statements, in accordance with U.S. GAAP, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of
contingent assets and liabilities. The Company defines critical accounting policies as those accounting policies that require the Company's management to exercise their most difficult, subjective and complex judgments. The Company’s critical accounting policies and estimates relate principally to the following key areas: (i) accounting for the acquisition of investments in real estate (specifically, the allocation between land and buildings); and (ii) evaluation of events and changes in circumstances indicating whether the Company’s rental properties may be impaired. The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates made by management.
The Company accounts for its acquisitions of investments in real estate by assessing each acquisition to determine if it meets the definition of a business or if it qualifies as an asset acquisition. We expect that acquisitions of individual operating communities will generally be viewed as asset acquisitions, and result in the capitalization of acquisition costs, and the allocation of purchase price to the assets acquired and liabilities assumed based on the relative fair value of the respective assets and liabilities.
In making estimates of relative fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent land appraisals which consider comparable market transactions, its own analysis of recently acquired or developed comparable properties in our portfolio for land comparables and building replacement costs, and other publicly available market data. In calculating the fair value of identified intangible assets of an acquired property, the in-place leases are valued based on in-place rent rates and amortized over the average remaining term of all acquired leases.
The Company periodically assesses the carrying value of its real estate investments for indicators of impairment. The judgments regarding the existence of impairment indicators are based on monitoring investment market conditions and performance compared to budget for operating properties including the net operating income for the most recent 12 month period, monitoring estimated costs for properties under development, the Company's ability to hold and its intent with regard to each asset, and each property's remaining useful life. Whenever events or changes in circumstances indicate that the carrying amount of a property held for investment may not be fully recoverable, the carrying amount is evaluated. If the sum of the property’s expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property, then the Company will recognize an impairment loss equal to the excess of the carrying amount over the fair value of the property.
When the Company determines that a property is held for sale, it discontinues the periodic depreciation of that property. The criteria for determining when a property is held for sale requires judgment and has potential financial statement impact as depreciation would cease and an impairment loss could occur upon determination of held for sale status. Assets held for sale are reported at the lower of the carrying amount or estimated fair value less costs to sell.
The Company bases its accounting estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.
Net Operating Income
Net operating income ("NOI") and Same-Property NOI are considered by management to be important supplemental performance measures to earnings from operations included in the Company’s consolidated statements of income. The presentation of Same-Property NOI assists with the presentation of the Company’s operations prior to the allocation of depreciation and any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual communities or groups of communities. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. The Company defines Same-Property NOI as Same-Property revenues less Same-Property operating expenses, including property taxes. Please see the reconciliation of earnings from operations to NOI and Same-Property NOI, which in the table below is the NOI for stabilized properties consolidated by the Company for the periods presented ($ in thousands):
| 2019 | 2018 | 2017 | |||||||||
| Earnings from operations | $ | 481,112 | $ | 511,989 | $ | 472,945 | |||||
| Adjustments: | |||||||||||
| Corporate-level property management expenses | 32,899 | 31,062 | 30,156 | ||||||||
| Depreciation and amortization | 483,750 | 479,884 | 468,881 | ||||||||
| Management and other fees from affiliates | (9,527 | ) | (9,183 | ) | (9,574 | ) | |||||
| General and administrative | 54,262 | 53,451 | 41,385 | ||||||||
| Expensed acquisition and investment related costs | 168 | 194 | 1,569 | ||||||||
| Impairment loss | 7,105 | — | — | ||||||||
| (Gain) Loss on sale of real estate and land | 3,164 | (61,861 | ) | (26,423 | ) | ||||||
| NOI | 1,052,933 | 1,005,536 | 978,939 | ||||||||
| Less: Non Same-Property NOI | (63,492 | ) | (53,044 | ) | (55,389 | ) | |||||
| Same-Property NOI | $ | 989,441 | $ | 952,492 | $ | 923,550 |
Forward-Looking Statements
Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Annual Report on Form 10-K which are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, including statements regarding the Company's expectations, estimates, assumptions, hopes, intentions, beliefs and strategies regarding the future. Words such as "expects," "assumes," "anticipates," "may," "will," "intends," "plans," "projects," "believes," "seeks," "future," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements include, among other things, statements regarding the Company's intent, beliefs or expectations with respect to the timing of completion of current development and redevelopment projects and the stabilization of such projects, the timing of lease-up and occupancy of its apartment communities, the anticipated operating performance of its apartment communities, the total projected costs of development and redevelopment projects, co-investment activities, qualification as a REIT under the Code, 2020 Same-Property revenue generally and in specific regions, 2020 Same-Property operating expenses, the real estate markets in the geographies in which the Company's properties are located and in the United States in general, the adequacy of future cash flows to meet anticipated cash needs, its financing activities and the use of proceeds from such activities, the availability of debt and equity financing, general economic conditions including the potential impacts from economic conditions, trends affecting the Company's financial condition or results of operations, changes to U.S. tax laws and regulations in general or specifically related to REITs or real estate, changes to laws and regulations in jurisdictions in which communities the Company owns are located, and other information that is not historical information.
While the Company's management believes the assumptions underlying its forward-looking statements are reasonable, such forward-looking statements involve known and unknown risks, uncertainties and other factors, many of which are beyond the Company’s control, which could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The Company cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect the Company’s current expectations of the approximate outcomes of the matters discussed. Factors that might cause the Company’s actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to, the following: the Company may fail to achieve its business objectives; the actual completion of development and redevelopment projects may be subject to delays; the stabilization dates of such projects may be delayed; the Company may abandon or defer development or redevelopment projects for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development, increases in the cost of capital or lack of capital availability, resulting in losses; the total projected costs of current development and redevelopment projects may exceed expectations; such development and redevelopment projects may not be completed; development and redevelopment projects and acquisitions may fail to meet expectations; estimates of future income from an acquired property may prove to be inaccurate; occupancy rates and rental demand may be adversely affected by competition and local economic and market conditions; there may be increased interest rates and operating costs; the Company may be unsuccessful in the management of its relationships with its co-investment partners; future cash flows may be inadequate to meet operating requirements and/or may be insufficient to provide for dividend payments in accordance with REIT requirements; there may be a downturn in general economic conditions, the real estate industry and the markets in which the Company's communities are located; changes in laws or regulations; the terms of any refinancing may not be as favorable as the terms of existing indebtedness; unexpected difficulties in leasing of development projects; volatility in financial and securities markets; the Company’s failure to successfully operate acquired properties; unforeseen consequences from cyber-
intrusion; the Company’s inability to maintain our investment grade credit rating with the rating agencies; government approvals, actions and initiatives, including the need for compliance with environmental requirements; and those further risks, special considerations, and other factors discussed in Item 1A, Risk Factors, of this Form 10-K, and those risk factors and special considerations set forth in the Company’s other filings with the SEC which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. All forward-looking statements are made as of the date hereof and the Company assumes no obligation to update or supplement this information for any reason, and therefore, they may not represent the Company's estimates and assumptions after the date of this report.
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