filings.toolsItem 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read in conjunction with the Company’s Condensed Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with the Company’s 2022 annual report on Form 10-K for the year ended December 31, 2022. Capitalized terms not defined in this section have the meaning ascribed to them elsewhere in this quarterly report on Form 10-Q. The Company makes statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-Q entitled "Forward-Looking Statements."
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 March 31, 2023, had an approximately 96.6% general partnership 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 March 31, 2023, the Company owned or had ownership interests in 251 operating apartment communities, comprising 61,924 apartment homes, excluding the Company’s ownership interest in preferred equity co-investments, loan investments, three operating commercial buildings, and a development pipeline comprised of one unconsolidated joint venture project.
The Company’s apartment communities are 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 (the Seattle metropolitan area)
As of March 31, 2023, the Company’s development pipeline was comprised of one unconsolidated joint venture project under development aggregating 264 apartment homes and various predevelopment projects, with total incurred costs of $101.0 million, and estimated remaining project costs of approximately $23.0 million, $11.7 million of which represents the Company's share of estimated remaining costs, for total estimated project costs of $124.0 million.
The Company’s consolidated apartment communities are as follows:
| As of March 31, 2023 | As of March 31, 2022 | ||||||||||||||||||||||
| Apartment Homes | % | Apartment Homes | % | ||||||||||||||||||||
| Southern California | 21,913 | 43 | % | 22,190 | 43 | % | |||||||||||||||||
| Northern California | 19,245 | 37 | % | 19,230 | 37 | % | |||||||||||||||||
| Seattle Metro | 10,341 | 20 | % | 10,341 | 20 | % | |||||||||||||||||
| Total | 51,499 | 100 | % | 51,761 | 100 | % |
Co-investments, including Wesco I, Wesco III, Wesco IV, Wesco V, Wesco VI, BEXAEW, BEX II, BEX IV and 500 Folsom communities, developments under construction, and preferred equity interest co-investment communities are not included in the table presented above for both periods.
Market Considerations
While COVID-19’s impact begins to dissipate, the Company continues to comply with the stated intent of local, county, state and federal laws, some of which limit rent increases during times of emergency and impair the ability to collect unpaid rent during certain timeframes and at various regions in which our communities are located, impacting the Company and its properties. Concurrently, geopolitical tensions between Russian and Ukraine increased uncertainty during 2022 and 2023. Inflation has caused an increase in consumer prices, thereby reducing purchasing power and elevating the risks of a recession. Due to increased inflation, the U.S. Federal Reserve raised the federal funds rate a total of seven times during 2022 and two times in 2023. In response, market interest rates have increased significantly during this time. At the same time, the labor market remains historically tight and companies continue to look to add employees, pushing unemployment lower.
The long-term impact of these developments will largely depend on future laws that may be enacted, the impact on job growth and the broader economy, and reactions by consumers, companies, governmental entities and capital markets.
Primarily as a result of the impact of the COVID-19 pandemic, the Company's cash delinquencies as a percentage of scheduled rental income for the Company’s stabilized apartment communities or "Same-Property" (stabilized properties consolidated by the Company for the quarters ended March 31, 2023 and 2022) have generally remained higher than the pre-pandemic historical average of 0.35% since the second quarter of 2020. Cash delinquencies were elevated at 2.2% for the three months ended March 31, 2022 decreasing slightly to 2.1% for the three months ended March 31, 2023. The Company continues to work with residents to collect such cash delinquencies. As of March 31, 2023, the delinquencies have not had a material adverse impact on the Company's liquidity position.
The foregoing macroeconomic conditions have not negatively impacted the Company's ability to access traditional funding sources on the same or reasonably similar terms as were available in recent periods prior to the pandemic. The Company is not at material risk of not meeting the covenants in its credit agreements and is able to timely service its debt and other obligations.
Comparison of the Three Months Ended March 31, 2023 to the Three Months Ended March 31, 2022
The Company’s average financial occupancy for the Company’s Same-Property portfolio was 96.7% and 96.3% for the three months ended March 31, 2023 and 2022, respectively. Financial occupancy is defined as the percentage resulting from dividing actual rental income by total scheduled rental income. Actual rental income represents contractual rental income pursuant to leases without considering delinquency and concessions. Total scheduled 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 Same-Property portfolio for financial occupancy for the three months ended March 31, 2023 and 2022 is as follows:
| Three Months Ended March 31, | |||||||||||
| 2023 | 2022 | ||||||||||
| Southern California | 96.8 | % | 96.3 | % | |||||||
| Northern California | 96.6 | % | 96.4 | % | |||||||
| Seattle Metro | 96.6 | % | 95.9 | % |
The following table provides a breakdown of revenues amounts, including revenues attributable to the Same-Properties:
| Number of Apartment | Three Months Ended March 31, | Dollar | Percentage | |||||||||||||||||||||||||||||
| Property Revenues ($ in thousands) | Homes | 2023 | 2022 | Change | Change | |||||||||||||||||||||||||||
| Same-Property Revenues: | ||||||||||||||||||||||||||||||||
| Southern California | 21,352 | $ | 163,265 | $ | 151,044 | $ | 12,221 | 8.1 | % | |||||||||||||||||||||||
| Northern California | 18,371 | 155,592 | 146,168 | 9,424 | 6.4 | % | ||||||||||||||||||||||||||
| Seattle Metro | 10,341 | 70,038 | 64,203 | 5,835 | 9.1 | % | ||||||||||||||||||||||||||
| Total Same-Property Revenues | 50,064 | 388,895 | 361,415 | 27,480 | 7.6 | % | ||||||||||||||||||||||||||
| Non-Same Property Revenues | 20,761 | 17,801 | 2,960 | 16.6 | % | |||||||||||||||||||||||||||
| Total Property Revenues | $ | 409,656 | $ | 379,216 | $ | 30,440 | 8.0 | % |
Same-Property Revenues increased by $27.5 million or 7.6% to $388.9 million in the first quarter of 2023 from $361.4 million in the first quarter of 2022. The increase was primarily attributable to an increase of 6.8% in average rental rates from $2,407 in the first quarter of 2022 to $2,571 in the first quarter of 2023 and 0.3% of the increase was attributable to a decrease in cash concessions in the first quarter of 2023 compared to the first quarter of 2022.
Non-Same Property Revenues increased by $3.0 million or 16.6% to $20.8 million in the first quarter of 2023 from $17.8 million in the first quarter of 2022. The increase was primarily due to the acquisitions of Regency Palm Court and Windsor Court in 2022 and an increase in average rental rates offset by the sale of Anavia in 2022.
Management and other fees from affiliates increased by $0.1 million or 3.7% to $2.8 million in the first quarter of 2023 from $2.7 million in the first quarter of 2022. The increase was primarily due to increase in revenues used to calculate management fees.
Property operating expenses, excluding real estate taxes increased by $5.0 million or 7.3% to $73.9 million for the first quarter of 2023 compared to $68.9 million for the first quarter of 2022, primarily due to increases of $2.8 million in maintenance and repairs expenses, $1.3 million in administrative expenses, $0.4 million in personnel costs, and $0.4 million in utilities expenses. Same-Property operating expenses, excluding real estate taxes, increased by $5.1 million or 7.6% to $71.8 million in the first quarter of 2023 compared to $66.7 million in the first quarter of 2022, primarily due to increases of $2.7 million in maintenance and repairs expenses, $1.0 million in insurance and other expense, $0.6 million in utilities expenses, $0.3 million in administrative expenses, and $0.3 million in personnel costs.
Real estate taxes decreased by $0.7 million or 1.5% to $46.5 million for the first quarter of 2023 compared to $47.2 million for the first quarter of 2022, primarily due to a decrease in Washington real estate taxes driven primarily by decreases in tax rates in 2022. Same-Property real estate taxes decreased slightly by $0.7 million or 1.6% to $43.0 million for the first quarter of 2023 compared to $43.7 million for the first quarter of 2022 primarily due to a decrease in Washington real estate taxes driven primarily by decreases in tax rates in 2022.
Corporate-level property management expenses increased by $1.2 million or 11.8% to $11.4 million for the first quarter of 2023 compared to $10.2 million for the first quarter of 2022 due to costs pertaining to the centralization of certain property level functions.
Depreciation and amortization expense increased by $2.8 million or 2.1% to $136.3 million for the first quarter of 2023 compared to $133.5 million for the first quarter of 2022, primarily due to an increase in depreciation expense from the completion of Station Park Green (Phase IV) development property in 2022 and the purchase of the Company's joint venture partners's 49.8% interest in Essex JV LLC co-investment that owned Regency Palm Court and Windsor Court, in 2022.
Gain on sale of real estate and land of $59.2 million in the first quarter of 2023 was primarily attributable to the sale of CBC and The Sweeps apartment home community.
Interest expense increased by $0.6 million or 1.2% to $51.0 million for the first quarter of 2023 compared to $50.4 million for the first quarter of 2022, primarily due to higher interest rates on the Company's unsecured lines of credit which resulted in an increase in interest expense of $0.5 million for the first quarter of 2023. Additionally, there was an $0.6 million decrease in capitalized interest in the first quarter of 2023, due to a decrease in development activity as compared to the same period in 2022. These increases to interest expense were partially offset by various debt that was paid off, matured, or regular principal amortization during and after the first quarter of 2022, which resulted in a decrease in interest expense of $0.5 million for the first quarter of 2023.
Total return swap income of $1.0 million in the first quarter of 2023 consists of monthly settlements related to the Company's total return swap contracts with an aggregate notional amount of $223.4 million.
Interest and other income (loss) increased by $20.1 million or 264.5% to an income of $12.5 million for the first quarter of 2023 compared to a loss of $7.6 million for the first quarter of 2022, primarily due to unrealized gains resulting from an increase in the fair value of marketable securities and an increase of $7.7 million in insurance reimbursements, legal settlements, and other, driven by a one-time legal settlement claim.
Equity income from co-investments decreased by $10.3 million or 48.6% to $10.9 million for the first quarter of 2023 compared to $21.2 million for the first quarter of 2022, primarily due to a decrease of $17.1 million in co-investment promote income and an $1.6 million increase in equity loss from co-investments partially offset by an $8.8 million decrease in equity loss from non-core co-investments.
Deferred tax benefit on unconsolidated co-investments of $0.9 million for the first quarter of 2023 is primarily due to net realized loss on deemed sales from non-core unconsolidated co-investments.
Liquidity and Capital Resources
As of March 31, 2023, the Company had $67.7 million of unrestricted cash and cash equivalents and $107.0 million in marketable securities, all of which were equity securities. The Company believes that cash flows generated by its operations, existing cash and cash equivalents, marketable securities balances and availability under existing lines of credit are sufficient to meet all of its anticipated cash needs during the next twelve months. Additionally, the capital markets continue to be available and the Company is able to generate cash from the disposition of real estate assets to finance additional cash flow needs, including continued development and select acquisitions. In the event that economic disruptions occur, the Company may further utilize other resources such as its cash reserves, lines of credit, or decreased investment in redevelopment activities to supplement operating cash flows. The Company is carefully monitoring and managing its cash position in light of ongoing conditions and levels of operations. 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 March 31, 2023, Moody’s Investor Service, and Standard and Poor's credit agencies rated the Company and the Operating Partnership, Baa1/Stable, and BBB+/Stable, respectively.
As of March 31, 2023, the Company had two unsecured lines of credit aggregating $1.24 billion. As of March 31, 2023, there was no outstanding balance on the Company's $1.2 billion unsecured line of credit. The underlying interest rate is based on a tiered rate structure tied to the Company's credit ratings, adjusted for the Company's sustainability metric grid, and was at Adjusted SOFR plus 0.75% as of March 31, 2023. This facility is scheduled to mature in January 2027, with two six-month extensions, exercisable at the Company's option. As of March 31, 2023, there was $0.5 million outstanding on the Company's $35.0 million working capital unsecured line of credit. The underlying interest rate on the $35.0 million line is based on a tiered rate structure tied to the Company's credit ratings, adjusted for the Company's sustainability metric grid, and was at Adjusted SOFR plus 0.75% as of March 31, 2023. This facility is scheduled to mature in July 2024.
In October 2022, the Operating Partnership entered into a $300.0 million unsecured term loan with an interest rate at Adjusted SOFR plus 0.85%. The Company also entered into an interest rate swap contract to fix the interest rate at 4.2%. The loan matures in October 2024 with three 12-month extension options, exercisable at the Company's option. The loan includes a six-month delayed draw feature. As of March 31, 2023, the term loan had not been drawn and had a balance of zero.
In September 2021, 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 “2021 ATM Program”). In connection with the 2021 ATM Program, the Company may also enter into related forward sale agreements, and may sell shares of its common stock pursuant to these 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 receipt of the proceeds from the sale of shares until a later date should the Company elect to settle such forward sale agreement, in whole or in part, in shares of common stock.
The 2021 ATM Program replaced the prior equity distribution agreement entered into in September 2018 (the "2018 ATM Program"), which was terminated upon the establishment of the 2021 ATM Program. During the three months ended March 31, 2023, the Company did not sell any shares of its common stock through the 2021 ATM Program. As of March 31, 2023, there are no outstanding forward purchase agreements, and $900.0 million of shares remains available to be sold under the 2021 ATM Program.
In December 2015, the Company’s Board of Directors authorized a stock repurchase plan to allow the Company to acquire shares in an aggregate of up to $250.0 million. 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 stock repurchase plan. In each of May and December 2020, 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. In September 2022, the Company's Board of Directors approved a new stock repurchase plan to allow the Company to acquire shares of common stock up to an aggregate value of $500.0 million. The plan supersedes the Company's previous common stock repurchase plan announced in December 2015. During the three months ended March 31, 2023, the Company repurchased and retired 437,026 shares of its common stock totaling $95.7 million, including commissions, at an average price of $218.88 per share. As of March 31, 2023, the Company had $302.7 million of purchase authority remaining under the stock repurchase plan.
Essex 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 line of credit.
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 March 31, 2023, the Company’s development pipeline was comprised of one unconsolidated joint venture project under development aggregating 264 apartment homes, and various consolidated predevelopment projects, with total incurred costs of $101.0 million, and estimated remaining project costs of approximately $23.0 million, $11.7 million of which represents the Company's share of estimated remaining costs, for total estimated project costs of $124.0 million.
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 communities 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.
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.
Alternative Capital Sources
The Company utilizes co-investments as an alternative source of capital for acquisitions of both operating and development communities. As of March 31, 2023, the Company had an interest in 264 apartment homes in a community actively under development with a joint venture for total estimated costs of $102.0 million. Total estimated remaining costs are approximately $23.0 million, of which the Company estimates its remaining investment in these development joint ventures will be approximately $11.7 million. In addition, the Company had an interest in 10,425 apartment homes of operating communities with joint ventures for a total book value of $468.8 million as of March 31, 2023.
Off-Balance Sheet Arrangements
The Company has various unconsolidated interests in certain joint ventures. The Company does not believe that these unconsolidated investments have a materially different impact on its liquidity, cash flows, capital resources, credit or market risk than its consolidated operations. See Note 4, Co-investments, in the Notes to Condensed Consolidated Financial Statements, for carrying values and combined summarized financial information of these unconsolidated investments.
Critical Accounting Estimates
The preparation of condensed 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 estimates as those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the Company. The Company’s critical accounting estimates relate principally to the following key areas: (i) accounting for the acquisition of investments in real estate; 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 various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates made by management.
The Company’s critical accounting policies and estimates have not changed materially from the information reported in Note 2, Summary of Critical and Significant Accounting Policies, in the Company’s annual report on Form 10-K for the year ended December 31, 2022.
Forward-Looking Statements
Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report on Form 10-Q which are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (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 expectations related to the continued evolution of the work-from-home trend as well as other impacts on the Company's financial statements and operating results, 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 Internal Revenue Code of 1986, as amended, 2023 Same-Property revenue and operating expenses generally and in specific regions, 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 such economic conditions, inflation, the labor market, supply chain impacts and ongoing hostilities between Russia and Ukraine, 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: potential future outbreaks of infectious diseases or other health concerns, which could adversely affect the Company’s business and its tenants, and cause a significant downturn in general economic conditions, the real estate industry, and the markets in which the Company's communities are located; 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, inflation, escalated operating costs and possible recessionary impacts; as well as uncertainties regarding ongoing hostilities between Russia and Ukraine and the related impacts on macroeconomic conditions, including, among other things, interest rates and inflation; 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; 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 referred to in this quarterly report on Form 10-Q, in the Company's annual report on Form 10-K for the year ended December 31, 2022, 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, 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.
Funds from Operations Attributable to Common Stockholders and Unitholders
Funds from Operations Attributable to Common Stockholders and Unitholders ("FFO") is a financial measure that is commonly used in the REIT industry. The Company presents FFO and FFO excluding non-core items (referred to as "Core FFO") as supplemental operating performance measures. FFO and Core FFO are not used by the Company as, nor should they be considered to be, alternatives to net income computed under U.S. GAAP as an indicator of the Company’s operating performance or as alternatives to cash from operating activities computed under U.S. GAAP as an indicator of the Company’s ability to fund its cash needs.
FFO and Core FFO are not meant to represent a comprehensive system of financial reporting and do not present, nor do they intend to present, a complete picture of the Company's financial condition and operating performance. The Company believes that net income computed under U.S. GAAP is the primary measure of performance and that FFO and Core FFO are only meaningful when they are used in conjunction with net income.
The Company considers FFO and Core FFO to be useful financial performance measurements of an equity REIT because, together with net income and cash flows, FFO and Core FFO provide investors with additional bases to evaluate operating performance and ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures and to pay dividends. By excluding gains or losses related to sales of depreciated operating properties and land and excluding real estate depreciation (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO can help investors compare the operating performance of a real estate company between periods or as compared to different companies. By further adjusting for items that are not considered part of the Company’s core business operations, Core FFO allows investors to compare the core operating performance of the Company to its performance in prior reporting periods and to the operating performance of other real estate companies without the effect of items that by their nature are not comparable from period to period and tend to obscure the Company’s actual operating results. The Company believes that its condensed consolidated financial statements, prepared in accordance with U.S. GAAP, provide the most meaningful picture of its financial condition and its operating performance.
In calculating FFO, the Company follows the definition for this measure published by the National Associate of Real Estate Investment Trusts ("NAREIT"), which is the leading REIT industry association. The Company believes that, under the NAREIT FFO definition, the two most significant adjustments made to net income are (i) the exclusion of historical cost depreciation and (ii) the exclusion of gains and losses from the sale of previously depreciated properties. The Company agrees that these two NAREIT adjustments are useful to investors for the following reasons:
(a)historical cost accounting for real estate assets in accordance with U.S. GAAP assumes, through depreciation charges, that the value of real estate assets diminishes predictably over time. NAREIT stated in its White Paper on Funds from Operations "since real estate asset values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves." Consequently, NAREIT’s definition of FFO reflects the fact that real estate, as an asset class, generally appreciates over time and depreciation charges required by U.S. GAAP do not reflect the underlying economic realities.
(b)REITs were created as a legal form of organization in order to encourage public ownership of real estate as an asset class through investment in firms that were in the business of long-term ownership and management of real estate. The exclusion, in NAREIT’s definition of FFO, of gains and losses from the sales of previously depreciated operating real estate assets allows investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT’s activity and assists in comparing those operating results between periods.
Management believes that it has consistently applied the NAREIT definition of FFO to all periods presented. However, there is judgment involved and other REITs’ calculation of FFO may vary from the NAREIT definition for this measure, and thus their disclosure of FFO may not be comparable to the Company’s calculation.
The table below is a reconciliation of net income available to common stockholders to FFO and Core FFO for the three months ended March 31, 2023 and 2022 (in thousands, except share and per share amounts):
Essex Property Trust, Inc.
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2023 | 2022 | ||||||||||||||||||||||
| Net income available to common stockholders | $ | 153,532 | $ | 73,254 | |||||||||||||||||||
| Adjustments: | |||||||||||||||||||||||
| Depreciation and amortization | 136,347 | 133,533 | |||||||||||||||||||||
| Gains on sale of real estate and land not included in FFO | (59,238) | — | |||||||||||||||||||||
| Casualty loss | 433 | — | |||||||||||||||||||||
| Depreciation and amortization from unconsolidated co-investments | 17,609 | 18,115 | |||||||||||||||||||||
| Noncontrolling interest related to Operating Partnership units | 5,404 | 2,563 | |||||||||||||||||||||
| Depreciation attributable to third party ownership and other (1) | (359) | (353) | |||||||||||||||||||||
| Funds from Operations attributable to common stockholders and unitholders | $ | 253,728 | $ | 227,112 | |||||||||||||||||||
| FFO per share - diluted | $ | 3.80 | $ | 3.36 | |||||||||||||||||||
| Non-core items: | |||||||||||||||||||||||
| Expensed acquisition and investment related costs | $ | 339 | $ | 8 | |||||||||||||||||||
| Deferred tax benefit on unconsolidated co-investments (2) | (900) | (2,754) | |||||||||||||||||||||
| Gain on sale of marketable securities | (912) | (12,171) | |||||||||||||||||||||
| Change in unrealized (gains) losses on marketable securities, net | (368) | 24,585 | |||||||||||||||||||||
| Provision for credit losses | 18 | (62) | |||||||||||||||||||||
| Equity loss from non-core co-investments (3) | 94 | 8,844 | |||||||||||||||||||||
| Loss on early retirement of debt from unconsolidated co-investments | — | 86 | |||||||||||||||||||||
| Co-investment promote income | — | (17,076) | |||||||||||||||||||||
| Income from early redemption of preferred equity investments and notes receivable | — | (858) | |||||||||||||||||||||
| General and administrative and other, net | 266 | 448 | |||||||||||||||||||||
| Insurance reimbursements, legal settlements, and other, net | (8,504) | — | |||||||||||||||||||||
| Core Funds from Operations attributable to common stockholders and unitholders | $ | 243,761 | $ | 228,162 | |||||||||||||||||||
| Core Funds from Operations attributable to common stockholders and unitholders per share-diluted | $ | 3.65 | $ | 3.37 | |||||||||||||||||||
| Weighted average number of shares outstanding, diluted (4) | 66,725,582 | 67,621,842 |
(1) The Company consolidates certain co-investments. The noncontrolling interest's share of net operating income in these investments for the three months ended March 31, 2023 was $0.8 million.
(2) Represents deferred tax benefit related to net unrealized gains or losses on technology co-investments.
(3) Represents the Company's share of co-investment loss from technology co-investments.
(4) Assumes conversion of all outstanding limited partnership units in the Operating Partnership into shares of the Company's common stock and excludes DownREIT limited partnership units.
Net Operating Income
Net operating income ("NOI") and Same-Property NOI are considered by management to be important supplemental performance measures to earnings from operations included in the Company’s condensed consolidated statements of income. The presentation of Same-Property NOI assists with the presentation of the Company’s operations prior to the allocation of depreciation and any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual communities or groups of communities. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. The Company defines Same-Property NOI as Same-Property revenues less Same-Property operating expenses, including property taxes. Please see the reconciliation of earnings from operations to NOI and Same-Property NOI, which in the table below is the NOI for stabilized properties consolidated by the Company for the periods presented ($ in thousands):
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2023 | 2022 | ||||||||||||||||||||||
| Earnings from operations | $ | 187,385 | $ | 109,850 | |||||||||||||||||||
| Adjustments: | |||||||||||||||||||||||
| Corporate-level property management expenses | 11,432 | 10,172 | |||||||||||||||||||||
| Depreciation and amortization | 136,347 | 133,533 | |||||||||||||||||||||
| Management and other fees from affiliates | (2,765) | (2,689) | |||||||||||||||||||||
| General and administrative | 15,311 | 12,242 | |||||||||||||||||||||
| Expensed acquisition and investment related costs | 339 | 8 | |||||||||||||||||||||
| Casualty Loss | 433 | — | |||||||||||||||||||||
| Gain on sale of real estate and land | (59,238) | — | |||||||||||||||||||||
| NOI | 289,244 | 263,116 | |||||||||||||||||||||
| Less: Non-Same Property NOI | (15,145) | (12,088) | |||||||||||||||||||||
| Same-Property NOI | $ | 274,099 | $ | 251,028 |
Previous: Item 1. Condensed Consolidated Financial Statements · Next: Item 3. Quantitative and Qualitative Disclosures About Market Risks