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ESS > SEC Filings for ESS > Form 10-Q on 5-Nov-2012All Recent SEC Filings

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Form 10-Q for ESSEX PROPERTY TRUST INC


5-Nov-2012

Quarterly Report


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion 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 2011 Annual Report on Form 10-K for the year ended December 31, 2011.

The Company is a fully integrated Real Estate Investment Trust ("REIT"), and its property revenues are generated primarily from apartment community operations. The Company's investment strategy has two components: constant monitoring of existing markets, and evaluation of new markets in the Company's current three geographical regions 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 the Company's acquisition, development, and disposition activities to markets that will optimize the performance of the portfolio.

As of September 30, 2012, the Company had ownership interests in 164 apartment communities, comprising 33,637 apartment units, excluding the Company's ownership in preferred equity interest co-investments. The Company's apartment communities are located in the following major West Coast regions:

Southern California (Los Angeles, Orange, Riverside, San Diego, Santa Barbara, and Ventura counties)
Northern California (the San Francisco Bay Area) Seattle Metro (Seattle metropolitan area)

As of September 30, 2012, the Company also had ownership interests in five commercial buildings with approximately 315,900 square feet.

As of September 30, 2012, the Company's development pipeline was comprised of two consolidated projects under development, seven unconsolidated joint venture projects under development, one unconsolidated joint venture predevelopment project and three consolidated land parcels held for future development or sale, all aggregating 2,985 units, with total incurred costs of $475.5 million, and estimated remaining project costs of approximately $523.9 million for total estimated project costs of $999.4 million.

The Company's consolidated apartment communities are as follows:

                           As of September 30, 2012             As of September 30, 2011
                        Apartment Units               %      Apartment Units               %
 Southern California             13,656              48 %             13,204              49 %
 Northern California              8,332              29 %              7,817              29 %
 Seattle Metro                    6,508              23 %              6,042              22 %
 Total                           28,496             100 %             27,063             100 %

Co-investments, including Fund II and Wesco I communities, and preferred equity interest co-investment communities are not included in the table presented above for both periods.

Comparison of the Three Months Ended September 30, 2012 to the Three Months Ended September 30, 2011

The Company's average financial occupancies for the Company's stabilized apartment communities or "Quarterly Same-Property" (stabilized properties consolidated by the Company for the quarters ended September 30, 2012 and 2011) increased 80 basis points to 96.1% as of September 30, 2012 from 95.3% as of September 30, 2011. Financial occupancy is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue. Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions. Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents. We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate.


Index

Market rates are determined using a variety of factors such as effective rental rates at the property based on recently signed leases and asking rates for comparable properties in the market. The recently signed effective rates at the property are used as the starting point in the determination of the market rates of vacant units. The Company then increases or decreases these rates based on the supply and demand in the apartment community's market. The Company will check the reasonableness of these rents based on its position within the market and compare the rents against the asking rents by comparable properties in the market. Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates as disclosed by other REIT, which may not be comparable to the Company's calculation of financial occupancy.

The Company does not take into account delinquency and concessions to calculate actual rent for occupied units and market rents for vacant units. The calculation of financial occupancy compares contractual rates for occupied units to estimated market rents for unoccupied units, thus the calculation compares the gross value of all apartment units 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 revenue is not considered the best metric to quantify occupancy.

The regional breakdown of the Company's Quarterly Same-Property portfolio for financial occupancy for the three months ended September 30, 2012 and 2011 is as follows:

                                            Three months ended
                                               September 30,
                                             2012          2011
                    Southern California       95.9%         95.2%
                    Northern California       96.5%         95.8%
                    Seattle Metro             95.6%         94.6%

The following table provides a breakdown of revenue amounts, including revenues attributable to the Quarterly Same-Property portfolio:

                                                               Three Months Ended
                                            Number of             September 30,             Dollar        Percentage
                                            Properties         2012           2011          Change          Change
Property Revenues (dollars in thousands)
Quarterly Same-Property:
Southern California                                  58     $   57,223     $   54,690     $    2,533              4.6 %
Northern California                                  33         40,427         36,724          3,703             10.1
Seattle Metro                                        28         21,542         19,762          1,780              9.0
Total Quarterly Same-Property revenues              119        119,192        111,176          8,016              7.2

Quarterly Non-Same Property Revenues (1) 15,878 6,050 9,828 162.4 Total property revenues $ 135,070 $ 117,226 $ 17,844 15.2 %

(1) Includes seven communities acquired after January 1, 2011, one redevelopment community, five development communities, and three commercial buildings.

Quarterly Same-Property Revenues increased by $8.0 million or 7.2% to $119.2 million in the third quarter of 2012 from $111.2 million in the third quarter of 2011. The increase was primarily attributable to an increase in scheduled rents of $7.0 million as reflected in an increase of 6.4% in average rental rates from $1,406 per unit in the third quarter of 2011 to $1,495 per unit in the third quarter of 2012. Scheduled rents increased by 3.8%, 9.5%, and 7.9% in Southern California, Northern California, and Seattle Metro, respectively. Income from utility billings and other income also increased $0.3 million and $0.2 million, respectively, compared to the third quarter of 2011. Quarterly Same-Property financial occupancy increased 80 basis points which also contributed to an increase of $0.2 million in revenues. On a sequential basis the Company experienced Quarterly Same-Property revenue growth from the second quarter of 2012 to the third quarter of 2012 of 2.0%, resulting from sequential revenue growth in all three regions mainly driven by a 2.1% increase in scheduled rent offset by a 10 basis point decrease in occupancy compared to the second quarter of 2012.

Quarterly Non-Same Property Revenues increased by $9.8 million or 162% to $15.9 million in the third quarter of 2012 from $6.1 million in the third quarter of 2011. The increase was primarily due to revenue generated from five development communities (Via, Allegro, Bellerive, Muse, and Santee Village) and ten communities acquired or consolidated since January 1, 2011 (Bernard, 1000 Kiely, Delano/Bon Terra, Reed Square, Park Catalina, The Huntington, Montebello, Park West, Domaine and Essex Skyline at MacArthur Place).


Index

Management and Other Fees increased by $1.1 million in the third quarter of 2012 as compared to the third quarter of 2011. The increase is primarily due to the asset and property management fees earned from Wesco I and II co-investments formed during 2011, and development fees earned from the joint ventures formed in 2011 and 2012 to develop Epic, Expo, Lync, Elkhorn, Folsom and Fifth, Fountain at La Brea, and Santa Monica at La Brea development projects.

Property operating expenses, excluding real estate taxes increased $3.3 million or 11.2% to $33.0 million in the third quarter of 2012 from $29.6 million in the third quarter of 2011, primarily due to the acquisition of ten communities and the lease-up of five development properties. Quarterly Same-Property operating expenses excluding real estate taxes, increased by $1.0 million or 3.6% for the third quarter of 2012 compared to the third quarter of 2011, due mainly to a $0.5 million increase in salaries and administration costs and a $0.3 million increase in utilities due increase in rates for water and sewer.

Real Estate taxes increased by $1.2 million or 10.3% for the third quarter of 2012 compared to the third quarter of 2011, due primarily to the acquisition of ten communities and expensing property taxes instead of capitalizing the cost for communities that were previously under development. Quarterly Same-Property real estate taxes increased by $0.2 million or 1.5% for third quarter of 2012 compared to the third quarter of 2011 due to an increase of 2% in property taxes for the majority of the properties located in California regulated by Prop. 13 as offset by a reduction in assessed property valuations for select communities located in California.

Depreciation expense increased by $5.2 million or 13.6% for the third quarter of 2012 compared to the third quarter of 2011, due to the acquisition of ten communities and the lease-up of five development properties. Also, the increase is due to the capitalization of approximately $58.2 million in additions to rental properties through the third quarter of 2012, including $31.3 million spent on redevelopment, $4.4 million spent on revenue generating capital and $6.7 million spent on recent acquisitions, and the capitalization of approximately $95.3 million in additions to rental properties for 2011, including $45.1 million spent on redevelopment, $16.4 million spent on improvements to recent acquisitions, and $7.6 million spent on revenue generating capital.

Cost of management and other fees increased $0.5 million for the third quarter of 2012 compared to 2011 primarily due to an increase in administrative costs due to hiring of additional staff to assist with the management of the Company's co-investments including Wesco I and II and the development joint ventures formed in 2011 and 2012.

Interest expense before amortization increased by $3.0 million or 13.4% for the third quarter of 2012 compared to the third quarter of 2011, primarily due to the payoff of the $250 million secured line of credit in the fourth quarter of 2011 which had an average interest rate of 1.3%. The Company replaced the secured line with debt at an average interest rate of 2.6%. Also, on March 31, 2011, the Company issued $150 million of private placement notes with an interest rate of 4.4%, and on August 15, 2012 the Company issued $300 million of unsecured bonds with an interest rate of 3.625%; thus the increase in interest expense is due to an increase in average outstanding debt and a higher average interest rate for the third quarter of 2012 as compared to the third quarter of 2011. Finally, the increase in interest expense for 2012 was offset by an increase of $0.4 million in capitalized interest in the third quarter of 2012 compared to the third quarter of 2011.

Equity income (loss) in co-investments increased $3.2 million in the third quarter of 2012 to income of $3.5 million compared to $0.3 million in the third quarter of 2011 primarily due to the income of $3.5 million related to the Company's preferred equity investments made in 2011 including the Wesco II preferred equity investment made in the fourth quarter of 2011 which earned $2.3 million in the third quarter of 2012.

Income from discontinued operations for the third quarter of 2012 was $0 as compared to a loss of $0.7 million for the third quarter of 2011 due to state taxes recorded in the third quarter of 2011 related to the gain from the sale of Woodlawn Colonial in the second quarter of 2011.

Comparison of the Nine Months Ended September 30, 2012 to the Nine Months Ended September 30, 2011

Our average financial occupancies for the Company's stabilized apartment communities or "2012/2011 Same-Property" (stabilized properties consolidated by the Company for the nine months ended September 30, 2012 and 2011) increased 20 basis points to 96.4% for the nine months ended September 30, 2012 from 96.2% for the nine months ended September 30, 2011.


Index

The regional breakdown of the Company's 2012/2011 Same-Property portfolio for financial occupancy for the nine months ended September 30, 2012 and 2011 is as follows:

                                             Nine Months Ended
                                               September 30,
                                              2012         2011
                     Southern California       96.2%        96.0%
                     Northern California       96.8%        96.7%
                     Seattle Metro             96.2%        96.0%

The following table provides a breakdown of revenue amounts, including revenues attributable to the 2012/2011 Same-Property portfolio:

                                                                Nine Months Ended
                                            Number of             September 30,             Dollar        Percentage
                                            Properties         2012           2011          Change          Change
Property Revenues (dollars in thousands)
2012/2011 Same-Properties:
Southern California                                  58     $  169,850     $  162,928     $    6,922              4.2 %
Northern California                                  33        118,654        107,983         10,671              9.9
Seattle Metro                                        28         63,395         58,354          5,041              8.6
Total 2012/2011 Same-Property revenues              119        351,899        329,265         22,634              6.9

2012/2011 Non-Same Property Revenues (1) 38,409 14,075 24,334 172.9 Total property revenues $ 390,308 $ 343,340 $ 46,968 13.7 %

(1) Includes seven communities acquired after January 1, 2011, one redevelopment community, five development communities, and three commercial buildings.

2012/2011 Same-Property Revenues increased by $22.6 million or 6.9% to $351.9 million for the nine months ended September 30, 2012 from $329.3 million for the nine months ended September 30, 2011. The increase was primarily attributable to an increase in scheduled rents of $20.9 million as reflected in an increase of 6.5% in average rental rates from $1,377 per unit for the nine months ended September 30, 2011 to $1,466 per unit for the nine months ended September 30, 2012. Scheduled rents increased by 3.7%, 9.7%, and 8.3% in Southern California, Northern California, and Seattle Metro, respectively. Income from utility billings and other income also increased $0.9 million and $0.9 million, respectively, compared to the nine months ended September 30, 2011. 2012/2011 Same-Property financial occupancy increased 20 basis points which also contributed $0.9 million in revenues.

2012/2011 Non-Same Property Revenues increased by $24.3 million or 173% to $38.4 million for the nine months ended September 30, 2012 from $14.1 million for the nine months ended September 30, 2011. The increase was primarily due to revenue generated from five development communities (Via, Allegro, Bellerive, Muse, and Santee Village), ten communities acquired or consolidated since January 1, 2011 (Bernard, 1000 Kiely, Delano/Bon Terra, Reed Square, Park Catalina, The Huntington, Montebello, Park West, and Domaine, and Essex Skyline at MacArthur Place) and the acquisition of the Santa Clara retail center.

Management and Other Fees increased by $3.7 million for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011. The increase is primarily due to the asset and property management fees earned from Wesco I and II co-investments formed during 2011, and development fees earned from the joint ventures formed in 2011 and 2012 to develop Epic, Expo, Lync, Elkhorn, Folsom and Fifth, Fountain at La Brea, and Santa Monica at La Brea development projects.

Property operating expenses, excluding real estate taxes increased $6.0 million or 6.9% to $92.4 million for the nine months ended September 30, 2012 from $86.4 million for the nine months ended September 30, 2011, primarily due to the acquisition of ten communities and one retail center in Santa Clara as a future development site, and the lease-up of five development properties. 2012/2011 Same-Property operating expenses excluding real estate taxes, increased by $0.8 million or 1.0% for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, due mainly to a $0.4 million increase in salaries and administration costs and a $0.2 million increase in maintenance and repairs.

Real Estate taxes increased by $2.9 million or 8.7% for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, due primarily to the acquisition of ten communities and one retail center and expensing property taxes instead of capitalizing the cost for communities that were previously under development. 2012/2011 Same-Property real estate taxes increased by $0.4 million or 1.4% for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 due to an increase of 2.0% in property taxes for the majority of the properties located in California regulated by Prop. 13 as offset by a reduction in assessed property valuations for select communities located in California.


Index

Depreciation expense increased by $13.8 million or 12.3% for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, due to the acquisition of ten communities and one retail center and the lease-up of five development properties. Also, the increase is due to the capitalization of approximately $58.2 million in additions to rental properties through the third quarter of 2012, including $31.3 million spent on redevelopment, $4.4 million spent on revenue generating capital and $6.7 million spent on recent acquisitions, and the capitalization of approximately $95.3 million in additions to rental properties for 2011, including $45.1 million spent on redevelopment, $16.4 million spent on improvements to recent acquisitions, and $7.6 million spent on revenue generating capital.

Cost of management and other fees increased $1.7 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011 primarily due to an increase in administrative costs due to hiring of additional staff to assist with the management of the Company's co-investments including Wesco I and II and the development joint ventures formed in 2011 and 2012.

Interest expense before amortization increased by $7.8 million or 11.7% for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, primarily due to the payoff of the $250 million secured line of credit in the fourth quarter of 2011 which had an average interest rate of 1.3%. The Company replaced the secured line with debt at an average interest rate of 2.6%. Also, on March 31, 2011, the Company issued $150 million of private placement notes with an interest rate of 4.4%, and on August 15, 2012 the Company issued $300 million of unsecured bonds with an interest rate of 3.625%, thus due to an increase in average outstanding debt and a higher average interest rate for the first nine months of 2012 compared to the same period in 2011.

Interest and other income decreased by $1.5 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011, due to $2.3 million of promote income earned from achieving certain performance hurdles related to the Essex Skyline co-investment and the sale of marketable securities for a gain of $0.5 million for the nine months ended September 30, 2012, compared to a gain of $4.5 million from the sale of marketable securities for the nine months ended September 30, 2011.

Equity income (loss) in co-investments increased $9.3 million for the nine months ended September 30, 2012 to income of $9.0 million compared to a loss of $0.3 million for the nine months ended September 30, 2011 primarily due to the income of $9.9 million related to the Company's preferred equity investments made in 2011 including the Wesco II preferred equity investment made in the fourth quarter of 2011 which earned $6.7 million for the nine months ended September 30, 2012.

Income from discontinued operations for the nine months ended September 30, 2012 was $10.0 million and included a gain of $9.8 million from the sale of Tierra del Sol/Norte and Alpine Country along with the operating results for these properties net of internal disposition costs. For the nine months ended September 30, 2011, income from discontinued operations was $5.3 million and included a gain of $4.4 million from the sale of Woodlawn Colonial net of internal disposition costs, and the operating results of these two properties sold in 2012.

Excess of the carrying amount of preferred stock redeemed over the cash paid to redeem preferred stock for the nine months ended September 30, 2011 was $1.9 million due to the redemption of all of the Series B preferred units, which resulted in excess of cash paid of $1.0 million over the carrying value of Series B preferred units and the redemption of Series F preferred stock which resulted in excess of cash paid of $0.9 million over the carrying value of Series F preferred stock due to deferred offering costs and original issuance discounts.

Liquidity and Capital

Standard and Poor's ("S&P") and Moody's Investors Service credit agencies rate Essex Property Trust, Inc. and Essex Portfolio, L.P. BBB/Stable and Baa2/Stable, respectively. Also, Fitch Ratings ("Fitch") assign a BBB issuer rating to Essex Portfolio, L.P., with a positive rating outlook.

As of September 30, 2012, the Company had $1.9 million of unrestricted cash and cash equivalents and $141.6 million in marketable securities, of which $90.9 million were held available for sale. We believe that cash flows generated by our operations, existing cash, cash equivalents, and 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 our reasonably anticipated cash needs during the next twelve months. 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 our plans for acquisitions, dispositions, development and redevelopment activities.


Index

The Company has two lines of credit aggregating $525 million as of September 30, 2012. The Company has a $500 million unsecured line of credit with an accordion option to $600 million. As of September 30, 2012 there was a $58 million balance on this unsecured line. The underlying interest rate on the $500 million line is based on a tiered rate structure tied to the Company's credit ratings on the credit facility and the rate was LIBOR + 1.20% as of September 30, 2012. This facility matures in December 2015 with two one-year extensions, exercisable by the Company. The Company has a working capital unsecured line of credit agreement for $25 million. As of September 30, 2012 there was a $3.9 million balance outstanding on this unsecured line. The underlying interest rate on the $25 million line is based on a tiered rate structure tied to the Company's credit ratings on the credit facility of LIBOR + 1.20%.

During the nine months ended September 30, 2012, the Company entered into an agreement to issue $200 million of private placement unsecured notes for a term of 9-years at an all-in fixed rate of 4.3%.

In July, the Company increased the capacity of its $200 million unsecured term loan originated in the fourth quarter of 2011 to $350 million, and the tiered pricing structure was reduced from LIBOR + 142.5 basis points to LIBOR + 130 basis points. The $150 million of additional funds were issued by the Company during October 2012.

The Company has entered into interest rate swap contracts with an aggregate notional amount of $300 million that effectively fixed the interest rate on $300 million of the $350 million unsecured term loan at 2.4%. These derivatives qualify for hedge accounting.

The Company has entered into equity distribution agreements with Barclays Capital Inc., BMO Capital Markets Corp., Liquidnet, Inc., Mitsubishi UFJ Securities (USA), Inc., and Citigroup Global Markets Inc. During the third quarter of 2012, the Company sold 633,636 shares of common stock for $97.9 million, net of commissions, at an average per share price of $155.97. From December 31, 2011 through November 1, 2012, the Company has sold 1,775,748 shares of common stock for $269.0 million, net of commissions, at an average price of $152.97.

Under this program, the Company may from time to time sell shares of common stock into the existing trading market at current market prices, and the Company anticipates using the net proceeds to pay down debt, acquire apartment communities and fund the development pipeline. As of November 1, 2012, the Company may sell an additional 2,700,231 shares under the current equity distribution program.

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