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ESS > SEC Filings for ESS > Form 10-K on 26-Feb-2014All Recent SEC Filings

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Form 10-K for ESSEX PROPERTY TRUST INC


26-Feb-2014

Annual Report


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.

On December 19, 2013, ESS and BRE Properties, Inc. ("BRE") entered into a definitive agreement to combine the two companies. Under the terms of the agreement, each BRE common share will be converted into 0.2971 newly issued shares of ESS common stock plus $12.33 in cash. The merger is subject to customary closing conditions, including receipt of approval of ESS shareholders and BRE shareholders. Additional information about the merger can be found in the Form S-4 filed with the SEC on January 29, 2014 and in other relevant documents that the Company files with the SEC, which are available free of charge on the Company's website at www.essexpropertytrust.com and on the SEC's website at www.sec.gov.

Certain statements below discuss the Company's estimates of its 2014 regional Same-Property revenues; these estimates are for Essex on a standalone basis, excluding the impact of the proposed merger with BRE.

OVERVIEW

ESS is a self-administered and self-managed REIT that acquires, develops, redevelops and manages apartment communities in selected residential areas located primarily in the West Coast of the United States. ESS owns all of its interests in its real estate investments, directly or indirectly, through the Operating Partnership. ESS is the sole general partner of the Operating Partnership and, as of December 31, 2013, had an approximately 94.6% general partner interest in the Operating Partnership.


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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, and disposition activities to markets that will optimize the performance of the portfolio.

As of December 31, 2013, the Company had ownership interests in 164 communities, comprising 34,079 apartment units, and the apartment communities are located in the following major West Coast regions:

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

As of December 31, 2013, the Company also had ownership interests in four commercial buildings (with approximately 315,900 square feet).

As of December 31, 2013, the Company's development pipeline was comprised of two consolidated projects under development, nine unconsolidated joint venture projects under development and one consolidated predevelopment project aggregating 2,701 units, with total incurred costs of $696.7 million, and estimated remaining project costs of approximately $407.0 million for total estimated project costs of $1.1 billion. By region, the Company's operating results for 2013 and 2012 and projections for 2014 new housing supply, job growth, and rental income are as follows:

Southern California Region: As of December 31, 2013, this region represented 46% of the Company's consolidated apartment units. During the year ended December 31, 2013, revenues for "2013/2012 Same-Properties" (as defined below), or "Same-Property revenues," increased 4.4% in 2013 as compared to 2012. In 2014, the Company expects new residential supply of 15,400 multifamily and 10,500 single family homes, which represents a total new multifamily supply of 0.7% and 0.5% of total housing stock, respectively. The Company assumes an increase of 132,400 jobs or 1.9%, and an increase in same-property revenues between 3.8% to 5.0% in 2014.

Northern California Region: As of December 31, 2013, this region represented 32% of the Company's consolidated apartment units. Same-Property revenues increased 8.2% in 2013 as compared to 2012. In 2014, the Company expects new residential supply of 10,800 multifamily and 5,225 single family homes, which represents a total new multifamily supply of 1.3% and 0.7%, respectively, of total housing stock. The Company assumes an increase of 73,000 jobs or 2.5%, and an increase in same-property revenues between 6.3% to 7.8% in 2014.

Seattle Metro Region: As of December 31, 2013, this region represented 22% of the Company's consolidated apartment units. Same-Property revenues increased 7.7% in 2013 as compared to 2012. In 2014, the Company expects new residential supply of 8,500 multifamily and 6,500 single family homes, which represents a total new multifamily supply of 1.9% and 1.3%, respectively, of total housing stock. The Company assumes an increase of 39,000 jobs or 2.6%, and an increase in same-property revenues between 5.5% to 7.0% in 2014.

The Company expects 2014 Same-Property revenues to increase compared to 2013 results, as renewal and new leases are signed at higher rents in 2014 than 2013. Same-Property operating expenses are expected to increase in 2014, and forecasted increases in property taxes account for approximately 56% of the forecasted increase in property expenses in 2014 compared to 2013.

The Company's consolidated communities are as follows:

                           As of December 31, 2013               As of December 31, 2012
                        Apartment Units               %       Apartment Units               %
Southern California              13,855              46 %              13,656              47 %
Northern California               9,431              32 %               8,987              31 %
Seattle Metro                     6,703              22 %               6,598              22 %
Total                            29,989             100 %              29,241             100 %

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


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RESULTS OF OPERATIONS

Comparison of Year Ended December 31, 2013 to the Year Ended December 31, 2012

The Company's average financial occupancies for the Company's stabilized apartment communities or "2013/2012 Same-Properties" (stabilized properties consolidated by the Company for the years ended December 31, 2013 and 2012) decreased 10 basis points to 96.2% in 2013 from 96.3% in 2012. 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.

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 units. The Company may increase or decrease 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 REITs, 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 2013/2012 Same-Property portfolio for financial occupancy for the years ended December 31, 2013 and 2012 is as follows:

                                                Years ended
                                               December 31,
                                              2013       2012
                       Southern California     96.1 %     96.1 %
                       Northern California     96.3 %     96.7 %
                       Seattle Metro           96.1 %     96.1 %

The following table provides a breakdown of revenue amounts, including the revenues attributable to 2013/2012 Same-Properties.

                                                         Years Ended
                                   Number of            December 31,            Dollar        Percentage
                                   Properties        2013          2012         Change          Change
Property Revenues ($ in
thousands)
2013/2012 Same-Properties:
Southern California                         58     $ 235,306     $ 225,435     $   9,871              4.4 %
Northern California                         35       184,508       170,578        13,930              8.2
Seattle Metro                               29        93,139        86,483         6,656              7.7
Total 2013/2012 Same-Property
revenues                                   122       512,953       482,496        30,457              6.3
2013/2012 Non-Same Property
Revenues (1)                                          89,050        44,200        44,850            101.5
Total property revenues                            $ 602,003     $ 526,696     $  75,307             14.3 %

(1) Includes fifteen communities acquired after January 1, 2012, two redevelopment communities, and three commercial buildings.

2013/2012 Same-Property Revenues increased by $30.5 million or 6.3% to $513.0 million for 2013 compared to $482.5 million in 2012. The increase was primarily attributable to an increase in scheduled rents of $29.6 million as reflected in an increase of 6.3% in average rental rates from $1,502 per unit for 2012 to $1,597 per unit for 2013. Scheduled rents increased in all regions by 4.1%, 8.4%, and 7.7% in Southern California, Northern California, and Seattle Metro, respectively. Income from utility billings and other income increased by $1.0 million and $1.2 million, respectively in 2013 compared to 2012. Occupancy decreased 10 basis points in 2013 to 96.2% compared to 96.3% in 2012.


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2013/2012 Non-Same Property Revenues increased by $44.9 million or 102% to $89.1 million in 2013 compared to $44.2 million to 2012. The increase was primarily due to revenue generated from fifteen communities acquired or consolidated since January 1, 2012 (Annaliese, Ascent, Bennett Lofts, Domain, Domaine, Essex Skyline at MacArthur Place, Fox Plaza, Montebello, Park Catalina, Park West, Reed Square, Slater 116, The Huntington, Vox and Willow Lake).

Management and other fees from affiliates increased $0.2 million or 1.8% to $11.7 million in 2013 compared to $11.5 million in 2012. 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 during 2012, and development fees earned from the development joint venture formed in 2013 and 2012 to develop Epic, Expo, Connolly Station, Park 20 (fka Elkhorn), Mosso I and II, The Huxley, The Dylan, The Village and One South Market. The increase in management fees was offset by a reduction of $2.3 million in asset and property management fees from the sale of eight Fund II communities since the fourth quarter of 2012. An additional four communities owned by Fund II were sold in 2013, and the remaining two communities are expected to be sold in 2014.

Property operating expenses, excluding real estate taxes increased $14.9 million or 12.1% in 2013 compared to 2012, primarily due to the acquisition of fifteen communities. 2013/2012 Same-Property operating expenses excluding real estate taxes, increased by $3.6 million or 3.2% in 2013 compared to 2012, due mainly to a $1.4 million increase in repairs and maintenance, a $1.2 million increase in utilities expense, and a $0.9 million increase in administration costs.

Real estate taxes increased $8.9 million or 18.5% in 2013 compared to 2012, due primarily to the acquisition of fifteen communities. 2013/2012 Same-Property real estate taxes increased by $2.6 million or 6.0% for the 2013 compared to 2012 due to $1.3 million or 17.5% increase in property taxes for Seattle Metro due to higher assessed values for 2013, and an increase of 3.7% in property taxes for the majority of the properties located in California.

Depreciation expense increased by $23.2 million or 13.7% in 2013 compared to 2012, due to the acquisition of fifteen communities. The increase is due to the capitalization of approximately $104.2 million in additions to rental properties through 2013, including $42.0 million spent on redevelopment, $21.2 million on improvements to recent acquisitions, $8.6 million on lessor required capital expenditures, and $5.3 million spent on revenue generating capital expenditures. Approximately $92.0 million in additions to rental properties was capitalized for 2012, including $39.0 million spent on redevelopment, $13.7 million spent on improvements to recent acquisitions, and $7.7 million spent on revenue generating capital expenditures.

General and administrative expense increased $2.3 million or 9.8% in 2013 compared to 2012 primarily due to annual compensation increases for merit, investments in technology, and the addition of staff.

Merger expenses include, but are not limited to, advisor fees, legal fees, and accounting fees related to the pending merger with BRE Properties, Inc. ("BRE"). The Company entered into a definitive agreement to combine with BRE in December 2013. Merger expenses were $4.3 million for 2013 and zero for 2012.

Interest expense before amortization increased $4.4 million or 4.3% in 2013, primarily due to an increase in average outstanding debt for the funding of 2012 and 2013 acquisitions and development pipeline.

Interest and other income decreased by $2.2 million in 2013 primarily due to $2.3 million of promote income earned from achieving certain performance hurdles related to the Essex Skyline co-investment in 2012.

Equity income in co-investments increased by $14.2 million to $55.9 million in 2013 compared to $41.7 million in 2012. The increase was primarily due to the Company's share of the gain on the sale of five Fund II communities of $38.8 million, net of internal disposition costs, and $1.4 million income earned from the early prepayment of a preferred equity investment in 2013. Additionally, equity income increased with income earned from four communities acquired by the Wesco joint ventures in the second half of 2012 and two communities in the second quarter of 2013. The increase in equity income in 2013 by the Wesco joint venture was offset by a decrease in income related to the sale of eight Fund II communities since the fourth quarter of 2012 including four communities sold in the third quarter of 2013.


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Loss on early retirement of debt, net was $0.3 million for 2013 compared to $5.0 million in 2012. The $0.3 million loss in 2013 reflects a gain of $1.5 million earned from the redemption of bonds in the second quarter of 2013 offset by losses incurred from the write-off of deferred financing costs and prepayment penalties related to the prepayment of secured debt loans in 2013. The 2012 loss was due to the write-off of deferred financing costs and prepayment penalties related to the early termination of secured debt related to six communities. The loss for 2012 also included the Company's pro-rata share of the write-off of deferred financing costs and prepayment penalties incurred for the prepayment of the secured debt for the Essex Skyline joint venture and seven Fund II communities sold in 2012.

Income from discontinued operations for 2013 was $31.2 million and included gains of $29.2 million from the sales of Linden Square, Brentwood and Cambridge. For 2012, income from discontinued operations was $11.9 million and included a gain of $9.8 million from the sale of Tierra del Sol/Norte and Alpine Country, net of internal disposition costs. Discontinued operations for 2013 and 2012 reflect the operating results of the three communities sold in 2013 and the two communities sold in 2012.

Comparison of Year Ended December 31, 2012 to the Year Ended December 31, 2011

The Company's average financial occupancies for the Company's stabilized
apartment communities for "2012/2011 Same-Properties" (stabilized properties
consolidated by the Company for the years ended December 31, 2012 and 2011)
remained consistent at 96.3% for 2012 and 2011.  The regional breakdown of the
Company's stabilized 2012/2011 Same-Property portfolio for financial occupancy
for the years ended December 31, 2012 and 2011 is as follows:

                                                Years ended
                                               December 31,
                                              2012       2011
                       Southern California     96.1 %     96.3 %
                       Northern California     96.7 %     96.6 %
                       Seattle Metro           96.1 %     96.4 %

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

                                                         Years Ended
                                   Number of            December 31,            Dollar        Percentage
                                   Properties        2012          2011         Change          Change
Property Revenues ($ in
thousands)
2012/2011 Same-Properties:
Southern California                         56     $ 224,779     $ 215,738     $   9,041              4.2 %
Northern California                         33       159,993       146,008        13,985              9.6
Seattle Metro                               27        83,153        76,650         6,503              8.5
Total 2012/2011 Same-Property
revenues                                   116       467,925       438,396        29,529              6.7
2012/2011 Non-Same Property
Revenues (1)                                          58,771        22,264        36,507            164.0
Total property revenues                            $ 526,696     $ 460,660     $  66,036             14.3 %

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

2012/2011 Same-Property Revenues increased by $29.5 million or 6.7% to $467.9 million in 2012 compared to $438.4 million in 2011. The increase was primarily attributable to an increase in scheduled rents of $27.7 million as reflected in an increase of 6.5% in average rental rates from $1,393 per unit for 2011 to $1,483 per unit for 2012. Scheduled rents increased in all regions by 3.8%, 9.5%, and 8.3% in Southern California, Northern California, and Seattle Metro, respectively. Income from utility billings and other income increased by $1.2 million and $1.4 million, respectively in 2012 compared to 2011. Occupancy was consistent between years at 96.3%.

2012/2011 Non-Same Property Revenues increased $36.5 million or 164% to $58.8 million in 2012 compared to $22.3 million in 2011. The increase was primarily due to revenue generated from five development communities (Via, Allegro, Bellerive, Muse, and Santee Village), thirteen communities acquired or consolidated since January 1, 2011 (Bernard, 1000 Kiely, Delano/Bon Terra, Reed Square, Essex Skyline at MacArthur Place, Park Catalina, The Huntington, Montebello, Park West, Domaine, Ascent, Willow Lake, and Bennett Lofts).

Management and other fees from affiliates increased $4.7 million or 69.5% to $11.5 million in 2012 compared to $6.8 million in 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, Connolly Station, Park
20 (fka Elkhorn), Mosso I and Mosso II (fka Folsom and Fifth), The Huxley and The Dylan development projects.


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Property operating expenses, excluding real estate taxes increased $10.1 million or 8.9% in 2012 compared to 2011, primarily due to the acquisition of thirteen communities and the lease-up of five development properties. 2012/2011 Same-Property operating expenses excluding real estate taxes increased by $1.9 million or 1.7% for 2012 compared to 2011, due mainly to a $1.5 million increase in salaries, marketing, and administration costs and a $0.3 million increase in utilities due to increases in rates for water and sewer.

Real estate taxes increased $4.6 million or 10.5% in 2012 compared to 2011, due primarily to the acquisition of thirteen communities 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 $0.9 million or 2.3% for 2012 compared to 2011 due to an increase of 5.3% in property taxes for the Seattle Metro and 2.0% in property taxes for the majority of properties located in California regulated by Proposition 13 offset by temporary reductions in assessed property valuations for selected communities located in California.

Depreciation expense increased by $19.2 million or 12.8% in 2012 compared to 2011, due to the acquisition of thirteen communities and the lease-up of five development properties. The increase is due to the capitalization of approximately $92.0 million in additions to rental properties in 2012, including $39.0 million spent on redevelopment, $13.7 million spent on improvement to recent acquisitions, and $7.7 million spent on revenue generating capital expenditures. Approximately $95.3 million in additions to rental properties was capitalized 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 expenditures.

General and administrative expense increased $2.6 million or 12.6% in 2012 compared to 2011 primarily due to an increase of acquisitions cost of $1.3 million compared to 2011 related to the increase in acquisitions in 2012 compared to 2011, annual compensation adjustments for merit, and the cost of hiring additional staff to manage the new acquisitions.

Cost of management and other fees increased $1.9 million or 41.3% in 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 $8.6 million or 9.3% in 2012 compared to 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 an unsecured term loan at an average interest rate of 2.7%. Also, on March 31, 2011, the Company issued $150 million of private placement notes with an average interest rate of 4.5%, on August 15, 2012 the Company issued $300 million of new unsecured bonds with an interest rate of 3.625%, and the Company drew an additional $150 million on a bank term loan in the fourth quarter of 2012. Thus, interest expense increased due to an increase in average outstanding debt for the funding of 2012 acquisitions and the development pipeline and a higher average interest rate for 2012 compared to 2011.

Interest and other income decreased by $3.3 million in 2012 primarily 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 $0.8 million in 2012, compared to a gain of $5.0 million from the sale of marketable securities, $0.2 million gain from the sale of a land parcel, and a $1.7 million income tax benefit from a taxable REIT subsidiary that met the "more likely than not" threshold in the fourth quarter of 2011. This tax benefit relates to the write-off of an investment in a joint venture development project recognized during 2009.

Equity income (loss) in co-investments was income of $41.7 million in 2012 compared to a loss of $0.5 million in 2011. The increase was primarily due to the Company's pro-rata share of the gain of $29.1 million from the sale of seven properties owned by Fund II, and income of $13.5 million in 2012 compared to $3.5 million for 2011, related to the Company's preferred equity investments made in 2011. In the fourth quarter of 2011, the Company made a preferred equity investment in Wesco II which earned $9.0 million in 2012 compared to $0.5 million in 2011.

Gain on remeasurement of co-investment of $21.9 million in 2012 was due to the Company's acquisition of the joint venture partner's membership interest in Essex Skyline at MacArthur Place which the Company subsequently consolidated. Upon consolidation, a gain was recorded equal to the amount by which the fair value of the Company's previously noncontrolling interest exceeded its carrying value.


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Loss on early retirement of debt was $5.0 million for 2012 and was due to the write-off of deferred financing costs and prepayment penalties related to the early termination of secured debt related to six communities. The loss for 2012 also included the Company's pro-rata share of the write-off of deferred financing costs and prepayment penalties incurred for the prepayment of the secured debt for the Essex Skyline joint venture and seven Fund II communities sold in 2012. During 2011, the loss on early retirement of debt was due to the write-off of deferred financing costs related to the termination of the Company's $250 million secured line of credit with Freddie Mac and mortgages paid-off before maturity in 2011.

Income from discontinued operations for 2012 was $11.9 million and included a gain of $9.8 million from the sale of Tierra del Sol/Norte and Alpine Country, net of internal disposition costs. For 2011, income from discontinued operations was $10.6 million and included a gain of $7.5 million from the sale . . .

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