Essex Property Trust, one of West Coast’s most prominent multifamily investment and development firms had its quarterly investor call last week, outlining for the industry its position on the industry and providing insight into its business practices and results.
The company is doing great is the sum of its results, and the team outlined a very convincing and impressive set of figures that show that its leadership understands the market dynamics as best as any team could. But it was the overview of the market that provided one of the most interesting aspects of the call, which gave a very insightful portrayal of the industry at its peak.
President and Chief Executive Officer Michael Schall opened the conference. Speaking on behalf of his leadership he proclaimed that the organization was pleased with the second quarter results. Most of the good news, he said, came from an outperformance in Seattle and Northern California. Southern California had mixed results that were impacted by supply and the region’s slowing job growth, even as the overall West Coast economy continues to outpace the slower-growth national economy.
Some early challenges for the organization, according to Schall, were disruptions caused by rental concessions introduced in the market in 2016 and earlier in 2017, which abated during this year helping Essex return to firmer pricing.
Labor markets in California pushed incomes higher. Essex sees personal incomes in 2017 growing by 4.9 percent across all its markets. San Francisco leads the pack at 5.9 percent compared to a national average of 3.2 percent.
At the same time, median home prices are growing faster than rental rates with Seattle leading the group at 14.8 percent year-over-year and California overall up 7.2 percent. This was an important aspect of the industry that Schall and team wanted to communicate. “First, higher home prices make the transition from a renter to a homeowner more difficult; and second, a significant part of the Essex portfolio is convertible into condos,” said Schall.
With that, however, Essex has reduced its job growth forecast across several metros. Schall added, “Across the Essex portfolio, job growth peaked in 2015 and has slowed since. Tech markets continue to report strong yet decelerating job growth that has consistently outperformed the U.S. average. Southern California, however, is a more diversified economy and therefore performing more in line with the broader U.S. average.”
The job growth slowdown is due to a number of factors, according to Essex. There is a shortage of skilled workers, and the unemployment rate is low. These issues are more pronounced on the West Coast where unemployment rates in markets with Essex properties are at or below the U.S. average of 4.5 percent, with San Francisco at 2.6 percent. Along with that, demographic factors are contributing to the slower job growth. Baby Boomers are turning 65 at a rate of 8,000 per day, according to one study, and the number of Millennials entering the workforce is declining. Finally, there is a limited supply of skilled construction workers, which is influencing the industry. There are many more construction workers at the end of their careers than those entering the trade.
“These forces should remain in place as we head into 2018,” concluded Schall. “Summing this up, as long as the economy continues to expand, we see apartment rents growing at near their long-term averages for the foreseeable future.”
So, that’s the good-news-for-us part even though some guidance indicators point to a softening of demand on the horizon. And one of the best ways to evaluate that is to see where is Essex putting its money.
One aspect of the booming economy is that prices for properties are also increasing, and in this case beyond Essex’s expectations, says Schall. “We are often outbid,” he said. To date the company had closed on $270 million in transactions, and according to John Eudy, co-chief investment officer, the company is in contract for three deals, which it plans to close by the end of the year. That will bring the investment for the year to approximately $500 million, in line with with its target of $400 million to $600 million.
But, “beyond that the pipeline is very, very skinny,” said Eudy. “We are looking at a couple of other opportunities … but clearly a year from now if you look at our pipeline in process, it will be significantly less than it is now.”
The main reasons for this, according to the statements are the anticipated slower job growth across the West Coast. The company is already seeing it in Souther California and expects it to be the same in Seattle and Northern California. Event though market rents in the Bay Area and Seattle have increased, occupancy in both markets has actually decreased, Essex stated. Some of this is attributed to seasonal turnover, but as Schall said to one of the analysts, “do a couple of months make the year or the quarter really fundamentally change? I’m not sure we can answer that question.” There is a shortage of skilled labor, it appears, and the company feels this will have the largest impact on job growth and demand.
It’s a supply issue not a demand issue, and how that plays out remains to be seen.