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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Essex Property Trust Fourth Quarter 2017 Earnings Call. As a reminder, today's conference is being recorded.
The statements made in this conference call regarding expected operating results and other future events are forward-looking statements that involve risks and uncertainties. Forward-looking statements are made on current expectations, assumptions and beliefs, as well as information available to the Company at this time. A number of factors could cause these actual results to differ materially from those anticipated. Further information about these risks can be found in the Company's filings with the SEC. Through the question-and-answer portion, management does ask that you please be respectful of everyone’s time and limit yourself to one question and one follow-up question.
It is now my pleasure to introduce your host, Mr. Michael Schall, President and Chief Executive Officer for Essex Property Trust. Thank you, Mr. Schall, you may begin.
Thank you for joining us today, and welcome to our fourth quarter earnings conference call. John Burkart, Angela Kleiman and I will make brief comments and John Eudy is here for Q&A. Today, I will discuss three topics: our fourth quarter results and expectations for 2018, recent regulatory activities and update on investment markets.
On to the first topic. 2017 was another successful year for Essex with core FFO per share growth of 7.9%, exceeding the high end of our initial guidance range and mostly driven by the same property portfolio, accretive investments and opportunistic capital market activities. As always, we have focused on driving growth to the bottom-line which allows us to have one of the best track records in the industry for dividend growth.
To that end, later this month, we expect our Board of Directors to approve our 24th consecutive annual increase in the common dividend positioning us nicely to become a dividend aristocrat a year from now. Since the IPO in 1994, we have paid about $85 in dividends, 4 times the IPO price.
On the Q3 conference call, we expressed concerns about slowing job growth for both the nation and on the West Coast, noting that unadjusted total non-farm employment declined sequentially in most of the Essex markets in Q3 2017.
In Q4, job growth improved in the Essex markets with the three month trailing average job growth at 1.6% better than the 1.4% estimate reflected on last quarter’s Essex gain. This significant volatility of job growth in the Essex markets and the improvement in Q4 is graphed on page S-16.1 of the supplemental along with historical information to provide contents.
Turning to our outlook for 2018, we published our key economic assumptions for the year on S-16 of the supplemental. In 2017 the U.S. economy experienced significant improvement in GDP relative to previous years and we believe the recently enacted Tax Reform bill will further stimulate economic growth into 2018. Thus, we have increased our GDP growth expectations in 2018 to 2.7%.
Turning to job growth, we expect U.S. job growth to remain relatively flat in 2018 at 1.4% primarily due to the tight labor markets and low unemployment rates both nationally and on the West Coast. Job growth in the Essex markets is expected to be 1.6% consistent with 2017 which should create about 201,000 jobs across our footprint.
This should be sufficient to drive housing demand above the 67,000 total housing units expected for delivery, both rental and for sale, thus continuing Coastal California’s chronic housing shortage.
Office construction which often perceives job growth continues at a robust pace in the tech market representing around 6% of stock in the Bay area and 5% in Seattle. For several years, virtually all of the apartment supply has been focused on the luxury segment creating shortages at lower price points and stretching rental affordability.
When wages grow faster than rent as is expected in 2018, the affordability issue for apartments abates. Thus while wage inflation may negatively impact interest rates, it improves affordability and often rent growth.
In 2017 personal income growth has been estimated at 4.5% in the Essex markets compared to 2.8% for the nation. In 2018 both U.S. average and Essex markets are expected to accelerate to 4.3% for the U.S. and 5.3% in the Essex markets. As you might expect rent-to-income ratio is still or remain unchanged in six of the eight metros in which we operate including those in Northern California.
Improving economic conditions overall lower supply levels and better affordability underlie our expectation for better market rent growth in 2018 versus 2017.
Now onto my second topic regulatory matters. I have commented on prior conference calls about California bill 1506 proposing to repeal the Costa-Hawkins rental housing act which limits the scope of rent control enacted by local governments.
As in 2017, AB 1506 recently failed to obtain the required support to move out of committee make it unlikely will be inactive at least in 2018. The bill analysis available online references a 2016 study by the legislative analyst office states that “expanding rent control protections would not increase the supply of housing and likely would discourage new construction flow.”
While we concur with this view it misses other important issues. Our recent study of San Francisco's rent control by faculty at Stanford Business School found that longer tenant fees and reduced supply growth citywide rents upward as apartment hunters had to compete for fewer available units.
As noted last quarter there is also referendum to repeal Costa-Hawkins which is currently in the qualification process for the November 2018 balance. In response to this effort a coalition named California's For Responsible Hosing was organized to oppose the effort. The coalition has strong support from owners, industry association and other impacted groups. We will provide an update on future calls as wanted.
Similar to AB 15016 California, there is a bill in the Washington state legislator to repeal the state’s ban and rent control and it seems like the other states will follow California's lead. we are monitoring the situation and we will provide an update on future calls.
Turning to the Federal Tax bill that passed late last year. while there is been a lot of attention on deduction limits related to state and local taxes, it’s important to distinguish between renters and homeowners. For renters who don't deduct property taxes of mortgage interest the lower tax rates are a clear bids to after-tax income.
These new limits also reduced the tax incentive to buy a home likely resulting in greater demand for rental housing. The tech market in Northern California and Seattle should also benefit from the repatriation of cash held overseas by large tech burns amounting to hundreds of billions of dollars.
Apple has already announced plans to repatriate cash and expand domestically. Overall, there has been a lot of negative press related to the tax law changes and it’s a fact on California, which generally appear to be overstated certainly from the prospective of apartment ownership.
Finally my third topic investment. Regarding asset values recent transaction activity indicates that cap rates remain stable. A quality property and locations continue to transact around a 4% to 4.25% cap rates using the FX methodology. These quality assets and locations are generally 25 to 50 basis points higher although often contemplate up side from reevaluate and/or value activity.
With the recent most other sideline due to the cost to capital and a meaningful increase in apartment mortgage rates, there are fewer motivated apartment investors in the market as compared to a year ago. Recent increases in interest rates have caused some noise and negotiation, but ultimately cap rates have not changed at this point.
In December, one of our co-investment entities completed the sale of two properties each about 28 years old at about a 4.1% cap rate which represents a lower rate and higher valuation relative to my previous comments about cap rates.
During the quarter, we started one development in Hollywood which is the legacy project where we have the very little land basis. As previously noted, it has become very difficult to make new deals pencil given double-digit increase of construction costs coupled with slower rent growth in the recent past.
Therefore, we have not assumed enemy starts as part of our 2018 guidance. Overall, we are seeing a general pullback in development stars in our market, which we believe will lead to lower levels of new supply in most of our markets over the next several years.
Finally, we originated three preferred equity investments during the quarter for $65 million as outlined in the press release bringing our total commitment at year-end to $394 million. We expect to bifurcate the program into two parts going forward; the first part will be for under construction apartment properties, which will be capped at $400 million.
The second part will represent investments involving completed apartment properties, which will generally have a lower preferred return and will be subject to an aggregate cap of $500 million. We are currently seen a slowdown in our pipeline of opportunity to originate preferred equity deals confirming our belief that apartment development starts are moderating.
That concludes my comments. Thank you for joining our call today. I will now turn the call over to John.
Thank you, Mike. Essex finished the year with another good quarter. Our fourth quarter year-over-year same-store revenue and NOI growth was 3% and 3.4% respectively. Our same-store results were slightly better than our expectations due to higher occupancy and greater growth in other income and [indiscernible].
These results are evidence of another strong year for the Company and I want to thank the Essex team for the continued dedication to our success. As we mentioned on our third quarter conference call, market net growth peaked earlier than normal due to elevated supply and slower than expected job growth.
The negative impact of the early market net peak will continue as a headwind for revenue growth in 2018 due to the volume of leases that we signed during this summer leasing month with little to no increase over the expiring leases.
Concessions in the fourth quarter of 2017 were approximately 700,000 consistent with the fourth quarter of 2016, however geographically the allocation was very different. In the fourth quarter of 2017, 70% of the concessions were related to Southern California asset compared to the fourth quarter of 2016 with 90% of the concessions were related to Northern California asset.
As the concentration of new highly competitive lease ups has decreased in Northern California, the concessions are declining for the new lease up and disappearing in the stabilized communities as expected.
Moving forward, we expect to see a more typical seasonal pattern in rent growth, which is assumed as part of our 2018 forecast. Therefore, we expect our loss-to-lease to rebound quickly as we enter the peak leasing season.
Regarding the executive order signed by Governor Brown as a result of the devastating California wildfires, which effectively limits rent increases on all housing to 10% above the price in place when the order was signed in October of 2017. It has been extended for all of California until mid April 2018 and for selected counties in Southern California through June 2018.
Although the market rents are now increasing at that rate, the application of the law leads to selected challenges such as pricing short-term premium, selected renovation, et cetera. We do not expect that the temporary law that’s currently applied to materially impact our earnings in 2018, however we are watching the situation closely.
Our full year expenses came in below our original guidance at 2.7% over the prior year as a result of the various cost saving initiatives that we have been working on. We were able to hold our controllable expenses to about 50 basis points year over prior year which helped offset the impact of the 7.3% increase in utility.
Now, I will provide an update on our markets. In Seattle, job growth remains strongest in the Essex portfolio posting year-over-year growth of 2.5% for the fourth quarter of 2017. Amazon continued to expand their Seattle footprint in Q4 adding over 300,000 square feet of space and bringing the total expansion for all of 2017 to just under two million square feet.
Additionally Microsoft announced a multi-billion dollar campus renovation and expansion in Redmond that will occur over the five to seven years and add up to 1.3 million square feet of new space. Office absorption in Seattle continues to be robust. In 2017 net absorption totaled 4.2% of existing stock, the highest percentage of any metro in the U.S.
Seattle’s medium home prices grew at 14.6% year-over-year for the month of December making it the third fastest growing market in the Essex portfolio only surpassed by San Francisco and San Jose. Our year-over-year same-store revenues for the fourth of 2017 were led by the CBD and north submarkets at 4.8% to 4.9% respectively while the east side and south submarkets grew by 3.6% and 4.2% respectively.
Turning to Northern California. For the fourth quarter, job growth in the Bay area averaged 1.7% year-over-year. In San Francisco [indiscernible] and Airbnb signed new leases which added over 300,000 square feet to the downtown tech footprint. In San Mateo an extraordinary development, Station Park Green, Guidewire Software fully leased an under construction office project that is scheduled to be completed in the first half of this year.
Moving south, Facebook extended footprint across the Bay in Fremont the market where Essex owns just over 3,000 units with the new 190,000 square foot lease. Tesla also announced that they were expanding their Fremont office to accommodate 1,500 employees in addition to the 10,000 employees already in the market.
And in the South Bay WeWork [Agnostis] (Ph) signed leases totaling over 8,000 square feet. Over 13 million square feet of office is under construction in the Bay area with San Francisco accounting for nearly half the pipeline and more than 70% of which is pre-leased.
Home prices in the Bay area continue to soar, as tenants lease their portfolio of 24% year-over-year growth in December with medium home prices at $1 million, over four times the national average. Essex continues to perform well in the Bay area during the fourth quarter of 2017 with year-over-year same-store revenue growth led by a Fremont submarket at 5.4%.
Moving down to Southern California, in Los Angeles, job growth lagged the U.S. with 1% year-over-year growth in the fourth quarter. LA’s tech footprint continued to expand during the quarter as evidenced by several noteworthy leases throughout the region.
Tesla, Facebook and Apple all signed new leases in LA during the quarter totaling 425,000 square feet from West LA to Culver City, co-working companies we work and states these leased in additional 150,000 square feet of office space in downtown and West LA.
Our LA year-over-year same store revenues for the fourth quarter grew at 4.6% in Long Beach, 3.7% in Tri-City, 3.3% in Woodland Hills and 1.7% in West LA. We saw a decline of 2.2% in the LA CBD due to elevated levels of new supply, which is leading to highly concessionary market.
Looking forward roughly 77% of the projected LA market 2018 supply is concentrated in the West LA as downtown submarkets, where two thirds of FX of LA portfolio is located. In the Orange County, year-over-year job growth improved in the fourth quarter to 1%, a 70 basis point increase from Q3.
Almost half of the 550,000 square feet of office absorption for the full year occurred in the fourth quarter of 2017, which is consistent with a pickup in job growth noted above. In the fourth quarter, our north and south submarkets grew at 5% and 3.3% year-over-year.
Finally, San Diego posted 1.3% year-over-year job growth for the fourth quarter, similar to Orange County almost half of the total full year’s office absorption occurred in the fourth quarter of 2017.
All those supplies expected to increase in San Diego in 2018 over 50% of the supply is coming from the downturn submarket, where we only have one asset. San Diego's supply outside of the downtown is actually projected to be lower in 2018 compared to 2017. Currently, our portfolio is at 96.7% occupancy and our availability 30 days out is at 4.7%. Our renewals are being sent out at about 3.3% for the first quarter overall.
Thank you and I will now turn the call over to our CFO Angela Kleiman.
Thank you, John. Today, I will focus on our 2018 guidance followed by capital market and balance sheet activity. Starting with our 2018 market outlook, page S16 of the supplemental provides an overview of the key healthy supply and demand assumptions supporting our market rent growth expectations.
In our West Coast markets overall, we expect similar total multifamily supply deliveries this year versus last year. Although our differences within each major region are more pronoun; for example, we expect Southern California supply to increase by 11% due to LA and San Diego.
In contrast, Northern California supply is expected to decrease by 28%, primarily attributed to San Francisco and San Jose. We noted that our key vendor, Axiometrics has significantly higher supply in our west and north in 2018.
In addition, their 2017 supply was also higher than ours and higher than what was actually delivered. From reconciling with them, we learned that Axio moved all of the delayed 2017 supply into 2018, but they have not yet made any adjustment for the expected delays in 2018.
Just a quick review of our process. We approach our supplier research with both a top-down and bottoms-up due diligence, which includes driving individual sides to verify the construction progress and we also state the delivery is consistent with how we would approach delivering our own projects.
Turning to demand. Historically, job growth in our markets outperformed the U.S. as Mike commented earlier. We expect that front to continue in 2018 with the forecast of 126% for our market compared to 1.4% nationally. Given this economic backdrop, we expect market rent growth of 3%, which is in line with a long-term average with multifamily fundamentals remain steady.
We expect revenue growth to lag market rent growth, which led to our 2018 guidance for same property revenue and NOI growth of 2.5% at the midpoint. Our forecast assumes lower revenue growth in the first half compared to the second half of the year as we rebuild more cities.
There is one reporting change to highlight. Starting in 2018, we are moving property management expenses out of same property operating expenses to be consistent with the peer group reporting. Going forward, property management expense will be reported on a separate line item on our income statement. This change has no impact to FFO or same property expense growth as the prior period will be restated to conform to the new reporting method.
Moving on to core FFO guidance. I’m pleased to report that we planned to continue on our long track record of driving operating results to the bottom line. We expect core FFO to grow a 4.5% at the midpoint, which is 200 basis points higher than our expected same property NOI growth. Other key assumptions supporting our 2018 guidance starts on page four of the press release.
Turning to investment activity. In 2017, we last funded our external activities using a combination of this position proceed, joint venture capital and common equity accessing the most attractive capital force at the time. As for 2018, our only required funding needs are 200 million of debt maturities and 250 million of unfunded development commitment, which is only about 1% of our total market cap.
So far this year, we have repurchased approximately $3.8 million of common stock under our $250 million stock buyback program. We continue to be mindful of current market conditions in order to thoughtfully approach capital allocation and we planned to continue manage funding our investment activities with most attractive cost of capital and on our leverage mutual basis.
On to capital market and the balance sheet. Last month, we amended an increase our line of credit by $200 million to $1.2 billion, which is expendable to 2023. The upsize is primarily a function of the Company’s growth as it’s been over four years since we last increased the line. We have also improved our unsecured debt from 58% last year to 65% today.
Our balance sheet remained strong to 26% leverage and 5.6 times debt EBITDA with the life debt maturities and horizon and ample liquidity. We are starting the new year in a solid financial position.
That concludes my comments. I will now turn the call back to operator for questions.
Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] And our first question is from Austin Wurschmidt from KeyBanc Capital Markets. Please go ahead.
Hi. Good morning. Mike, the midpoint of your same-store revenue guidance assumes a deceleration versus what you achieved in the fourth quarter and Angela mentioned that you expect revenue growth to be lower in the first half of the year, which would imply pretty significant deceleration I guess early in the year versus the fourth quarter figure. What is driving that sizable decel given the fact that you expect the market rent growth in 2018 will be similar to 2017?
Yes, Austin. I will make a couple of comments and then may be John Burkart would want to follow-up. It goes back to what happened in Q3 of 2017, in that, we had a period of very weak job growth, which led to a low demand period significant supply coming in. We signed leases at little or no increase and we carried those leases obviously for typically about a year.
And so we are going to carry those leases into the New Year and it’s going to compress our growth a little bit. And then that changes as we get into 2018, we expect a more normal peak leasing season in 2018.
But again, jobs can change pretty abruptly anywhere in the United States, and therefore subject to how the demand curve looks versus how many units of supply come on throughout the year. John, do you have anything else to add?
Yes, I will just add that. Again, we feel good. We feel optimistic about this year going forward. But a part of it is a starting point issue as Mike said, and to put some numbers around that, in December 2016, our gain to lease was 50 basis points; in December 2017, our gain to lease was 200 basis points. So, we are in a sense, starting in a little bit more of a whole, but the outlook is very positive going forward.
And so what does that assume in terms of What is earned then I guess going into 2018 from a revenue growth perspective?
Well the gain to lease means that our rents in place are 2% below the market – I’m sorry, it is 2% below, where our rents in place are. So it means we are upside down. But again, there is a seasonality to it, so I’m quoting you as a low demand point, but I’m just trying to give you compare of 2016 versus 2017. But in reality to answer to your question, yes, rents in place at December were lower.
As you go forward into January, that 200 basis points gain to lease moves to 130 basis points gain to lease, so it improves and that’s what will happen, seasonally rents will move up. We expect them to peak in this summer and they have a solid year. But my point is that the reason why we can have stronger revenue growth overall expected for 2018 over 2017 when we are looking at this really related to our starting point. Does that make sense?
Yes, I know, that’s helpful. I appreciate the commentary there. And then just secondly, as focused I guess specifically on Seattle, which was a market last year that surprised at the upside. It has the most or biggest magnitude of deceleration assumed in your 2018 guidance. And I guess I was just hoping you could provide some detail on the range of outcomes there and What is really driving the magnitude of that deceleration as well?
We’ve mentioned for some time that Seattle has in a certain sense, there is a highest risk associated to it related to the supply that’s out there and then job, and clearly jobs had slowed down some. What we saw at the end of last year was that in a low demand period. Seattle is the most seasonal market that we have. It can move up as much as 10 plus percent at the peak and then back down.
So, Seattle at the low point moved down to a gain to lease situation, where was at 490 almost 5% and then we are pulling out of that. So Seattle market has slowed down in part because of the supply or the demand slowed down, but we are seeing a pickup in demand as we had mentioned and expect Seattle to have a strong year, but it doesn’t have the same tailwind that we’ve had in the past.
All right. Thanks for the time.
Sure. Thank you.
Our next question is from Nick Joseph from Citi. Please go ahead.
Thanks. I appreciate the regulatory overview. Just in terms of the referendum movement on Costa-Hawkins. What's the process you did in that on the ballet? And then theoretically if it does make the ballet and taxes, is Costa-Hawkins immediately repealed or are there additional specs up to that?
Yes, it’s Mike here and John Eudy is also here and he is spending a fair amount of time on this issue for Essex. There is a qualification process, which includes signature gathering, which is currently occurring and we’ll go on for another month or two. And at that point in time, we will know whether it would be qualified or not.
The industry is assuming that it will be qualified and so we have amounted pretty strong support opposing the effort, but I want to make sure everyone understands that the repeal of Costa-Hawkins does not immediately mean rent control, it is enacted that requires cities or local governments to pass different rent control ordinances. And I think on the last ballot some around half of them passed on and several passed out.
Less than a quarter.
I know San Mateo, [indiscernible] were defeated and then one or two passed. So, there is a process here, this is not an immediate thing, but there is a process here and we feel pretty good about the effort to oppose the proposal.
But if it is on the ballot, State [indiscernible] the municipalities, if it does pass that, is it repealed from a state perspective or their additional steps at the legislature or anything outside tax that recurred before it actually is repealed?
Yes. They would effectively repeal, it’s a referendum, so that would effectively repeal it. Keep in mind in my comments I talked about 1506, which was a legislative proposal to repeal of Costa-Hawkins, which did not get out of committee either in 2017 or 2018.
And previously on the Q3 call, I talked about these 15 bills that were passed in California related to housing created more affordable housing developers, requiring developers to produce more affordable housing and process reforms involving cities and that type of things.
So, none of those things involved Costa-Hawkins and except for 1506, which didn’t get out of committee in either year. So, I mean we feel pretty good with the legislators not fully behind this idea of repealing of Costa-Hawkins, because obviously, they would have taken actions if they did support it, but the value proposition is a completely different thing.
Thanks. And then what was the average price of the $4 million of share buybacks?
Well, we bought some heading into the blackout, but the pricing has been in kind of low 220-ish range, I read and I gave out specific numbers, as you probably can understand why.
And then just if you were to continue to execute on a larger scale, how do you think about the timing of buybacks versus asset sales?
I think ultimately, our plan is to have the buyback on a leverage neutral basis. And so it’s a little bit harder to exactly match the timing of the stock buyback and the asset sales, but we do have asset sales planned and so it’s going to be match fund as any of our other investment activities and I think you guys put in that piece about overtrading close to that 5% by cap rate, it makes the buyback very attractive that should be when we were selling assets at close to a low 4% cap rate.
Thanks. Are you comfortable buying back shares before and taking on the execution risk of selling assets later or do you need to sell the assets before executing?
No, no. We don’t need to sell the assets for executing. We are comfortable reaching it with our line. We have ample amount of capacity there.
Thanks.
Our next question is from John Kim from BMO Capital Markets. Please go ahead.
It sounds like you’re accounting for a lot of 2018 deliveries to be the late 2019, but can you provide some colors where you see 2019 supply versus 2018 in the market?
Yes, John. It’s Mike and again, others made pitching here. I have to say the visibility about supply is problematic. So, we compare our information with Axio and some of the other sources. It would be pretty confusing. So we sympathize with all of you out there. As Angela noted on her comments, we go on drive the properties, we have a little bit different methodology than Axio.
And so we make them to a little bit different conclusion, but the marks that we are most concerned about is downtown LA or LA let’s say. When we started 2017, we had around 10,700 units expected to be delivered in LA, it’s now by the end of 2017, it was 8700, so there is not 2000 units that were moved.
I think Axio had a much larger number moved. I think they went from 18,000 units, 19,000 units in 2018, which is a huge number, but they moved a lot more units and this is pretty confusing, because trying to track what's moved and what's not moved and the different assumptions that we understand is very confusing to everyone.
So having said all that, our view is that 2018 supply will ultimately be somewhere around 3% to 4% reduction from 17% and there are some variations by geography there, but a little bit left supply, the regional differences will be pretty significant.
LA primarily because of the move to cut units from the 2,000 units from 2017 to 2018, we will have an increased supply will go from about 8700 units to about 11,000 units, and that’s the most significant increase I think across the portfolio. But again, we understand it’s a challenge to bigger front around these numbers.
So, is 2018 to peak in Southern California?
Well, and again I think what will happen it depends for example on how many units get move from 2018 into 2019 assuming these construction delays continue, because I don’t think Axio for example, certainly have not moved any of beginners from the end of 2018 into 2019 and so this is what is causing I think the confusion because these construction delays are more significant than anyone expected, and therefore it’s moving these numbers in significant amounts and it is obscuring the picture.
I know in our case we think 2019 will be a little bit less than 2018 but not substantial. I think we’ve kind of hit the peak of - let’s say we are leveling out is in Northern California so it looks like the peak is in the path there, Southern California depends a little bit by market but and it appears that LA will continue to have significant supply going into 2019.
And Seattle will slowdown over the next couple of years as well. But again I think there will be some challenges in Southern California but Northern California, Seattle probably get better over the next couple of years.
And then as part of your guidance you are mentioning that you are not going to have any development starts this year. Why not deliver into 2020, 2021 year, is this related to Costa-Hawkins or?
No it relates more to you having risk premium for development yield and it goes back to what is the multi-year effect of the things we’ve been talking about mainly that construction costs are going up somewhere around 10% and rents are not going up anywhere near that.
So your cap rates are compressing and lot of cap rates out there that are in the 4.5 plus or minus range measured today and so you just don’t get there. I mean all things being equal we would rather acquire and not take the development risk unless there is a risk premium for development.
So John Eudy is here, he underwrites a lot of development deals. What is interesting is, even deals that appear to have attractive land basis and have decent agreements with the city as to affordable units which we obviously lose money on every affordable unit and therefore increase of the cost relative to the recurrence of these assets. And as a result, we are just not seeing the yields that we need to make significant investment and development.
Thanks for the color.
Thank you.
Our next question is from Nick Yulico from UBS. Please go ahead.
Thanks. Mike you talked about cap rates not having moved higher yet, but interests up sharply. Do you think it’s reasonable cap rates increase this year? And I guess going back to the development question, is that also shaping your decision making and not starting more development projects this year?
Not really, I mean interest rates are going up a little bit and I think as long as on the longer term obviously a lot of on the short end of the curve. But as long as there is positive leverage, I think it’s a good thing for real estate. And so we are still seeing five to seven year mortgage somewhere in the 4% range.
So there is still a little bit of a positive leverage. And I remember back to periods of time when we had significant negative leverage and real estate did pretty well then as well. So I don’t think it’s necessarily interest rates it is causing the problem here. You want to follow up to that?
Yes, just one another question here. When you give on S-16 where you give the market forecast for economic rent growth. can you just remind me does that number that’s not just new lease growth like for example if you look at the recent actual data on Seattle its shown new lease growth for the whole market in 1% to 2% range and your number here is higher than that. So just trying to make sure I understand that. and then also if you could explain how you are thinking about new lease pricing in Seattle? Where is that right now? And whether it improves or gets worse as the year goes on?
Yes, I will have john to handle the second part of that. the first part S-16 that is meant to be a broad measure of the marketplace really based on a scenario the scenario is how many jobs did we produce, how many units have supplied those for sale and rental, did we produce during that period of time and what does that mean for rents.
So as you saw last year these numbers can be wrong they represent a scenario what we think is going to happen and then we midcourse correct throughout the year. So based on 201,000 jobs being produced 1.6% we cover the supply about three to one on jobs the long-term relationship is typically two to one.
And as a result of that we feel pretty good about supply and demand, we feel good that California is going to continue to have a pretty significant housing shortage. And therefore we think the economic rent growth will improve in 2018. And that is what is reflected here.
So it's not meant to be us, it’s meant to be the broad measure of the marketplace based on how we see supply and demand for the market. And what we do may vary a little by that but that goes back into the budget. And john do you want to kind of reconcile from the market forecast to what we budgeted.
Sure let me just step back for a second and the comment on the activity data that you are seeing. The information we see right now is relatively consistent, in Seattle our year-over-year I think it was probably close to 70 basis points year-over-year in December, but realize that that market is the most seasonal market. So as I said before, it will move up over 10% at the peak and then back down again.
So we really are sampling it at the wrong time, because what happens with supply deliveries, property management operating companies tend to a pretty focused on the absorption amount the number of units they want and when you deliver units into the slow demand period you end up having to push pricing down.
So that’s largely what is occurred there and our expectations are as we move through the season things we will improve pretty dramatically. But going on to what we see housing for Essex in Seattle going forward again we're starting in a whole as mentioned 4.9 or 490 basis points gained to lease right now.
So even though we have an optimistic outlook our expectations are more in line well they are exactly in line with our guidance that we laid out for Seattle on revenue. So those won't be as strong as it has been in the past but still another good year.
So if I could just sum it up and it sounds like what you are saying is that overall you think Seattle is the market that’s going to put up little over 3% rent growth this year and don’t worry about the leasing numbers from January, December which are more seasonal that are showing new lease growth below that?
Absolutely, correct. If the demand fixed up you will see the rent starts to move pretty dramatically. I think what we saw in the fourth quarter was, the supply have an exceptional impact on pricing, but as demand picks, things will come closer to equilibrium and the rents will move pretty dramatically.
Again, as they always do. I mean I think last year, we were up in Seattle from the beginning of the year about 12%.
12% in the peak and then same thing in 16.
These numbers move significantly. And when we talk about seasonality, what we're really saying is, jobs are not irritable throughout the year. They are very seasonal. You get into the fourth quarter and the colder markets are -- Seattle worse for this reason, jobs put to a trickle, and if you end up with bunch of apartments delivering during that period, you have a period of zero demand delivering apartments. So you’re trying as a landlord to pull people out of the stabilized communities, which is where concessions pick up both on the lease ups and in the stabilized portfolio.
So, this is the way that the rental markets work, and so pricing to move around pretty significantly, certainly more with as job got slows and amount of apartment deliveries increases. When those don’t connect timing wise, you end up pretty significant swings in rent as you would imagine, and then as soon as the apartment deliver or stabilize, the lease up to stabilize then you go back to a period of no concession.
So this is what's driving this market, that was causing the volatility of pricing that’s what limits our visibility or anyone’s visibility in the marketplace, we don’t know exactly how many units are coming and exactly when they are coming. And so, there is a certain amount of just trying to understand market the best we can, and then reacting appropriately when things occur. So, this is a forecast, big picture forecast, and when you get into the market that will -- it will depend on exactly who is delivering and what type of concessions they are offering and how we react to that.
Our next question is from Juan Sanabria from Bank of America Merrill Lynch. Please go ahead.
Just hoping you could talk to where you see the best potential usage of capital, including a buyback with all the different options you have preferred redevelopment et cetera, acquisitions, kind of highlighted the feelings on potential preferred investments kind of above where you are today. So hope you could kind of outline where you see the best opportunities?
Hi Juan, it’s Mike. It’s a good question and the scenario has changed pretty rapidly over the last quarter in terms of stock price. So, obviously we -- as Angela said, we completed some stock buyback, so we've done that attractive relative to acquisitions that we’re seeing and we also liked the preferred equity program and that becomes how do you fund that, obviously issuing common stock at current prices doesn’t make sense to us and rather beyond the other side of that equation.
And so, I think the disposition process is one that's kind of in full swing here, and I think that’s the way that yours going to play out. It’s interesting we had almost exact same comments about cap rates, interest rates a year ago. We had a plan that was much the same conference call that was much the same and it changed throughout the year because the stock recovered I think was started the year in somewhere around the 225 level and went back to 270. And so, these things are fluid discussions again reacting to changing conditions in a thoughtful way, and I think there’s a good chance that 2018 will be one of those years.
And just on the preferred breaking out now two kind of separate buckets. What’s the strategy behind that? What drove that new line of thinking?
Yes, the strategy is that you’re trying to really separate the preferred because there’s a different risk element with respect to an under construction project in, which you get a higher return for that. But we also think that let’s say that you are in the 8% to 9% range for a stabilized community. Yes, we think that that is an attractive programs and in fact we had at least one deal last year that converted from a under construction to a stabilized community at a lower preferred returns.
We’ve had acknowledged that that’s an attractive business too, again relative to the opportunities that we are seeing on in the marketplace and we have wanted to create a bucket for the lower risk and a bit lower preferred return of properties that are in that area. We also depending upon what happens with rent growth, some of the refinances of the development deals may be a little bit short and that creates a bucket to continue to be involved in those transactions.
And then you kind of talked about Seattle a bit in terms of your spot off the leased. Would you mind kind of hitting on the other two major markets?
Sure, this is John. In December '17, SoCal, we had a gain to lease of 90 basis points and that obviously improved in January, so now a 30 basis point. The NorCal, it was 190 basis points gain to lease and now it’s also improved to a 130 basis point. I mentioned Seattle which was 490 basis points in December and it’s improved to 420 now. So, overall the Company went from about 200 basis points gain to lease to a 130 basis points gain to lease in January. Again, right at signs, things are improving, the December numbers are the low point but things are going in the right direction as we’ve planned.
Our next question is from Rich Hill from Morgan Stanley. Please go ahead.
Just following up on a couple of comments that you made previously, I just want to make sure I understand. Why are seeing this construction blaze at this point? You mentioned rising construction costs, there’s also a lack of available skilled labor. Why are these projects getting pushed out at this point in time? Or the delivery shut site, sorry about that.
This is John Eudy. You hit it on the head. Lack of skilled labor is the main reason and short of that in order to answer.
Okay, great. It would enough answer then. And then just another follow-up question, you guys seemed to have a really good handle on job growth, so two parts here. Remind us about what happened in 2016, when job growth may be slowed more than what the market was expecting? What gives you confidence that that’s not going to happen this time? And then secondly, I've heard a lot of discussions about job growth, but not a lot of discussions about income growth. And I am wondering as income growth starts to pick up. Is that more of a tailwind than it’s been previously the rent inflation particularly, if household formations start to increase as people don’t double up any more, people move out of the parents houses. How are you thinking about income growth going forward? And is it more or less important than it's been in the past?
Great questions. So having a good handle on job growth, I don't think anyone in the room processes to have a good handle on job out here. It bounces around like crazy. We attached schedule 16.1 to demonstrate the volatility of job growth. And the problem that we talked about on last quarter call, which I think surprised everyone. But jobs are going to do what they are going to do, we don't have any particular insight into the jobs are going to whether going to go up or down.
And so, I'll have to distance myself from that one. We are just going to be a cog in the wheel. We do look at some of the broader indicators. I mentioned for example having 5% to 6% office construction or 5% to 6% of the office stock under construction for delivery in the future I mean presumably those landlords are not building the buildings and much are going to be occupied by workers that therefore we think that that's an interesting forward indicator. And it's interesting to look at 5% to 6% of the office buildings under construction versus the 1.4% growth job growth and 0.8% overall supply growth.
So again we try to determine whether we have a supply or demand in balance which we think is in favor of California ultimately however it can be messy in terms of how all that plays out. So that’s kind of a job growth picture. We are going to have to wait and see what -- again F-16 is our planning mechanism. So, we are trying to understand the world in which we live and because some of these decisions that we have to make about asset sales which markets to select et cetera they require some template of what you think is going to happen.
So that’s what F-16 really is useful for us to. It will change and we expect it to change but again for -- to have a good planning process you need to have a pretty good starting point. And as to the second point income growth, we totally grew with it. We think that is the key metric. And in my comments I mentioned that wage inflation is ultimately a very good thing for apartments.
And we think that is a pretty significant potential tailwind for us again subject to supply and demand. And these personal income numbers and the slow amending of the rent to income ratios are positive signs for us and those are really the things that we are planning to give us confidence that we are going to hit these economic rent growth numbers in 2018.
Our next question is from Alexander Goldfarb from Sandler O'Neill. Please go ahead.
Mike, just a quick question on the peak leasing season. Last year, you guys mentioned that it peaked earlier because of supply and jobs. What are some other things that you would look for this year? It sounds like you think this year should be more of normal one, but what would give you pause that this year could end up being similar to last especially, if supply is being pushed into this year, and so far employers are having a tough time finding people to fill the spots?
Alex, welcome to the call. It’s a good question. Again, I think it’s all about jobs and we have pretty good idea what's happening on the supply front. We send our people out to walk the buildings and try to understand as well as anyone what's happening. We keep track of each year’s production of housing how many units that delivered in each year. And so, the good thing is, we don't have any confusion about what is going on the supply side. Here you know again, we look at where we started last year where we ended and that type of things.
The real issue comes back to jobs and as we said on last quarter’s call which affecting the shape of the curve this year and how our rents grow and why we will decelerate into Q2 and then turn the corner this year, I mean all that is related to what happened last year in the third quarter which to remind everyone it was basically a job drive. We ended up with fewer non firm jobs at the end of the third quarter than we had at the end of the second quarter.
I think it was incredibly unusual and not something that we could anticipate, there was nothing in the numbers. If you look at open provision that various tech companies had or whatever data that we might have there was nothing that really indicated that that was going to happen. And so again we don’t have any great inside into the jobs during the quarter and so like everyone else waiting for those specifics. So I can’t help you more than that how lot our process what is mean to us and again we’ll adjust to the world that we experience it.
Okay. And then the second question is, on the rent control just a few things here; one, it almost sounds like the governor or whoever the governor end up being next election could almost [indiscernible] invoke sort of a rent control by capping price increase. But if they do repeal Costa-Hawkins, is there any sense that they would impose income limits on who can have rent control? And would they could see decontrol be eliminated as well, so you’d be sort of locked in, you couldn’t bring that unit to market, you’d be capped and how much you did increase the price of a vacant unit?
Yes, Alex, I mean you are way down the road ahead us on that. I mean I think that we are following up with respect to what's happening now. John, do you have something?
Just one follow-on, Alex. If the Costa-Hawkins did get repeal it just enables local peer rent control. And yes, it would not protect, if you will the vacancy control issue. But one important aspect in rent control orders that are in place, it does have a provision that requires a fair return to the owner, which basically if you took away they can see decontrol you just took their rate return away.
So, even if individual city decided to an act that control there would be other measures we could look to keep vacancy decontrol that’s speculative in the future right now. We think we have a good choppy industry is organized at foot pushing back assuming that development does go forward in November. So we’ll monitor closely and we’ll report while a better update for you.
Our next question is from Drew Babin from Robert W. Baird. Please go ahead.
Two questions on east day, which we haven’t talked about a whole lot. Looking there was a big sequential kind of pick up both Alameda and Contra Costa counties. In the fourth quarter, I was curious what specifically is happening there, if anything in those markets?
That’s a combination of a few things. As I mentioned in the comments on the call, there is clearly a pick up as it related to jobs, we noted Facebook and Tesla and others that are out there which is clearly a positive thing for that portfolio. There’s also a year-over-year benefit in the sense that -- which makes the comp easier in the Alameda area due to last year’s movement in pricing, we ended up with more vacancy a year ago. So we had a benefit from a year-over-year, but it’s really both of those combined, the positive jobs that we’re seeing out there, high gain jobs out there as well as the benefit from the easier comp.
Okay. And then on the -- I guess taking the other end of the wage growth equation, as it pertains to end portfolio. I guess what’s in there because it seems to extend the guidance for '18 in terms of payroll at the property level and it’s becoming harder and harder to retain quality, recent pushing on this environment?
Yes, it is overall. We struggle and we are working hard to pay all of our team fairly and we had increased wages, the wage rate goes up somewhat significantly. But we have been able to find offsets in other areas by operating more efficient way. One of the areas we mentioned previously was our asset collections. And so we’ve found opportunities to reduce labor and vendor cost by bidding out the collected assets as groups and what not. And so that’s enabled us to keep the expenses under control while we continue to push our wages and meet the market there. I think last year our wages were probably up 5% for our staff on the sites. But again it is a struggle, not doubt.
That’s helpful. And one last one just on kind of bread and butter acquisition whether they're current JVs or wholly owned. It seems from some of the commentary that I guess with potential. Acquisition cap rates could potentially exceed kind of the average disposition cap rate. Should they be in the low 4s kind of in some of the recent transactions have illustrated? I guess, can you talk about what’s being assumed in guidance as far as acquisition and disposition cap rates more specifically?
We are assuming that we will be in the 4% to 4.5% range on acquisitions. Dispositions, it depends on how we execute dispositions. You may recall a year ago that we did a -- we took several assets and contributed them into a joint venture entity and put some loans on it and took some capital out that way. That would be one of the things we’re thinking about. But we are working on it and I don’t want to give any more specific guidance because we have a variety of strategies that we’ll work on and pick the best one. And we just don’t have -- we are not at the level -- we are not ready to give that type of guidance and that level of detail.
Our next question is from Dennis McGill from Zelman & Associates. Please go ahead.
First question, just Mike your tone I would say sounds much more positive today than it did three months ago and you walks through kind of job, shift and the uptick in the government data there. But then, you also acknowledged that data can bounce around and at time it can be pretty volatile and sometimes follow over the things of the market though. So, is it fair to call you more optimistic today, and if so, is there anything else you would point to besides the job data that leaves you there?
Dennis, that’s good question. Today, 16.1 of supplement really outlines why we are so much more optimistic and it really is all about jobs. So, we feel like we have a good handle on supply. And we have a good handle on affordability. And we need these jobs I mean that really comes down to that. When we saw Q3 essentially not produce any job which is very unusual, and started thinking about well is this a trend or is this a data point? That was a distressing discussion, and obviously we didn’t know. And so when Q4 came back and came back pretty darn strong when you look at the December over December numbers it gives us a lot of confidence.
And then, earlier timing as well about the shift in or the difference in first half versus second half for rent growth, how much variation is there around that 2.5% midpoint?
Not a whole lot, I mean we are talking about somewhere in the low twos in the first half versus similar to higher high twos in the second half, so between say 25 to 50 basis points for the range.
And then just one last technical question. When you guys do your supply work on year end, do you draw a line as far as how big development needs to be before you considered it to be competitive?
50 units, is our -- yes that was the -- we tried to conform because there were so many different assumptions out there that we are trying to simplify the data, and we are trying to conform to action. We have that comment on a conference call in the past year at some point and time. So again, we tried to take out senior student et cetera and then focused on 50 and above. And I think that the other difference that different people have is the denominator.
We are using I think everything I think it’s a entire stock especially California has so must older housing that if you eliminate the smaller units out of the denominator in this calculation, you get some pretty whacko. So, anyway that’s how we do it and that was conforming to active. And again, the acting numbers have moved so substantially that we are still trying to reconcile what Angela said, our number to their numbers.
Our next question is from Omotayo Okusanya from Jefferies. Please go ahead.
I just wanted to go back to the question on same-store OpEx and again with everyone really talking about big increases in payroll and taxes. Trying to understand what assumptions you are making about other payroll expenses just to kind of get to this 2% to 3% same store OpEx for '18?
We do expect our payroll for a site level people to continue to move and I don’t have that -- I'm not going to give up the details with the numbers, but it will move. It's an aggressive area. We are meeting the market as it relates the compensation there, but what we are finding again is offset and opportunities. So our controllable expenses we expect next year to also be down. We did a very good job this year. The team did an outstanding job as a matter of fact along the lines of controllable. And we expect that same thing to happen in the next year.
So at the end of the day even though we're increasing our competition for the site level people at market and market is moving rather aggressively, we are finding opportunities, we have done various things from restructure our call center to making adjustments in market even and elsewhere to offset cost. So, we expect control that the areas that cost are moving more that harder to control relate to utilities.
There is a lot of work that’s being done in California certainly on utilities that relates to infrastructure it relates to accomplishing the objectives for the green requirement which require the utilities to buy certain amounts of energy from solar and other renewable sources which is increasing cost and we’ve also done work there in the sense of installing TV panels and other things, but that utilities as a higher growth area on expenses.
So what are the things that can come down? Is it like more of the office expenses, advertising? I’m just kind of curious like what those offsets can be after as to look how much kind of control that last year?
Well, I don’t want to net to give away all of our playbook to our peer. But again, we are doing what we can to leverage technology. I've mentioned the call center, we recent restructures there in the last five, six months. And we continue to find opportunities to make win-win environment. I mean interestingly on the asset collections, it was really a win-win. It's not a grinding down vendors, it’s a matter of us providing a package that reduces their communities from asset to asset and ultimately saves their labor costs and then that was driven through that came back to us. So, again, I don’t want to go into extreme amounts of details, but we do expect to maintain a strong hold of controllable and keeping down to about 1% year-over-year.
And then, I don’t know if you answered this before and I may have missed it, but the big increase in things of OpEx for I think was Seattle for the quarter and then the big decline in Northern California. We do kind of talk a little bit about what kind of happened in the quarter?
Well, actually, I allow Angela to go ahead with that.
Yes, in Seattle, it’s really property tax driven, no surprise there. And it’s consistent with what we had expected and budgeted. So we ended up coming in, the year coming in line with that 2.7 as planned.
And then Northern California to decrease?
Just timing issues, I mean with expenses, they don’t follow rents. We look at them closely of course monthly daily. Expenses are better looked that over the course of the year their ends up being timing issues there. So, the numbers move around a little bit, but nothing that indicates the change in the future.
Yes and keep in mind there, something like repairs and maintenance, we have controlled as far as when those get implemented. But we don’t specifically say, they are going to be done in second quarter or third quarter, we planned that we’re going to do it over the year and it’s really depend on what the focus for the operation team is at the time. And so when we focus under leasing that these were not going to distract by saying driven also have to get the repair and maintenance done.
Our next question is from John Guinee from Stifel. Please go ahead.
Great. John Guinee here. I guess Mike or maybe John, your Station Park Green, Phase III and then Hollywood looks like your 721,000 units and 500,000 units. Can you talk about I guess three things. One is what exactly you’re building for 721 and 500,000 unit what kind of property type? Two, what that cost would be, if it was fair market land? And then three, what sort of yield are you expecting on these developments as your basis and then also at a fair market land basis?
This is John Eudy, I will try to answer all those questions. But just to start off with Station Park Green is core peninsula top of San Francisco and the building type, it’s a tight high density type 3, if that means anything to you meaning expensive to build. Our land basis is just over 100 a door. It has a 10% affordable requirement. We just opened up our leasing ops about 10 days ago. And I can tell you we’re having a very good reaction and there’s a lot of construction around it obviously days two and three right next door.
The difference between that 720,000 versus Hollywood is rent driven. Rents in Northern California are in the high $3 square foot and Southern California, it’s obviously less and in Southern California we have a much lower land basis as Mike mentioned. The legacy land basis of Hollywood is about 68,000 a door versus over a 100,000 in Northern California, and much higher up here as well. If we mark them to market on what the land would get sold for, in both cases it would be about 50,000 to 70,000 a door more in both San Mateo and Hollywood. Cap rates, we expect both to be right at about 5% and if we mark it to market that would under 4.5%. Those are the round numbers for it.
Okay, perfect. So what you are saying Mike is that the reason you are not developing is that has market rate land, the yield of development is 4.5%?
Okay. You asked a question on -- this is John Eudy again, on parking or land market, what’s happened on both cases is the cost of production has gone up. So there’s another quarter or two half way if we rebuilt those with the mark to market on the land and today’s construction costs.
The next question is from Conor Wagner from Green Street Advisors. Please go ahead.
May be Angela or John, could you give us some insight on the other income in the fourth quarter? It seem like it grew around 6% versus 2% and 2.8% for the rental revenue?
It’s a combination of once performing better than expected, we had anticipated kind of in that high twos range and it came in the threes and on the right on the scheduled rent piece of it. And other income also performed better than expected. So, it would be…
What was the other income though? Is there anything -- so is any one-items there and may be as you segway and so what your expectation for other income is in the ‘18 guidance?
Yes, it is mostly driven by rev and as you can see our utility costs have gone up so correspondingly the revs income has also increased. And so, we expect similar relationship in 2018.
Okay. And then you had I think bad debt payback in 1Q ‘17, is there anything like that in terms of the headwinds on the other income side? Or just again anything we should, that we done necessarily have visibility on outside of just the organic demand?
Yes, to your point that was a one-time item and we don’t see that recurring in 2018.
And then Mike on the regulatory front, it seems like things are moving more and more towards greater housing production or some sort of reaction to the chronic housing started what you spoke about the call. Could you give us some comments on first John maybe the impact of SP35, I think they released that. Most cities in California can now be subject to a streamline process on any development that has 10% affordable? And then if you could give us your thoughts on SPA27 the one that would allow reduce cities ability to enact zoning ordinances around mass transit development?
It's Mike, Connor. Our experience and over many years and the recent activity and you may want to add Vision [indiscernible] County through that. All of these things that require prevailing wage or affordable unit mandates or density bonuses in San Francisco has once density bonus for more 30% affordable units. All these things have the affect generally of increasing cost, and when you increase cost, again you know what's happening with rents. When you're increasing cost to a greater extent, it just puts more pressure on the cap rate.
And the number of deals that penciled are fewer, which is I think part of these measures had been -- had the effect of actually having less housing being produced, which is why we are confident that when you look at starts that they are trending down, not that they are going to zero, we are not saying that. And as you look at northern California which has gone from somewhere around 10,500 units in '17 and it will be probably 7,500 in '18 and about the same in '19. That’s a pace that I think probably level off that lets say.
And one of the factors here, again the construction cost increases these additional mandates from the cities to produce more housing, some of which as you point out come back to the developer, and what that means for the overall economics of the deal. I think it just continues to pressure the deals. Again, we all know there is a housing shortage here and California was first and we want there to be affordable housing. Unfortunately, most of these laws and rules and proposition have an unintended consequence of driving cost up and reducing our deals, which makes development difficult to pencil, hence my comments.
And do you see A27 is likely to get to the assembly?
I think it will, but it doesn’t really -- it does, you are talking about TOD high density residential state control.
Yes.
Yes, it clearly I think it will. That doesn’t change the economics again getting to Mikes comment on and I don't believe that there are that many barriers to those transactions going residential to be honest with you at a practical level when you get to TOD station to TOD station. There has been encouragement to develop residential. So, that’s one more step to help make it easier, but it doesn't make it happen.
Yes, I mean they all do the same thing ultimately. And again, so I don’t think you should focus on any one per se because truly the collection of all of them and that’s what given us part of our confidence with respect to supply not going crazy in California. The one can bury that we have the most concern is really L.A. and really downtown L.A., which we also think is probably the long-term beneficiary of it as well because that basically transforms the downtown into it more and more of the 24 hour city. And right now, I recently took my wife down there for a romantic evening of visiting Essex Apartment communities at night and it’s amazing, the amount of construction and just general activity there basically the downtown is not really arrived yet, but it’s going to be I think a pretty special place setting down the years from now.
I hope you think you have better plans for next Wednesday?
Yes.
Just again property that maybe just kind of follow up again knowing that this builds specifically aren't going to do much, but it seems like the overall direction in California is towards try to address this housing crisis and it seems to have major gap right now is the funding. What is your concern about the state enacting some changes to get the funding either through increased tax on landlords or again there is a proposal for the ballot to repeal Prop 13 on non-residential commercial building. What you guys are concerned maybe over multiyear period that the state is going to come after you in some way for more money?
Yes, that's a good question and yes, as you point out is. There is a ballot proposition underway to create a split role. And but fortunately, it’s clear in that case that multifamily is on the side of residential therefore we'd maintain the same rules. And in that deal, it was pretty filed pretty late in terms of the process. And so, we’re not sure exactly where it’s going to go, but we’re keeping an eye on it and we’ll continue to watch it as time goes on.
You do have, on this development side, you do have other things that come into play John mentioned whatever earlier which is we have the right to a fair return on our property and so there is a limitation, and there are also core cases that restrict cities ability to change the rules and require densely and let they give something.
So in other words if you require a zoning change or more density or any number of things from the city that triggers a variety of requirements, which could include prevailing wage, could include other items that will affect your cost. So, it probably is simple as the governments can and act whatever they want and we’re just going to have to live with it.
There are some boundaries out there that I think are important here and we’ll prevent it from getting completely out of whack. And I guess it maybe the final comment I’ve made which I commented on earlier is, the 15 bills were passed in California in September that I commented on the Q3 call.
Again, they were trying to come up with process reforms panelizing cities that didn’t produce housing, four cities to produce more housing and funding more affordable housing programs with the bond issue and other.
So that, those were pretty constructive from our perspective and we think those were the right direction with respect to trying to address the affordable housing issue and the chronic shortage we have here in California as to affordable housing. So, I think that good progress has been made and we just hope for kind of more of the same thing.
Yes, but those bills you know that the funding isn't there to do it and the bond issue into the -- a drop in the bucket compared to what's needed right, I mean that issues in last state forest land to re-price, most of the things don't cancel due to the affordability requirements or union wages. So it seems like the first step is getting these cities to rezone, to you know streamline projects, but the economics still aren't there. And so I guess my concern would just be, when the state takes the next step to tackle the economics, they're either going to have can they mandate land prices or they're going to try and find the funding to build the house, this housing through some other means.
You know, Conor we're spending our effort on what is right in front of us. So we have -- the repeal of Costa- Hawkins, we have a number of issues that are here or we're pretty focused on, remaining targeting our efforts towards opposing those proposals. And we'll see what happens down the road. Again almost all of these things have unintended consequences which are put the burden back on the developer, which is going to compress their yield and actually are going to make the problem worse.
So I don't know what's going to happen, I've seen a lot of proposals come and go and you know at the end of the day you have to believe that there will be reason and/or something will get passed and then they will realize -- they will realize the unintended consequence and then they will have to change it. So we have to assume that reason will prevail end of the day.
My next question is from Karin Ford from MUFG Securities. Please go ahead.
Hi, sorry to drag this out. Just a couple of quick questions. First, on your 2018 disposition plans to, do you expect to sell any properties to condo convertors this year?
Hi, Karin, it's Mike. I don’t know, I mean that is out there is part of you know the opportunities that I've commented on this before that we're -- we've looked at several properties. And when you look at the for sale price activity in California there were some very large numbers there. California in total was up 9.5% and there were some Bay Area cities or areas that were up in the 15 to 20% median price home increased year-over-year. And that would be positive for the spread between condo values and apartment values.
However, as I mentioned on the call, we also have the new tax law which is probably part of the reason for pushing up prices in the fourth quarter, as people were trying to lock in the deductibility of their mortgage. So we may see that turnaround because actually we think that it'll be a headwind to home ownership going into 2018 given the new tax law.
Great, thanks. And my second question is just on the preferred equity program. If memory serves, I think you talked on the last call that you might want to reduce the programs that was hitting sort of $400 million level. And now it appears you're pushing your cap up to that 900 million. Can you just talk about your decision to give on? Is it just because you are taking the risk level down on the program a little bit?
We took further program and looked at it and we realized it really does have two very different components. And so, we would like to return on it. The question is what is the risk relative to that return and how does that compared to the other options that we have to invest money. And we decided in the current environment that both pieces of that business are important and attractive to us. Both the under construction piece, but then we should be separating is really separate piece be the financing on apartment buildings that are completed where essentially the risk is mostly out of the equation.
So, we found them both attractive and we wanted to have that ability, and so we went to the board, and they improved the program as submitted. In terms of can we get to the 500 million on the completed apartments, I'm not sure we are able to get there, certainly not going to get there any time soon. So I think practically speaking, we are going to -- the program will be probably in the 500 million plus or minus range, although we will see what happens because we wanted to have the ability to increase it from there if we saw the opportunity.
And we will take our last question from Juan Sanabria from Bank of America Merrill. Please go ahead.
Sorry just a quick modeling question. Can you guys give us a sense of the new and renewal spreads you guys got in the fourth quarter in January as well as what's embedded in guidance?
Let me give you this kind of summary here. So in the going forward Q3, I'm sorry, Q1 we are setting our renewals at about 3.3. If we go back to Q4, our renewals were at about 3.4. So they are down a little bit, our new leases in Q4 average at about 1.4%, so below the renewal.
And do you guys expect any occupancy gains or declines or steady in '18 as part of guidance?
Steady in '18 as part of guidance and you know we are major focused on how we can optimize revenue. So, the plan is steady and our occupancy is relatively high for the market, but as we see opportunities we will make adjustments, strategic adjustments to optimize the returns on the market by market basis.
This concludes the question-and-answer session. I would like to turn the floor back over to Mr. Schall for any closing comments.
Thank you, operator, and thanks everyone, really appreciate your participation on the call. Sorry for its length. And we look forward to seeing many of you at the Citi Conference in March. Have a good day.
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