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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 2021 Earnings Conference Call. As a reminder, today’s conference is being recorded. Statements made on 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 based on current expectations, assumptions and beliefs as well as information available to the company at this time. A number of factors could cause actual results to differ materially from those anticipated. Further information about these risks can be found on the company’s filings with the SEC.
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.
Good day and welcome to our fourth quarter earnings conference call. Angela Kleiman and Barb Pak will follow me with comments and Adam Berry is here for Q&A.
Today, I will provide an overview of fourth quarter and full year results, our expectations for 2022 and an overview of the apartment investment market. Essex experienced a strong recovery in 2021, following the unprecedented and extraordinary challenges of 2020. The fourth quarter was our second consecutive quarter of positive same-store results and core FFO exceeded our original guidance midpoint by $0.05 per share. Overall, net effective rents remain above pre-COVID levels, despite a modest seasonal slowdown that occurs every fourth quarter.
In California, the pandemic and related regulation has led to an unprecedented divergence in apartment performance across our portfolio. The suburban areas that underperformed for most of the past 30 years are now our top performers and our historical top performers are now our ladders. To demonstrate, net effective rents in San Diego, Orange and Ventura counties are up at least 25% from pre-COVID levels, pushing rent-to-income ratios in these counties to all-time highs. Conversely, rents in the tech markets remain well below pre-COVID levels, especially San Francisco and San Mateo counties, which remained down at least 15% and now screen affordable relative to their much higher median household incomes. There is a similar divergence in performance in the large metros that contain both urban and suburban areas.
For example, in Los Angeles County, Downtown LA net effective rents are flat from pre-COVID levels, while suburban areas, such as Long Beach and Santa Clarita are up 15% to 20%. We attribute the underperformance of the urban core to the damaging lockdowns in 2020, which resulted in severe job losses in restaurants and the service sectors. More broadly, recoveries in the urban core and major tech companies have been slowed by ongoing government restrictions, worker shortages and delayed return to office plans. While the large tech companies generally did not experience job losses, their hiring slowed during the pandemic and many employees relocated in the initial phase of the pandemic due to citywide shutdowns.
As of December 2021, the U.S. has recovered about 96% of jobs lost in the pandemic compared to only 78% for the Essex markets. Obviously, we are disappointed that many tech employers pushed back their office re-openings during the surge of the Omicron variant over the holidays. However, the data indicates that most large tech employers will adopt a hybrid office environment and therefore, the return to office should be a significant catalyst for housing demand in our poorest performing markets. With job growth now exceeding the U.S. average, we believe that our recovery is well underway and several observations support our positive outlook.
As highlighted on previous earnings calls, there has been many large investments in office space by the large tech companies this past year, contributing to positive net office absorption in 7 of our 8 major markets, representing 4.8 million square feet of space. Available office sublease space has begun to decline in San Francisco, San Jose, Los Angeles and Seattle, which supports our belief that many companies are moving forward with their return to office plans. As expected, there is a resurgence in service and hospitality-related hiring as our cities recover, with year-over-year increases in leisure hospitality employment ranging from about 29% in Ventura to about 56% in San Francisco. Recent immigration policy changes from the White House announced last week should also support the positive momentum that we are seeing in job growth at the higher income levels.
For many years, Santa Clara and San Mateo counties disproportionately benefited from foreign immigration. However, during the COVID pandemic, stricter immigration policies during the previous administration drove net foreign immigration to a 30-year low. We suspect that the recently announced immigration policy changes will contribute to job growth, particularly in the Bay Area. Venture capital investment in the Essex markets continues unabated. In the fourth quarter, approximately $37.5 billion of capital was invested in West Coast-based companies or approximately 40% of the total venture capital deployed in the United States and representing 124% year-over-year increase. The West Coast remains a leader in venture capital, which is a driver of global innovation and in turn local economies and job growth. The top 10 tech employers in our markets continue to seek talent and with open positions listed in California or Washington reaching 47,000 in the fourth quarter, far exceeding the pre-COVID peak by 62%.
Turning to our expectations for 2022, Page S-17 of our supplemental package summarizes our key operating expectations and assumptions. We continue to expect full year rent growth of 7.7% for Essex’s West Coast markets. Our rent estimates are derived from a top-down and bottoms-up approach that we continue to refine with each passing year. We are expecting 4.1% job growth in our markets next year, suggesting moderation from the 5.5% trailing 3-month average Essex markets achieved as of December. Even at 4.1%, West Coast job growth should significantly outpace the nation.
Our research team conducts its own fundamental analysis of apartment supply and they expect around 37,000 apartment deliveries in 2022. This is slightly higher compared to 2021 and should lead to a limited disruption at stabilized communities. Similar to 2020, there are pockets of apartment supply deliveries in some urban submarkets, notably CBD LA. Similar to 2021 for-sale housing deliveries will remain very muted at about 0.6% of total stock of for-sale homes. Continued improvement in apartment trends in 2022 maybe bolstered by inflationary pressures in the United States currently at the highest level since the early 1980s.
While inflation and its countermeasures have the potential to slow the economy, it’s worth noting that apartments are resilient with short lease durations and high operating margins. In addition, it is incredibly difficult to ramp up rental and for-sale housing production on the West Coast given long entitlement processes, government restrictions and construction labor shortages. Finally, we have a conservative debt structure characterized by minimal levels of variable rate debt, staggered debt maturities, and low leverage. Estimating future supply a few years from now is another important part of Essex’s capital allocation process and Page S-17.1 of the supplemental highlights recent increases in housing permit activity in various prominent residential REIT markets. While supply – while future supply in the Essex markets is expected to drop in 2023 and remain at manageable levels thereafter, supply appears to be increasing in several other markets. It is also important to note that we have limited exposure to the institutional single-family rental market compared to other metros. We continue to believe that housing supply and demand is the fundamental driver of our business and our capital allocation priorities.
I have a few brief comments on the apartment investment markets where the deal volume in our markets has now surpassed pre-COVID levels as institutional capital targets West Coast apartments. Cap rates are consistently in the low to mid 3% range and we have seen yields converge across markets, construction types, location and age. We sold 4 properties last year valued at $330 million, using the proceeds to fund stock repurchases early on and then acquisitions as the year progressed and our cost of capital improved. For the year, we acquired $432 million, with the majority of acquisitions completed in a co-investment format to conserve capital. Generally, we see greater deal volumes during uncertain conditions, so we are optimistic about more opportunities to create value in the transaction market in 2022 and Barb will detail our ‘22 guidance assumptions in a moment.
With that, I will turn the call over to Angela Kleiman.
Thanks Mike. First, I’d like to express my gratitude for the exceptional operations and support teams we have here at Essex. As the challenge to our business continue to evolve, our team has also continued to step up, which speaks to the dedication, work ethic and the can-do attitude across the organization.
On to today’s comments, I’ll begin with key operational highlights of our major regions, then focus on our outlook for the year, followed by an update on the progress we are making by leveraging technology, data analytics and transforming our operating platform. We are pleased with our fourth quarter results of 4% year-over-year and 1.6% sequential growth in same-property revenues. We have detailed on S-16 of our supplement, which shows the fourth quarter year-over-year new and renewal rent spreads up by 17.1% and 10.7% respectively. The significant recovery in rents over the last year was bolstered by the occupancy and concession strategies we implemented throughout the pandemic.
To review our markets by region, I will begin in Southern California, which represents almost 45% of our NOI and was our best performing region in 2021. Through many economic cycles, we have consistently relied on Southern California for steady performance. And during the pandemic, it had exceeded our expectations. The one caveat is the Los Angeles submarket. While it is also showing strong rent growth, this market faces offsetting challenges from the ongoing eviction moratorium and disproportionate bad debt. Notwithstanding these challenges, we remain optimistic with the broader Los Angeles submarket because of the continued strategic commercial investments by companies like Warner Bros, which is planning to develop a 1.3 million square feet of studio and office space in Burbank. This will be the largest studio development in the country and is expected to bring about 1,400 new jobs to the market. Film LA recently reported the production activity hit an all-time high in the fourth quarter and Apple recently proposed a 0.5 million square foot office development in Culver City, which should create approximately 2,500 new jobs. The continued job growth and high cost of homeownership amidst a slight increase in supply deliveries in Orange County and San Diego are factors considered in our expectation for demand for rental housing and the basis for our 2022 outlook for Southern California market rent growth of 7.1%.
Moving north to the Bay Area and Northern California, it is no secret that Northern California’s rents have lacked the nation and the Essex portfolio average. We view the region is in early stages of its recovery. Unlike most markets across the country, which are effectively back to normal economic levels, the Bay Area has yet to fully recover due to ongoing COVID regulations such as mask mandates and delayed return to office tempering the momentum of normal economic activities. We have seen communications by Bay Area companies informing employees of plans to return to office after Omicron case subsides and we remain encouraged by the large tech companies’ expansion plans and commercial investments in our markets, as highlighted by Mike.
Furthermore, our supply delivery forecast a decline in 2022. Thus, we anticipate rapid recovery in rent growth without requiring a comparable level of increased housing demand. Keep in mind, that our Northern California portfolio is mostly suburban and should benefit from those employees having fewer commuting days in a hybrid environment. These factors contribute to our expectation for Northern California to be one of our strongest rental markets in 2022, with market rent forecasted to increase by 8.7%.
Turning to our Seattle portfolio, which continues to perform well, we anticipate a similar level of supply deliveries this year as last year with the majority concentrated in downtown Seattle. Because our portfolio skews to the east side in Bellevue and surrounding suburbs, the demand for our communities remain strong from the continued investments by several companies, most notably Amazon, which has committed to developing a second tower in Bellevue, with construction to start this year and is expected to create an additional 3,500 jobs. Therefore, we forecast Seattle’s market rent growth at 7.2% for 2022.
Moving on to the advancements in our operating model, by way of background, our disciplined focus of investing in high-quality submarkets has resulted in 70% of our properties being located within 5 miles of each other. With this competitive advantage in geographic concentration and innovation in technology and data analytics, we have re-envisioned Essex operating model with property collections. Essentially, we are transitioning from a dedicated team at an individual property to teams that will cover a collection of properties along with each associate to specialize in specific function and improving our ability to cross-sell among nearby properties.
By organizing properties into collections and centralizing certain administrative duties, we expect to generate more efficiencies across the portfolio. We have already implemented this collections model in Orange County and San Diego and have achieved a reduction in personnel by approximately 10% to 15% through natural attrition. In addition, our data analytics has determined that our ability to cross-sell neighboring communities has increased by over 800 basis points following the adoption of the collections model. We plan to complete the rollout of the collections operating model to the remaining regions by the end of this year.
While Essex has been efficient historically with each associate covering 40 units prior to 2019, with recent enhancements, we currently have each associate covering 43 units across the entire portfolio. Further benefits are expected in 2022 and thereafter as we complete our technology and other implementation plans. We are currently co-developing proprietary applications with partners from RET Ventures Fund and other software developers that will enhance the associate and customer experience. One example of advancements in our operating model over the past months has enabled 100% contactless tours, which currently consist of 92% self-guided tours and 8% virtual tours.
As part of our technology initiative, we are starting the rollout of Alloy Access, a smart rent common area access solution, which will elevate the resident experience, while also further the productivity of our operations team by enhancing security, usability and monitoring, along with improving the effectiveness of the self-guided tours for prospective customers. In addition, we are working with Funnel to co-develop a tailored solution to further automate our platform, which we plan to rollout later this year. We believe this will directly benefit both the associates and customers through streamlined systems, on-demand features and link communications across properties, which will meaningfully accelerate the timetable to turn prospects into renters.
We integrate these advancements with our data analytics platform to provide new operational insights. For example, leveraging newly available data on our leasing patterns from Funnel has improved the quality and effectiveness of our customer interactions. We have also applied advanced analytics with data from site plan to streamline our maintenance workflow, which reduced our unit churn times by 10% in the fourth quarter on a year-over-year basis despite COVID-related labor challenges. We expect that these initiatives will continue to provide us with additional levers and insights to improve our revenue growth and operating margins in the coming years.
With that, I will turn the call over to Barb Pak.
Thanks, Angela. Today, I will discuss the key assumptions supporting our 2022 guidance and conclude with an update on the balance sheet. We ended 2021 with strong momentum in the fourth quarter as demonstrated by 4.7% same-property NOI growth and 7.6% core FFO growth. We believe the economic recovery has only just begun on the West Coast and thus, this positive momentum will continue throughout 2022. As such, we are forecasting core FFO per share growth of 9.7% at the midpoint, which is the highest growth in 6 years. We are pleased that our 2022 core FFO per share guidance is expected to exceed our pre-pandemic FFO achieved in 2019 despite the challenging operating environment. This is a testament to our disciplined operating strategy and capital allocation process, which is driving results to the bottom line.
Our 2022 FFO growth is primarily driven by a 7.8% increase in our same-property revenues on a cash basis and 8.3% on a GAAP basis. For the year, we expect fewer concessions as compared to last year, but delinquency remains a challenge and we are expecting delinquency of 2.4% of scheduled rent in 2022, which is 30 basis points higher than 2021. We have two counties representing 50% of our total delinquency, where tenant protections remain in place. In addition, response times on tenant applications seeking emergency rental assistance remains slow and outside of our control, leading to large monthly swings in the delinquency line item.
As a reminder, our historical annual delinquency has been around 35 basis points of scheduled rent. And given our long history of high collections, we believe we can ultimately return to this level once the various restrictions are lifted. We continue to assist residents in applying for federal tenant release funds and have received $29 million to-date, of which $12 million was in the fourth quarter. As for operating expenses, we are forecasting a 4% increase, which is above our historical average of 2% to 3%. This is the result of wage pressures in the market along with general inflation in the economy for materials. In total, same-property NOI is expected to grow 9.4% on a cash basis.
Continuing with our investment expectations for 2022, as we have discussed throughout the past year, we have seen an elevated level of early redemptions of our preferred equity and subordinated loan investments due to high demand for West Coast apartments and low interest rates. In 2021, we had approximately $210 million of redemptions and our 2022 guidance contemplates another $350 million of redemptions. Some of this was pushed from the fourth quarter into this year. Over the past year, it has become more challenging to find new investments given the influx of capital to this segment. However, we were able to secure $117 million of new commitments, with an average yield of 11%, maintaining our disciplined approach to underwriting these projects. Our 2022 guidance contemplates an additional $100 million of new commitments at the midpoint, of which we assume $50 million will be funded during the second half of the year. The remainder of the preferred equity redemption proceeds will be used to fund new acquisitions.
Finally, the balance sheet remains in a strong position. During the quarter, we saw continued improvement in our credit metrics and our net debt-to-EBITDA ratio declined to 6.3x as EBITDA grew. We expect this trend to continue throughout 2022. Over the past 2 years, we have taken advantage of the low interest rate environment and refinanced nearly 40% of our debt, locking in low rates and reducing our weighted average interest rate by 70 basis points. As such, we have only 6% of our debt maturing over the next 2 years. In addition, we have minimal exposure to short-term rates, with only 4% of our consolidated debt subject to floating rates. As such, we have minimal risk to the rising interest rate environment. Given limited near-term maturities, no material development funding needs and ample liquidity, the company remains in a strong financial position.
With that, I will now turn the call back to the operator for questions.
Thank you. [Operator Instructions] Our first questions come from the line of Rich Hill with Morgan Stanley. Please proceed with your questions.
Hi, good morning, guys. I wanted to maybe just start off with a question about new leases relative to same-store revenue. I typically view new leases as leading indicator of particular revenue and you put up just a huge number for new leases in January, I think, of around 17%. So how are we supposed to think about that and maybe if I could push you a little bit, why is the same-store revenue higher?
Sure, Rich. It’s Angela here. So let me just give you a little context on the S-16 that shows our new lease it is terrific with 17%. But keep in mind, that’s a year-over-year number to start. And we had communicated that between fourth quarter of 2020 to first quarter of 2021, so that comparable period, that’s when market rent troughed. And so from a year-over-year perspective, we are really hitting kind of the greatest delta, if you will, from a differential perspective. So if we’re talking about really the same-store guidance, what we probably – I think a better indicator is to look to the S-17 that Mike talked about earlier and you take that market rent of 7.7%, that market rent growth. And then you factor in the loss to lease at year-end. And I know we normally do – look to the September loss lease, but you might recall that we were – we had a typical seasonality and the seasonal peak was pushed. So we had caution against using the September loss lease. So if we look at the December loss lease, it’s around 6%. And after and then some of these other factors such as legislation and delinquency, that’s what ultimately drives our midpoint guidance of 7.8%.
Got it. And look, that makes sense to me. We spend a lot of time on your macro forecast. So I guess your revenue guide was consistent with that, which is sort of what we expected. The newly spread, which is really high, and that’s helpful color. Just one more question for me. When we’re unpacking what you reported and guided to relative to our numbers, one of the things that stood out to us was rising interest expenses and then rising non-same-store expenses. Can you just maybe talk through what you’re expecting for the interest expense side of the equation? And if you’re intentionally being conservative given the interest rate environment that we’re in right now?
Hi, Rich, it’s Barb. In terms of the interest expense line, the biggest factor there is the reduction in cap interest as our development pipeline has substantially rolled off. And so that’s a pretty substantial increase in the interest expense. We do have a couple of rate increases forecasted in the guidance, and we will – it’s really why we have a range, but have a lot of variable rate debt. We only have 4% of our consolidated debt is variable rate. So that’s a small impact to the numbers. It really is the cap interest side of the equation. I think that’s a $4 million reduction.
Okay, that’s helpful. Thank you, guys. I will jump back in, but thank you for that.
Thanks, Rich.
Thank you. Our next questions come from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your questions.
Hi, good morning. So just a few questions for me. As far as Southern California goes, the strength that, that market is experiencing in general, do you think that will continue? So when San Francisco reopens and those tech jobs once again have to be in the office, are you expecting a migration back of people who migrated down to Southern Cal going back to Northern Cal? Or your view is that everyone who has populated Southern Cal love the lifestyle and is not looking to relocate back.
Hi, Alex, it’s Mike. I’ll start with this and then flip it to Angela maybe for some more comments. We think that there is a reversion underway, and it will draw people back to where the jobs were kind of pre pandemic. And so the pandemic caused a lot of disruption with respect to where people went and many people went to Southern California and elsewhere. And so we think as the pandemic winds down, people will go back to where they once were, again, hybrid model being the typical format for a lot of the big companies out here. So we think that some of the people will move from Southern California back to Northern California. But keep in mind, there were people from Southern California that moved to Phoenix and other places as well. So it’s not just a one direction movement, and we think that the overall impact will be beneficial for California in total. So even though some people move from Southern California back to Northern California, that will be offset by potentially other people moving back for job reasons and/or lifestyle decisions. So with that, I’ll turn it over to Angela. Anything to add, Angela?
Maybe just a little historical context, Alex, with the Southern California portfolio and in particular, San Diego, Ventura and Orange County, these are markets that were at – that perform at a 97% occupancy even pre-COVID. So it’s already a highly desirable place to be. And we combine that with this region having the most – the strongest loss to lease and it actually has, as far as we can see, pretty long legs. So in the interim, during the reversion that Mike is referring to, it may be more of a net neutral, but long-term, this market will still – we will see this market continue to perform well with a good tailwind from loss to lease.
Okay. And then just as a follow-up to that, as part of guidance, and Mike, you’ve spoken about the exodus of the high-tech worker and then the service worker who left when their businesses were shut down. But as far as guidance goes, how much of guidance is predicated on the return of tech workers, return of the baristas? Just trying to get a sense – or if return to office occurs and if service job, those people who left came back, that’s incremental above and beyond what you’re already assuming in your numbers?
Yes, Alex, I would say that it’s already happening. So it’s not a future event necessarily. I think we’re in the middle of the reversion. And I think to point to a statistic just look at job growth, and job growth is – trailing 3-month job growth is highest in Seattle, 6.2%, followed by Northern California at – I’m sorry, Southern California by 5.8% and Northern California by 5%. So jobs are coming back. People are starting to move. The Bay Area, obviously, is a step behind, but we think it will catch up given the strength and the uniqueness of the tech employers that are there. And so we think it’s all underway, and it’s just going to take some time to play out. I guess the question is, can it accelerate? I mean we actually expect it to accelerate, especially in the tech markets, which were, of course, those that were most impacted. By the end of the year, we expect that California will – or our markets will have about 93% of their jobs that they lost during the pandemic recovered. We’re currently at about 78% now. So we expect, again, these trends to continue and pretty favorable for our markets given what the impact on jobs is.
Thank you.
Thank you.
Thank you. Our next questions come from the line of Nick Joseph with Citi. Please proceed with your questions.
Thanks. Maybe just following up on that, it seems like another topic at least for San Francisco and maybe Seattle as well as just been quality of life overall. And obviously, a return to the office will help improve things, but do you think there is other steps that need to be taken or will the return to the office really help with quality of life as well?
I think quality of life considerations really come into play in the CBDs. The homelessness, concerns about defunding the police, etcetera, I think that is where quality of life issues are more manifest and obvious. And as I say, they are not creating any more beaches around here. So that’s obviously a benefit. And so I think that the quality of life in suburbia is actually very high. And we’re – as we said before, we’re going to push out a little bit further strategically into some other – some different markets. And Adam’s here can talk about this, which we’ve never bought invested before, but it represents one of those markets in suburbia. Good community, good decent schools in a very nice Northern San Diego submarket. And we’re looking for that, and we think that we can find great quality of life in some of those markets, and there is great opportunity out there.
Thanks. And then as you think about the co-investment and the preferred and the Med book, obviously, you’ve gotten good returns from it, and it’s led to some opportunities. But as you think about kind of earnings and some of the volatility that we’re seeing this year associated with it, how do you think about the size going forward from a strategic perspective?
Yes. Nick, I think it’s about right, actually. So we have about $700 billion combined between preferred equity and the debt. And again, we don’t want that business to get to be too large. We, I think, took advantage of an opportunity in 2020 to grow the business a bit given that there was very little else that was working. And I think that’s helped, but it will be somewhat lumpy and that’s the primary reason why the Board and all of us think that we should control its size and not let it get too large. So that’s first and foremost on our mind. If in our – from our perspective, it is probably the best risk/reward of what we do in terms of how we generate income, and plus there are some other advantages. One of our investments this quarter was a joint venture that came out of the preferred business. So I thought that was having other types of business tied to that is important. Plus, we get we get a look at many development deals that are going on in the marketplace and that allows us to be more discerning with respect to our development pipeline.
Thank you.
Thanks.
Thank you. Our next questions come from the line of Rich Hightower with Evercore. Please proceed with your questions.
Hi, good morning, guys. I want to go back to a couple of the prepared comments in terms of delinquencies, and I guess the longer term assumption that that delinquency rate will revert more to historical norms. Every time we talk to your coastal peers, regulatory risk is obviously very prominent in the decision to diversify outside of certain markets. I assume this is part of that. So I guess what over the longer term gives you the confidence that the regulatory environment in that regard will indeed get back to where we were pre-COVID?
Yes, it’s a good question. And it’s definitely something that’s on our mind. And we will say that it’s frustrating from time to time, but I guess we would ask that everyone take a balanced view of these regulatory risks and look at the other side. And then the other side is that limited housing supply really comes from all the regulations that make it difficult to build housing in these markets. And so we try to balance that equation as best we can and knowing that we are a beneficiary of the supply issues that California has because there is always another regulation that is making it more difficult for us to build housing right around the corner, which is what keep supply under control in California. So keep that in mind. And we know that we need to be a strong advocate with respect to sensible housing policies, and we’re going to be active in that area going forward. But again, we would hate to trade away the unique benefits that we have given the supply restrictions in California.
Okay. I appreciate. There is two sides to the comment there, Mike. Maybe one quick follow-up, I mean just are you able to delineate for us on this call, the bad debt percentages in terms of leases that were signed in the pre-COVID advantage, true sort of COVID hardship at the time versus any leases that were signed in the world started to get better again. I mean – and people that were gaining the system after COVID was already a factor early to do that?
I’ll start and then flip it to Barb. A lot of this – there was nothing in the pre-COVID period that indicated that there were any issues with delinquency. So I’ll make that comment number one. Most of the issues that we have are really related to the government – the governmental agency, which is – there is a website called Housing Is Key. And they have very recently about 7 billion in applications and they paid out about 1.9 billion, so they are way behind. And so there is this delay in getting reimbursed for all these claims, and Barb has some information about what’s in process, etcetera. But I guess the key here is that the state agencies are way behind, and there is a lot of money that has been submitted, and we don’t know – we don’t have control over what’s going to happen with those funds. And so we’re just going to have to wait, which led to what we hope to be is obviously conservative guidance. We weren’t intending to be conservative, but we realize that some of these factors are out of our control and so that we are maybe to the conservative perspective, but we just don’t know. Barb, with that said, I think you have some additional numbers.
Yes, Rich. So in terms of our cumulative delinquency, we’re at about $67 million. We have applied for reimbursement for 80% of that, so about $53 million. And of that amount, $33 million relates to our existing residents. However, the tenant – the timing and amount of being able to collect that is unknown because the program prioritizes based on the resident area meeting income, which is something that we’re not fully privy to at the time they apply. The remainder is applications we apply for on behalf of past residents. Now our ability to collect on that is if the resident will engage, and that’s unknown at this time, but we have applied for everything that we can. And as Mike said, the state of California has been slow to disburse funds, which is causing a lot of the noise in our numbers at this point.
Okay, thanks for the color, guys.
Thank you.
Thank you. Our next questions come from the line of Brad Heffern with RBC Capital Markets. Please proceed with your questions.
Hi, Barb, thanks. I was wondering about rent to income. You talked in the prepared comments about the big divergence between urban and suburban. Can you give any figures about where rent to income have trended in those two splits? And if they have moved, has that largely been because rent has moved or has income moved as well? Thanks.
Yes. This is Mike, and maybe Angela may have a comment too here. But generally speaking, the good news is that incomes are moving and that affects us in terms of our guidance, but it also helps us charge more rent or allows us to have higher rent levels and helps us much more than what it cost us on the operating expense side. So we’re pleased with higher income levels, and we’re seeing that throughout our portfolio. And in terms of numbers, so Southern California, for example, has a rent to median income. This is the median – this is not our data, this is a general data that comes from our data vendors, but using median rents and median incomes, we’re currently at 26.9% rent to income in Southern California versus the long-term average of 22.3%, so well in excess of that average. And then conversely, in Northern California, we’re currently at 22.1% rent to income versus a long-term average of 23.1%, so well below in that regard. Seattle is a little bit different. It’s at 21.1% versus 18.7%, respectively. So it suggests that it’s higher in the rent to income versus the long-term average, although that market has changed pretty dramatically in terms of it going from being a lower cost to a higher cost or higher rent market over the last 10 years or so. So I’d say, it’s fundamentally changed its nature. Does that help answer your question?
It does. I mean one of the things I was trying to get at is, specifically for Northern California, when you have the backfill after the initial sort of COVID pain, I’m curious, did you see significantly lower incomes from those people? And that’s part of what caused the pricing pressure? And is there any reversion of that or is the pricing pressure truly just due to other factors?
Yes, if that’s the question, yes. No, we see – so take the leisure and hospitality segment, which lost a tremendous number of jobs because the state shutdown the restaurants and the hotel shut and travel were shutdown basically. So all those people that are generally pretty low wage earners left the Bay Area and went somewhere else. They migrated far and wide or went home with parents, etcetera. And so we’re starting to see them come back. They are skewing the data in terms of their impact on rent income. It looks like we’re bringing in a lot of lower-income workers, but it’s just replacing what we lost a while ago. So there is nothing fundamentally wrong with the Bay Area or any of our markets with respect to income levels. I think they are still in very good shape. The tech companies continue to – they didn’t lose a lot of employees, and they continue to hire at robust levels, at high income levels. And then those high income levels are what really drive the demand for the services, all the jobs that we lost early on in the pandemic. And the high incomes – people here make enough money that they can pay a little bit more for their dinner and some of these other services. And so we just don’t see that as a key issue. The key issue is, how do you draw back people that left in the early parts of the pandemic, how do you draw them back now. And I think that’s an ongoing process. Is that helps?
Thank you. Yes, that’s perfect.
Thank you. Our next questions come from the line of John Kim with BMO Capital Markets. Please proceed with your questions.
Hello. I was wondering if you talked about sourcing new preferred Med has been challenging in this environment. Would you consider doing deals outside of your core markets, not necessarily to own the equity, but just provide a wider pool of more opportunities?
This is Mike. Actually, I’m going to give it to Adam in a minute, but we – the answer is, we are, to some extent. In other words, we’re not going to completely different markets that we’re pushing into other markets. Adam, we want to give them a couple of examples of deals that we’ve done?
Yes. John, so we have been tracking in other markets since really the platform was put into place, and we’ve actually – we’ve done – echo on my set. So we look slightly outside of our markets to where we think the fundamentals are still there. They – and so a couple of that we have done, we did one in Redland [ph], which is Inland Empire. That one is going well currently funded. And then we have one round trip in Sacramento. That market has obviously done very well. So we continue to track markets within our overall footprint, but a little outside, and we will consider a little further beyond that.
Okay. So nothing outside of the West Coast really?
Yes.
My second question is on your revenue-generating CapEx guidance of $100 million, which is more than double what you invested in last year. How much does this add to same-store revenue growth this year versus 2023? Is it fair to assume that most of this CapEx will be outside of Northern California?
We actually are looking at these opportunities throughout the portfolio. So it’s not skewed toward one region because we are seeing strong market rent growth in all of our portfolios in all of our regions. And as far as when they will be realized, less likely in 2022, just because, as you know, it takes time to renovate and then get them leased up until that time. By the time that occurs, you certainly wouldn’t have a full year of revenue. So it’s more likely going to impact 2023.
Great, thank you.
Thank you. Our next questions come from the line of Austin Wurschmidt with KeyBanc. Please proceed with your questions.
Hi, thank you. Mike, in your prepared remarks, you referenced that buyers in the markets are not really discerning, I guess, between location and maybe vintage of product. And so is that simply just a function of the amount of capital that’s coming into your markets and chasing deals? And separately, is there really any opportunity for you to pull forward any portfolio management objectives as a result of kind of everything seemingly converging in pricing?
Hi, Austin, this is Adam. I can start with that and then if Mike has any follow-ups. So we’re seeing a different buyer pool for different vintages and different locations, but ultimately, what you said in your question is right. There is so much capital chasing these deals, whether it’s coming from value-add funds or larger core funds or whomever that the compression between product age type, construction type and location has been significant and continues to remain today. As it relates – Mike, do you want to cover that?
Yes. The – could you repeat the question about the portfolio?
Yes. Just portfolio management objectives trading around some markets, increasing product quality, whatever sort of is in your...?
Yes, the broader management objectives, yes. We continue to believe that we can add value in a variety of ways. And it isn’t that we are necessarily going to dramatically increase our portfolio allocation to any one market or decrease it. I think that we are overall pretty happy. We want our to see how the pandemic recovery plays out. Like everyone else, there is a number of unknowns about portfolio transitions, and we would like to get into a more normal world. As I mentioned in the – in my prepared remarks, the laggards of the last 30 years from now are top-performing markets. Is that possible that, that continues, or does it revert back. And I suspect that there will be some fairly significant amount of reversion. As we think of the world, we think that probably the urban core – again, given issues with homelessness, crime, etcetera, are probably a mile – negative mile to significant negative. Hopefully, the cities get control over some of these issues. I think they can definitely do that with respect to crime. I am not so sure that there is a plan when it comes to homelessness. But again, that’s pretty focused on the urban core, much less so in – throughout the suburban parts of our portfolio, which is where the vast majority of our property is located. We have commented actually before the pandemic on deemphasizing the city centers, partially due to what I just said. And so that remains something that we will take a look at and potentially transact around going forward. But overall, North South balance, Seattle, I think was doing really incredibly well, great job growth and couple of key drivers up there in Microsoft and Amazon are really pushing that market. So , we would like to increase our portfolio up there actually, but it’s difficult to find the product at the price that adds value, so more to say, we have been there before.
Yes. Got it. And then just maybe given where the stock is trading, certainly preferred, I think have the preferred equity investments have been one of the most attractive you have referenced. But beyond that, given where your stock is trading, is the joint venture still one of the best uses? Do you take a look at issuing from time-to-time where you are trading today? What’s sort of the thinking around your cost of capital and potential uses?
Yes. When we look at deals, our deal generation is sort of independent of how we capitalize or how we take the deal down. And where we believe that we are adding value to the company and that could be core FFO or cash flow and/or NAV per share to the company, we will take it down on the balance sheet. And at times like now where we don’t think we can add value, we will do it in our – one of our co-investments where we are still a substantial owner. We still own about 50% of these transactions, and we manage it and therefore, we earn some – a small amount of fee income. But it’s really driven by the capital side of the equation. And again, at this point, we probably wouldn’t issue stock. We would prefer to transact in a co-investment format.
Thank you.
Thank you. Our next questions come from the line of John Pawlowski with Green Street. Please proceed with your questions.
Thanks. Just one follow-up question to that, the North and South – Southern California balance in the portfolio either for Mike or Adam, I guess I am listening, Mike, to your opening remarks and the unset investment takeaways by Northern California by the laggard or maybe sell or prune the winners just in terms of the dispersion of relative rents we have seen in the last 24 months. So, kind of pounding the table on the mean reversion trade, why don’t you have as much conviction to go out and tilt the portfolio on the margin towards Northern California more heavily?
John, it’s a great question, and Adam, will you bring me 100 buildings in Northern California, please, at a 3.8% cap rate. That’s the answer. It’s not there. And if we could do it, we would. We did buy one property in Fremont, again, a co-investment. We would buy more if we could, John. But again, the markets are going to evolve and perhaps, we will continue to see more products hit the market. And we wouldn’t – for high-quality property in the right areas of the Bay Area, we are not black lining the Bay Area by any means.
Just to tack on a little there. We see every deal that’s marketed and every deal that’s not marketed, and so it’s always a relative game. And so we are underwriting consistently up and down the portfolio and jumping in where we see opportunity for that value add. Otherwise, we have seen deals in Bay Area closed at 3.1%, 3.2% cap, and that’s not where we are going to compete.
Okay. So, going in economic yields are still meaningfully lower in Northern California than LA, Orange County, San Diego?
I keep telling Adam. I say, Adam, well, interest rates are going up. So, what’s going on with cap rates. And Adam keeps telling me, they are pushing down, right. I mean that’s effectively what we have seen.
That’s effectively right. And so John, it’s not even going in. So that 3.1%, 3 2% cap that I quoted is economics. So, taking all units to market as of today. So, there is – it doesn’t include any future growth, but that’s still absorbing loss of lease, so, yes, very competitive.
Okay. Thank you.
Thanks John.
Thank you. Our next questions comes from the line of Haendel St. Juste with Mizuho. Please proceed with your questions.
Hi. I guess it’s still morning out there. Good morning. I wanted to – I have a question on your blended rate. I guess I am trying to better understand the cadence in the back half of the year versus the first half and some of the key drivers or underlying assumptions. You started off the year on a strong foot. You seem to be fairly optimistic about an improvement in back half of the year. But looking at the guide, there is a massive drop-off to get to your same revenue guide. So, maybe you can help me understand or square that a bit more. Thanks.
Sure, Haendel. It’s really more of a function of the year-over-year comparable. And so we expect the first half to be much stronger because first half of 2021, it was still quite soft. And of course, we started recovering in the second half of 2021. And so from a year-over-year perspective, this year, the second half will be harder comparable, and that’s really what’s driving the trends.
No, I understand that. So, I guess maybe helping us understand maybe the delta perhaps between some of the regions in the back half of the year. Obviously, there is some tailwinds helping North Cal, but perhaps, North Cal has more headwinds given how well it’s reformed. So, maybe a bit more color perhaps on maybe the spread that you are thinking of there?
Well, in terms of the spread, what we see is, in Seattle, would be the highest from a year-over-year on the second half because it has higher loss to lease and lower delinquency and better concession benefit. And Northern California and Southern California are pretty much very comparable. Southern California, because of the challenge by delinquency, while Northern California has that concessionary benefit and so they end up more similar, but in terms of spread, we are not talking – we are talking, say, 40 basis points versus not hundreds of basis points. So, they are all pretty not close.
Okay. That’s helpful.
And Haendel, just one question, are you asking about market rent growth or same-store growth? I am just trying to understand?
Yes. No, I guess the first question was more on the blended rate growth within the same-store, but the market commentary is helpful.
Okay.
Where are you guys – I mean I don’t know if I missed it, but you guys mentioned where you are sending out renewals today for February and March?
We didn’t – let me take a quick look. So, on the renewals, we are sending out – hold on, 2022. Where is that, here. So, we are sending renewals out, portfolio average in the low teens, so around, say, 13%-ish. And with Seattle, the highest, followed by North Cal and in South Cal, around 10%-ish.
Got it. And that’s helpful. Mike, I guess a question for you. I heard your comments earlier about VC investment. And I understand there is a lot of profitable and very viable, established companies, tech companies today, but I guess I am curious, how concerned you might be regarding the ongoing Facebook or Meta troubles and the number of not yet profitable start-ups. I guess I am curious what – any level of concern you might have at all as to what might happen to your job growth assumptions that these companies have to cut G&A?
Yes. Haendel, it’s definitely a concern. But I don’t think in terms of the STEM graduates and the workers that are in these fields, I don’t think there is any shortage of positions that might be available to them. There is plenty of jobs out there. I was coming out of college, I worked for venture capital company. And so I was there for quite some time, and it’s amazing how different the world is. And these companies are venture financed for a much longer period of time now, and the rounds are much larger. In fact, I think most of the money that was deployed that I discussed in the script was mega rounds, rounds exceeding $100 billion. So, we have some concern about it. Obviously, those companies are more vulnerable. And therefore, I think that’s warranted. I have been through that in my career in the late ‘90s, where all these companies went public and without a product, and they didn’t work out well. So, I think the current model of venture capital funding is much better and much more resilient. And a lot of these companies, the best ones will see it through. And the ones that don’t succeed, I think the employees have plenty of opportunity out there at some of the other companies. That’s what makes the Bay Area such a unique place from a technology employment standpoint.
That’s helpful. And if I could squeeze one more. I don’t know if I missed that number, too, but did you guys tell us what’s embedded in the guide for rental assisted payments for this year?
Haendel, this is Barb. Like I mentioned earlier, we have applied for $52 million of our cumulative delinquency, $32 million of that is our existing tenants, and we feel good about that number. However, the timing is very uncertain. And what we do is, we forecast on a net basis. So, we have assumed that delinquency does increase this year because of the uncertainty related to the timing of payments on the – these applications as well as the California program, which the applications have exceeded the amount that’s already been allocated to the State. So, there is a variety of things that led us to that assumption.
Okay. So, if I understand it, should you be successful in getting – I guess I am trying to understand, how – what level of payments are kind of embedded? And where the upside – where that line lies, I guess I am having trouble understanding what exactly is the net number, the absolute number that’s included in the guide this year?|
So, in our guidance is a 2.4% delinquency as a percent of scheduled rent. That’s what will drive our numbers. And one thing that we are seeing is our delinquency has gotten worse overall – our net delinquency has gotten more over the last couple of months as more of our tenants are applying for aid as the program has changed recently to allow tenant supply for three additional months. Therefore, applications are going up. So, there is a lot of moving parts on that front, but the net number is, we do expect delinquency to get slightly worse this year before it gets better.
Okay. Thanks. I will follow-up offline. But thank you all. I appreciate the time. Thanks.
Thank you. Our next questions come from the line of Rich Anderson with SMBC. Please proceed with your questions.
Hi. Thanks. Good afternoon. So, is there any logic to the concept that regulatory environment could actually be a good thing in terms of being a magnet for residents. I know some of your peers are running because of regulation, but on the other side of that table is perhaps a resident – I don’t know. I would like to know that I have tenant-friendly regulation behind me if I am living in California. Is there any relevance to that line of thinking in your mind, Mike?
Yes, Rich, it’s a good concept. People generally don’t think they are landlord very much. We don’t hear a great deal of appreciation. But having said that, I mean I think that tenants do appreciate it. Candidly, from my perspective, I worry that it’s taking advantage of the system as opposed to we will offer a safety net, we are all for helping people out that it can go too far in trying to find that comfortable middle ground, I think is what they are trying to do. And I am very glad I am not managing that program, by the way. So, I think it’s a good point. I think people do appreciate that part of California, and – but they are going to do what’s best for them, which ultimately will come down to their job and their quality of life and those factors that we spend most of our time thinking about.
Right. I mean Costa-Hawkins reversal is defeated. CPI plus 5% state-wide rent cap. I mean these weren’t terrible events in the life cycle of multifamily California, but anyway. Second question is, you mentioned that cap rates are still going down with, I guess what we would call the threat of rising interest rates, still tenures at historical lows. But I look back, 2018 tenure was over 3%. And I had looked at what you said in your call at the time, you said cap rates are running around 4.25%. So, are you kind of quietly hoping for perhaps an increase in interest rates to something more like that and also inflation because of the pass-through qualities of multifamily and that you could really start to see some opportunities come. I know it’s 3.1% now on the cap rate, but maybe that changes if we get some real change to the interest rate environment, and that perhaps opens up opportunities for you and you are more substantial cost or capital raising opportunities versus your peers?
Yes. No, it’s a great question, great observation. And I think that the company is positioned sort of for the worst-case scenario, whatever might be in terms of the balance sheet and the overall structure. A world in which incomes are inflating and rents are inflating is a good world for us, I think. I mean I think that there will be opportunity. And even though our – probably, our interest costs would go up in that scenario, the vast majority of our debt is pretty well locked down in terms of maturities and rates. So, that would be a good world for us, and I think there is a reasonable chance that’s where we are on.
So, is a four -handle type cap rate, is there anything systemic about your world right now that, that can’t happen even if a scenario of 3% plus 10-year were to happen because that – I would assume that, that’s a very realistic?
Yes, it’s – I mean the comment I would make is that cap rates tend to be pretty sticky over time. So, they don’t just change overnight just because interest rates move up or down. And I would say, back in those – the 2018 period you were referring to, we were maybe a little frustrated that cap rates weren’t moving down somewhat given how much the tenure had rallied. But until the COVID period, they remain pretty sticky even though you had pretty significant reductions in interest rates over that period of time. I think that probably you are not going to see cap rates adjust upward quickly. There is too much money looking for a yield and yield investment and 3% versus some of the options is still 3% and is still in the scheme of things interesting to some investors. So, I wouldn’t expect that to change it. Really is all about the flow of money and the number of investors that need yield and what the other yield alternatives are.
Okay. Great. Thanks very much.
Thank you.
Thank you. Our next questions come from the line of Chandni Luthra. Please proceed with your questions.
Hi, good afternoon everyone. Thank you for taking my questions. Could you talk about the drivers behind sequential same-store revenue declines in some of your markets in fourth quarter? I am talking about markets like San Diego 3%, San Fran down – about 2%. Similarly, Contra Costa, I mean how much of this was perhaps a disappointment on return to offices? We were just crossing that Labor Day mark versus faced some seasonal factors that had a role to play here.
Sure, happy to. It’s Angela here. The sequential revenue decline really was not a concern for us this time because it’s really attributed to the timing of the lumpy delinquency recovery. And so what I mean by that is, in the third quarter, we have very favorable delinquency recovery. So, if you take San Diego, for example, if I back out delinquency, the sequential revenue growth would have been 1.6%. And so a similar relationship plays out for both Contra Costa and in San Francisco as well.
Very helpful. Makes sense. And my follow-up question is around your collections operating model. Now you talked about rollout by the end of 2022. And you also said that you implemented this in Orange County and San Diego. So taking that sort of as an example, and let’s say, thinking about 10% to 15% reduction in personnel to natural attrition across the portfolio. Is there a way to contextualize that in some cost savings, either in terms of dollars or in terms of margins? That would be very helpful.
Yes. I think the one example that we provided with the rollout and some of our other enhancements has already realized a saving of about 150 basis points in margin improvement and that represents about $15 million to the bottom line to NOI. And so my point in providing that context is that from a – if you look at the rollout, we are only a third way through and that was – that represents a rollout of really just two of our major regions. And so – which is why I provided indication of an additional 200 basis points to 300 basis points expectation of margin improvement just from the cost savings. And of course, with revenue, there is more to come on there, but that’s several years down the road.
Very helpful. Thank you so much.
Thank you. Our next questions come from the line of Joshua Dennerlein with Bank of America. Please proceed with your questions.
Yes. Hi. Just maybe wanted to explore your comments around being pushing further out in the suburbs. I guess how do you think about kind of identifying these new targets further out from the urban core? And does this also imply you will have more capital recycling for those assets closer in?
Hi Joshua. This is Adam. I can start off. As Mike noted previously, we have been somewhat rotating outside of the urban centers now here for a few years since – before the pandemic, and so we use our research team to assess. We look at all the top line metrics to see what areas within kind of our core footprint makes sense. And that’s how to say, Sacramento, for instance, that deal was done pre-pandemic. And even at that point, the – between job growth and income and affordability, lack of affordability for single-family homes, it made sense on all of our metrics, which – that’s what drives our investment decisions. So, we have a research team that reviews all those metrics amongst a number of both our more core markets as well as more secondary markets.
Got it. Thank you.
Thank you. There are no further questions at this time. I would like to turn the call back over to Michael Schall for any closing comments.
Thank you. Thank you, everyone, for joining us today. I appreciate your participation on the call, and we hope to see many of you in the not distant future at the Citi Conference. Thank you. Good day.
This does conclude today’s teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.