ESSEX PROPERTY TRUST, INC. quarterly report, Q3 FY2010

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Essex Property Trust, Inc. — Q3 2010 Form 10-Q

Reporting period: Three and nine months ended September 30, 2010. Unaudited results; dollar amounts below are in millions except per-share data. Essex is a West Coast apartment-focused REIT. At quarter-end it had ownership interests in 139 apartment communities totaling 28,702 units, five office/commercial buildings, and development activity across California and Seattle.

Financial performance and liquidity

  • Q3 revenue: Total revenue was $104.8, up 3.0% from $101.7; rental and other property revenue rose 3.1% to $103.8.
  • Q3 earnings: Operating earnings were $27.5 versus $18.6. Net income attributable to controlling interest was $6.9 versus a loss of $1.2; net income available to common stockholders was $6.4, or $0.21 per diluted share, versus $21.7, or $0.74 per diluted share. The prior-year comparison benefited from a $23.9 preferred-stock redemption accounting gain; 2010 had no such gain.
  • Nine-month results: Revenue was $306.6 versus $310.4; operating earnings were $86.5 versus $84.6. Net income available to common stockholders was $29.0, or $0.99 per diluted share, versus $75.4, or $2.69. The 2009 period included a $49.6 preferred-stock redemption accounting gain and $5.8 of discontinued-operations income.
  • Property operating performance: Q3 same-property revenue declined 1.9% to $92.6, while same-property occupancy fell 30 basis points to 96.7%. Nine-month same-property revenue declined 4.3% to $277.5, despite occupancy rising 30 basis points to 97.2%. Management attributed revenue pressure primarily to lower scheduled rents. Total property NOI was $65.9 in Q3 (about 63.5% of property revenue) and $196.0 year to date (about 64.7%).
  • FFO: Funds from operations, a non-GAAP measure, was $39.9, or $1.25 per diluted share, in Q3 versus $50.8, or $1.69. Nine-month FFO was $128.3, or $4.05 per diluted share, versus $164.6, or $5.61.
  • Cash flow: Nine-month operating cash flow was $148.3 versus $147.7. Investing used $251.5, including $96.6 for acquisitions and $111.0 for development; financing provided $97.2. Cash and equivalents ended at $14.7, down from $20.7 at year-end 2009.
  • Debt and liquidity: At September 30, mortgage notes were $1,711.2, credit lines $348.0, and exchangeable bonds $3.2. The company also held $21.7 of restricted cash and $95.9 of marketable securities, including $77.7 available for sale. Management said operating cash flows, cash and securities, credit availability, capital-market access, and potential property dispositions should cover reasonably anticipated cash needs for the next 12 months. The company reported compliance with credit-line covenants.
  • Dividends and capital: Common dividends were $1.033 per share for Q3 and $3.098 for the first nine months. The company issued 1.14 million common shares through September, raising $116.6 net; it issued a further 491,100 shares for $54.6 net in October.

Material changes and management outlook

  • Q3 same-property revenue was down year over year, but increased 0.3% sequentially from Q2, the first sequential quarterly growth since Q4 2008. Management expected sequential same-property growth in Q4 and Q4 revenue consistent with Q4 2009. It projected full-year 2010 same-property revenue to decline approximately 3.3% from 2009.
  • Q3 non-same-property revenue increased 79.1% to $11.2, mainly from acquisitions and development properties entering operations. Nine-month non-same-property revenue rose 50.2% to $25.6.
  • At quarter-end, consolidated development/predevelopment and land activity covered 2,277 units, with $239.9 of incurred costs and $68.4 of estimated remaining project costs. Redevelopment covered four communities and 1,032 units, with $33.1 of estimated costs remaining. The filing also describes an unconsolidated development project; project pipeline figures are presented under different classifications in the filing.
  • Q3 included $1.6 of expense from ineffectiveness of forward-starting swaps. The company had $275.0 notional of forward-starting swaps and a net derivative liability of $71.7 at quarter-end. In July it paid $16.7 to settle $100.0 of swaps, increasing the effective rate on $130.1 of new mortgage loans to 6.0% from a stated fixed rate of 4.6%.
  • Subsequent financing: On November 5, the company entered a 10-year, $207.2 Fannie Mae facility at a stated 4.3% fixed rate. It also settled $225.0 of forward-starting swaps for $60.5; the filing says the resulting effective rate was 7.1% on the facility and 6.4% on the July mortgage loans. October acquisitions and equity issuance also followed quarter-end.
  • Management cited tighter credit conditions, wider spreads, and more restrictive loan-to-value and debt-service coverage requirements as risks to acquisitions, development, and refinancing. It cautioned that future Fannie Mae and Freddie Mac financing is not assured. Other stated exposures include interest-rate and derivative valuation changes, development cost/completion risk, and apartment-market weakness.
  • The company faced mold-related and other ordinary-course lawsuits. It said material adverse effects were not expected, but potential mold/environmental liabilities were not quantifiable. Substantially all properties are in earthquake-prone areas; the company disclosed no earthquake insurance for certain extraordinary losses. Management reported effective disclosure controls and no material change in internal control over financial reporting.

Important facts for investors to verify

  1. Whether rent trends and same-property revenue stabilize after Q3’s sequential improvement, and whether the stated 2010 revenue outlook is achieved.
  2. The effect of swap settlements, the $71.7 derivative liability, and post-quarter financing on effective borrowing costs and cash flows.
  3. Development and redevelopment remaining costs, completion and lease-up assumptions, and the funding required to meet project commitments.
  4. Debt maturities, variable-rate exposure, credit-line availability and covenants, and the extent to which equity issuance supports liquidity and growth.
  5. The sustainability of FFO and dividends relative to operating cash flow, and the impact of nonrecurring items on comparisons with 2009.
  6. Potential exposure from mold, environmental, earthquake, and other legal or insurance matters; the filing provides no clear estimate of possible losses for mold and environmental claims.