ESS

Business Context and Reporting Period

Company: Essex Property Trust, Inc. (REIT)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2004
Portfolio Overview: As of June 30, 2004, the Company owned interests in 125 multifamily properties (26,991 units), five recreational vehicle parks, five office buildings, and two manufactured housing communities. Operations are concentrated in Southern California, Northern California, and the Pacific Northwest.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 11.3% ($7.4M) for the quarter and 9.0% ($11.7M) for the six months compared to the prior year. This was driven primarily by acquisitions and the consolidation of properties under FIN 46 Revised, rather than organic growth in same-store properties.
• Net Income Decline: Net income decreased 41.7% ($4.1M) for the quarter and 37.5% ($7.3M) for the six months. The decline is attributed to increased operating expenses (depreciation, administrative, taxes) related to new acquisitions, an impairment charge of $756,000 on a discontinued property, and higher interest expenses.
• Same-Store Performance:
  • Southern California: Revenues increased 3.4% (quarter) and 3.9% (six months) due to rental rate increases.
  • Northern California: Revenues decreased 5.3% (quarter) and 6.8% (six months) due to declining rental rates.
  • Pacific Northwest: Revenues increased 0.5% (quarter) and 0.2% (six months).
• Accounting Changes: The Company retroactively adopted FIN 46 Revised (consolidating Variable Interest Entities) and SFAS 123 (fair value accounting for stock-based compensation) as of January 1, 2004. This resulted in the consolidation of 17 Down REIT limited partnerships and other entities, significantly increasing reported assets and liabilities.

Guidance, Outlook, and Risks

• Outlook: Management expects Southern California to continue generating positive results. Northern California rents are expected to remain flat in fiscal 2004 with positive fundamentals anticipated after 2004. The Pacific Northwest is expected to see job growth and positive fundamentals in fiscal 2004.
• Strategic Initiatives:
  • Fund I Sale: The Company retained Credit Suisse First Boston to evaluate strategic alternatives for the Essex Apartment Value Fund I portfolio. A sale could occur as early as December 2004, potentially generating over $18 million in incentive interest.
  • Fund II Launch: Initial closing of Essex Apartment Value Fund II occurred July 1, 2004, with $195 million committed (targeting $250 million), allowing for approximately $700 million in West Coast investments.
• Recent Dispositions: Sold Golden Village RV Park (July 2004) for $6.66 million and The Essex at Lake Merritt (August 2004) for $88 million. The Lake Merritt sale includes a $5 million participating loan.
• Risks:
  • Market Conditions: Exposure to economic downturns in high-tech sectors (Northern California) affecting occupancy and rents.
  • Interest Rates: Significant exposure to variable rate debt; rapid rate increases could impact earnings and refinancing costs.
  • Development: Risks associated with construction delays and cost overruns on current development projects ($9M remaining commitment).

Investor Verification Checklist

• Debt Maturities: Verify the schedule of mortgage note maturities, noting $13.4M due within one year and significant fixed-rate debt maturing between 2006 and 2032.
• Fund I Sale Status: Monitor the progress of the Fund I portfolio sale process and the realization of the projected $18M+ incentive interest.
• Same-Store Trends: Track the divergence between Southern California (growth) and Northern California (decline) to assess regional concentration risk.
• Capital Commitments: Confirm funding sources for the $9M remaining development commitment and the $9.6M unfunded commitment to Fund I.
• Preferred Stock Redemption: Note the notice of redemption for $55M of Series E Preferred Units scheduled for September 3, 2004.