ESSEX PROPERTY TRUST, INC. annual report, FY2017

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Essex Property Trust, Inc. — 2017 Form 10-K

Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017, and combines filings for Essex Property Trust, Inc. and its operating partnership, Essex Portfolio, L.P. Essex is a REIT focused on owning, operating, acquiring, developing and redeveloping apartment communities, primarily in Southern California, the San Francisco Bay Area and the Seattle metropolitan area. At year-end, the portfolio included 247 operating apartment communities with 60,239 homes, seven active development projects and one commercial building. Essex owned approximately 96.7% of the operating partnership.

Financial and operating performance

  • Revenue: Rental and other property revenue was $1.354 billion, up 5.3% from $1.286 billion in 2016. Total revenue, including affiliate fees, was $1.364 billion versus $1.294 billion.
  • Profit: Net income was $458.0 million, up from $438.4 million; net income available to common stockholders was $433.1 million, or $6.57 diluted per share, versus $411.1 million and $6.27 in 2016.
  • REIT performance measures: FFO attributable to common stockholders and unitholders was $812.1 million, or $11.91 per diluted share, compared with $754.6 million and $11.12. Core FFO was $812.0 million, or $11.91 per diluted share, versus $749.2 million and $11.04. FFO and Core FFO are non-GAAP supplemental measures.
  • Property operations and margins: Same-property revenue increased 3.7% to $1.226 billion, while Same-Property NOI rose to $857.7 million from $823.2 million (approximately 70.0% of Same-Property revenue, versus 69.7% in 2016). Average financial occupancy increased to 96.6% from 96.3%; average rents increased 3.3%.
  • Cash flow and liquidity: Operating cash flow was $766.2 million, compared with $711.8 million. Investing activities used $477.2 million and financing activities used $309.2 million. Year-end unrestricted cash was $44.6 million and marketable securities were $190.0 million. Management said available cash, operating cash flow, credit facilities, capital-market access and potential property dispositions should meet reasonably anticipated 2018 cash needs.
  • Debt: Total indebtedness was $5.689 billion, up from $5.563 billion. Debt included $3.501 billion of unsecured debt and $2.008 billion of mortgage debt, net. The filing reports $799.2 million of variable-rate debt; $175.0 million was effectively fixed through swaps and $20.7 million had cap protection at year-end. The company was in compliance with debt covenants.
  • Distributions: The annual common dividend was $7.00 per share, up from $6.40. The fourth-quarter dividend of $1.75 was paid in January 2018.

Material changes versus 2016

  • Same-property revenue growth slowed to 3.7% from 6.7% in 2016; same-property occupancy nevertheless improved by 30 basis points.
  • Total property revenue rose 5.3%, partly reflecting the consolidation of Palm Valley. Non-same-property revenue increased 23.6% to $128.5 million.
  • Net income increased modestly, but included significant transaction-related gains: an $88.6 million gain on remeasurement when Essex acquired its partner’s Palm Valley interest, $44.8 million of the company’s share of gains on co-investment property sales, and a $26.4 million gain on the direct sale of Jefferson at Hollywood. Direct real estate sale gains were $26.4 million versus $154.6 million in 2016.
  • Operating cash flow rose by $54.3 million. Total indebtedness increased by $125.9 million. Essex issued 345,444 shares through its equity distribution program for net proceeds of $89.1 million.
  • Interest expense increased 1.5% to $222.9 million. The company issued $350 million of 3.625% senior notes due 2027 and repaid $300 million of 5.5% notes at maturity.

Outlook, risks and notable items

  • 2018 outlook: Management projected Same-Property revenue growth of 2.0%–3.0% and Same-Property operating expense growth of 2.1%–3.1%. Regional revenue growth projections were 1.9%–2.9% for Southern California, 2.0%–3.0% for Northern California and 2.4%–3.4% for Seattle. These are forecasts, not guarantees.
  • Investment program: Development and predevelopment projects had estimated total costs of $1.3 billion, with approximately $752 million remaining to spend, including $572 million attributable to Essex. Five major redevelopment communities had estimated costs of $138.8 million, with $43.6 million remaining.
  • Key risks: The portfolio is concentrated in coastal West Coast markets; 83% of 2017 rental revenue came from California. Risks include local economic or housing-market weakness, rising operating costs and interest rates, rent-control regulation, development cost overruns and delays, and earthquake exposure. Insurance may not cover all losses; the company self-insures certain earthquake and property risks through its subsidiary, which held approximately $81.8 million in cash and marketable securities.
  • Tax and accounting: The 2017 Tax Act lowered the corporate tax rate and prompted a $1.5 million net deferred-tax benefit. On adoption of new partial-sale accounting guidance in 2018, management expected an approximately $123.7 million cumulative adjustment to retained earnings related to the 2016 BEX II transaction. The company said the revenue standard was not expected to materially affect results or financial position.
  • Contingencies and controls: The filing describes mold-related claims and other legal and regulatory proceedings; management did not expect currently known proceedings to have a material adverse effect. Potential mold and environmental liabilities were not quantifiable. The financial statements received an unqualified audit opinion, and management and the auditor reported effective internal control over financial reporting.

Important facts for investors to verify

  • Whether 2018 Same-Property revenue and expense growth track management’s projections, by region, and how rent growth, concessions and occupancy develop.
  • How much reported earnings and FFO growth reflects recurring property operations versus Palm Valley remeasurement and co-investment/property-sale gains.
  • Development spending, project completion and lease-up progress, and the effect of remaining commitments on debt and liquidity.
  • Debt maturities, variable-rate exposure, refinancing costs and availability under credit facilities; the filing reports that the main facility was amended in January 2018, increasing capacity to $1.2 billion and extending its scheduled maturity to December 2021.
  • Exposure to California rent-control changes, property-tax increases, seismic losses and insurance limitations, as well as the outcome of environmental and mold claims.
  • The actual accounting impact of adopting the new partial-sale guidance and any subsequent changes to the expected $123.7 million retained-earnings adjustment.