ESSEX PROPERTY TRUST, INC. annual report, FY2018

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Essex Property Trust, Inc. — FY2018 Form 10-K

Business context and reporting period. This combined filing covers Essex Property Trust, Inc. and its operating partnership for the fiscal year ended December 31, 2018. Essex is a West Coast apartment REIT. At year-end, it owned or held interests in 245 operating apartment communities with 59,661 homes, concentrated in Southern California, Northern California, and the Seattle metro area.

Financial and operating performance

  • Revenue: Total revenue was $1.400 billion, up 2.7% from $1.364 billion. Property revenue was $1.391 billion, up 2.7%. Same-property revenue grew 2.8%; average same-property rental rates rose 2.5%, and average financial occupancy increased to 96.7% from 96.6%.
  • Profit: Net income was $413.6 million, down 9.7% from $458.0 million. Net income available to common stockholders was $390.2 million, or $5.91 per diluted share, compared with $433.1 million, or $6.57, in 2017.
  • Funds from operations: FFO attributable to common stockholders and unitholders was $871.8 million, or $12.76 per diluted share, versus $812.1 million, or $11.91. Core FFO was $858.9 million, or $12.57 per diluted share, versus $812.0 million, or $11.91.
  • Expenses and margins: Same-property NOI was $922.5 million, up 2.9% from $896.8 million. Total NOI was $1.006 billion, approximately 72.3% of property revenue, broadly unchanged from 2017. Property operating expenses excluding taxes rose 2.1%; real estate taxes rose 3.6%. Depreciation and amortization increased 2.3% to $479.9 million.
  • Cash flow: Operating cash flow was $826.6 million, up from $769.6 million. Investing activities used $59.9 million, versus $567.9 million, while financing activities used $676.4 million, versus $310.8 million. Cash dividends paid were $484.2 million. Non-revenue-generating capital expenditures averaged approximately $1,342 per apartment home.
  • Debt and liquidity: Total indebtedness, net, was $5.606 billion, compared with $5.689 billion a year earlier. Unrestricted cash was $134.5 million and marketable securities were $209.5 million. The Company had $1.24 billion of unsecured credit lines, with no balance outstanding at year-end; it reported compliance with debt covenants. Ratings were BBB+/Positive (Fitch), Baa1/Stable (Moody’s), and BBB+/Stable (S&P).
  • Distributions: Common dividends were $7.44 per share for 2018, up from $7.00. The fourth-quarter dividend of $1.86 per share was paid January 15, 2019.

Material changes versus 2017

  • Revenue and same-property revenue continued to grow, but growth moderated: same-property revenue growth was 2.8% in 2018 versus 3.7% in 2017.
  • Net income declined despite higher revenue. 2017 included an $88.6 million gain from remeasuring the Palm Valley co-investment; the corresponding 2018 Marquis remeasurement gain was $1.3 million. Property sale gains increased to $61.9 million from $26.4 million, partly offsetting the absence of the prior-year remeasurement gain.
  • Operating cash flow improved, while investing cash use fell substantially, reflecting changes in acquisitions, dispositions, and co-investment contributions.
  • Essex sold Domain and 8th & Hope for a combined $352.0 million, recognizing $61.9 million in gains. It acquired the remaining interest in Marquis, consolidating the 166-home community, and acquired an interest in Meridian at Midtown through a joint venture.
  • Debt declined modestly overall. The Company issued $300 million of 4.50% senior notes due 2048 and used proceeds primarily to repay credit-facility borrowings and for general corporate purposes.

Outlook, commentary, risks, and unusual items

  • 2019 outlook: Management projected same-property revenue growth of 2.5%–3.5% and same-property operating expense growth of 2.5%–3.5%. Regional same-property revenue growth projections were 2.5%–3.5% for Southern California, 2.6%–3.6% for Northern California, and 2.3%–3.3% for Seattle. These are forecasts, not guarantees.
  • Development: Six development projects totaling 1,861 homes had estimated total costs of approximately $1.2 billion, with about $417 million remaining to spend ($310 million estimated to be the Company’s share). Five major redevelopment communities had estimated costs of $140.1 million, with $27.8 million remaining.
  • Liquidity assessment: Management said operating cash flow, cash and securities, credit availability, capital-market access, and property dispositions should be sufficient for anticipated 2019 cash needs. This depends in part on capital-market conditions and the timing of investment activity.
  • Key risks: 83% of 2018 rental revenue came from California, creating geographic concentration. Other material exposures include rent control and regulatory change, housing supply and local economic conditions, interest rates and refinancing, development cost or schedule overruns, earthquakes and uninsured losses, environmental claims, and co-investment partner risks.
  • Unusual accounting item: Adoption of ASU 2017-05 produced a $123.7 million cumulative-effect adjustment to equity related to a partial sale of the BEX II interest in 2016. The filing says the adoption did not affect reported revenue in the current or prior periods. Adoption of the new lease standard was expected in 2019, with operating lease assets and liabilities not expected to exceed $85 million.
  • Subsequent events: In January 2019, Essex repaid $290 million of secured notes. In February 2019, it issued $350 million of 4.00% notes due 2029 and used proceeds to repay credit-line borrowings and for general purposes. It also amended its $1.2 billion credit facility to extend scheduled maturity to December 2022.
  • KPMG gave an unqualified opinion on the financial statements and reported effective internal control over financial reporting for Essex. The filing notes that Essex adopted new accounting guidance for derecognition of nonfinancial assets in 2018.

Important facts for investors to verify

  • Review the 2019 same-property revenue and expense outlook against subsequent results, particularly as rent regulation and new housing supply evolve in the Company’s core markets.
  • Track development and redevelopment spending, completion schedules, lease-up, and whether remaining project costs stay within estimates.
  • Examine debt maturities, variable-rate exposure, refinancing costs, and the effect of the 2019 credit-facility amendment and note issuance.
  • Assess the quality and repeatability of reported earnings, separating recurring property operations from property sale gains, co-investment promote income, and remeasurement gains.
  • Monitor California concentration, insurance coverage and self-insurance exposure, and any material environmental, litigation, or regulatory developments.