Essex Property Trust, Inc. (ESS) Q2 2012 Earnings Report, Transcript and Summary

Greetings, and welcome to the Essex Property Trust Second Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this 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 in 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 now begin.

Thank you, operator, and welcome, everyone, to our second quarter 2012 earnings call. Erik Alexander and Mike Dance will follow me with brief comments on operations and finance, respectively; John Eudy and John Lopez are here for Q&A. I'll cover the following 3 topics on the call: number one, Q2 results and market commentary; second, the investment market; and third, an update on California, California itself and the policies and political situation. First topic, Q2 results and market commentary. Last evening, we reported core FFO of $1.66 per share for the second quarter of 2012, which was at the high end of the company's guidance range discussed on last quarter's call. We continue to see strong growth in Northern California and Seattle and an uneven recovery with pockets of strength in Southern California. Apartment conditions remain strong, demonstrated by same-store revenue and NOI growth of 6.3% and 9.2%, respectively. These results lead us to reiterate our expectation for a strong second half of 2012 and continuing into 2013, driven by limited supplies of housing and job growth that exceeds the national averages in Northern California and Seattle and is modestly below the national average in Southern California. We don't see a significant departure from this basic theme until at least 2014. Erik will discuss portfolio trends in greater detail. Our research team tracks many of the major employers in our coastal markets for insights into hiring expectations and other trends that can affect apartments. While job growth has remained quite strong, there are several companies, including Hewlett-Packard, Yahoo! and Cisco, that have reported job reductions, along with restructuring programs. Still, other tech companies have missed analyst expectations and have reported slower earnings growth. We view these announcements as typical and necessary for technology companies. Tech companies of all sizes are…

Thank you, Mike. As always, it's a pleasure to be here. I'm happy to report on another solid quarter of operations for Essex. So following the strong first quarter we executed the plan that we discussed on our last call, by trading some occupancy for rent growth in order to achieve the desired revenue gains. We actually only shed 70 basis points of occupancy during the quarter compared to the estimated 90 basis points, of which about half of that decline is attributable to increased renovation activities. As with the first quarter, demand in all of our markets remained strong, including improvement in San Diego. As expected, we experienced seasonally higher turnover during the second quarter, but our annualized rate of turnover through the first half of the year is only 50%. We still expect this ratio to be in the low 50% range for the full year. Although move-outs due to home purchases and rent increases were higher this quarter compared to the first quarter, both reasons for move-out are well within historical ranges. Less than 12% of residents moving out during the second quarter stated that they were doing so to purchase a house or condominium. This compares to 11% of responses received last quarter and 10% of move-outs during the second quarter of 2011. You may recall that this figure was north of 12% as recently as the second quarter of 2010 and as high as 18% in 2007. During the quarter, about 18% of residents moving out cited some kind of affordability issue as the primary motivation for giving us notice to vacate, including their most recent rent increase. This compares to 15% of all residents moving out last quarter and 15% in the second quarter of last year. The primary reason people give for leaving…

Thanks, Erik. Today, I will provide brief commentary on our recent balance sheet activities and an update on our 2012 guidance. During the quarter, we prepay $138 million of secured mortgage debt on 8 properties, with proceeds from our private placement note offering announced earlier this year. We recorded $1.5 million of prepayment penalties during the second quarter and expect to record up to $1 million of additional prepayment penalties in the third quarter from a repayment of additional secured debt with the proceeds from the last tranche of our unsecured notes offering. We also expanded the capacity on our 5-year bank term loan by $150 million to $350 million and reduced the spread to 130 basis points over LIBOR. We entered into a $100 million of swap contracts to lock in an effective fixed interest rate for 5 years of 2.2%. With the prepayment of secured debt obligations, we have approximately 50% of the portfolio's net operating income generated from assets that are now unencumbered. This quarter's capital market activities reduce our cost of capital and our variable interest rate exposure, extend our debt maturities and strengthen our balance sheet so that we are now in a position to access the public debt market. Now turning to guidance. Our second quarter funds from operations results exceeded the guidance we provided on the first quarter call by $0.02 per diluted share, with better-than-expected net operating income results from our balance sheet portfolio and the co-investment activities, leading to the increase in the midpoint of our guidance of $0.05 per diluted share. Our same-property net operating income for the first 6 months is up 10.2% over the 6 months results ending in 2011. The new guidance for 2012 forecast net operating income increasing in a range of 8.5% to 9.5% for the entire year. The new guidance range includes an estimate for increases in property taxes of up to $400,000 per quarter, starting in the third quarter. Our second half forecast also assumes we continue to increase our renovation program to include over 700 apartment units before year-end, increasing the rehab-related vacancy by approximately $750,000 over the same period in 2011. The benefits from our renovation program will be reflected in better 2013 results. I will close my remarks with some numbers that underscore our sequential growth. The sequential same-property average rents actually increased 1.7% in the second quarter, with average rents increasing from $1,439 per month in the March quarter to $1,464 per month in the June quarter. This compares to the 1% sequential growth in average rental rates achieved in the first quarter. Based on the July 2012 preliminary results of over $1,560 per month on over 2,600 new and renewal lease transactions, we are not seeing any slowing in sequential average rental rates. This ends my comments, and I'll now turn the call back to the operator for questions.

[Operator Instructions] Our first question is from Eric Wolfe of Citi.

You mentioned this in your remarks, but you moved up the stabilization date on a couple of development projects. Just wondering whether that reflects a more optimistic view on your markets, in general, being able to sort of absorb supply faster, if it's something particular to those particular assets.

Eric, it's Mike Schall. I think we just moved up this time the Expo deal, and I think it's more related to the construction labor pool. I don't -- we're not moving up the stabilization. We're moving up the date that the building is available for occupancy. And as you all know, the quality of the labor pool increases when there's not a lot going on in the development world, and so I think it's just, overall, we're able to build things faster and better and get better contractors and better subs, which ultimately leads to a faster construction period. And John Eudy is here, he probably can answer that better than I did. John, [indiscernible]?

Expo, that's pretty much it, Mike. The only other difference is we had a really light winter last year in Seattle, so we picked up probably 2.5 to 3 months just because it didn't rain until February, March, to any degree.

I think the basic comment still -- well, also holds true to other development deals because the quality of the construction and labor force is very good, I think, right now, right?

Yes, on everything we have under contract.

Okay, that's helpful. Yes, I mean, I was just looking at the stabilized operations data and comparing with last quarter's supplemental, but I'm probably just reading a little wrong or something. You talked about the initial and stabilized yields you're seeing on development as well. I think you said 5% to 5.5% on initial, 6.5% to 7% maybe on stabilized. Just curious, what sort of value creation that implies relative to where you could acquire assets today. And if you think about that spread there, how that compares to the typical value creation that you've been able to achieve over time.

Yes, it's a good question. The reality is, we can do both though, right? We can build and we can buy. We can find opportunities to, on a risk-adjusted basis, contribute meaningfully to the portfolio. And so we're pursuing both aggressively. I would say, in the development side, I think I reported last quarter that our cap rate, based on today's rents as of March 31, just mark-to-market, the cap rates, they were around 6%. I think everyone of those development deals would sell for a 4-type cap rate, if not lower than that. And so there's very significant amount of value creation. And I updated this quarter on Expo and said it was probably going to be around the 7% or higher stabilized cap rate again. I think that would sell for a 4 all day long. But we view those -- the value proposition differently between development and acquisitions. Development obviously involves more risk from a variety of perspectives. We expect to get a premium for that risk, and so we underwrite it a little bit differently. With the expectation, again, on the acquisition side of trying to get -- trying to accomplish something, improve our growth rate of the portfolio, we can move a lot more money faster in acquisitions, obviously. So if we see a change in market growth rates, we could buy into that with acquisitions, which is very difficult to do with development because you have transactions delivering several years after you start up. So I think that they're fundamentally different. I think you can add value in both of them. And so we continue to have a dual-pronged type of approach to investments, and we're still very active in both areas.

Got you. That's helpful. And then just last question. On the co-investment structure, you mentioned the need, I guess, there, I guess the want to mitigate your risk in forward funding commitments. Is there any risk to giving your JV partner though too much control over asset management and operating decisions? Or do they just, at the end of the day, not have that much control based on the way you're structuring it?

Yes, we're in control of all the major decisions on those transactions. In the case of the CPP joint ventures, they have say over major decisions, obviously. They're an important part of the overall equation. But they trust us for 55% of those -- 55% ownership in those transactions, and we're the providers of the services. And we believe in communicating very well with our partners, and we spend a lot of time and effort to make sure that, that goes right. But I think that, that partnership has worked very well up to this point, and we're excited about that relationship. So we try to maintain control, but we don't have complete control, obviously. And -- but I think in the broader scope, it makes sense from a risk reward standpoint. Again, if the world wasn't maybe as uncertain as it is and the issues weren't what they are, we might approach it differently. But I think in this world, this is a prudent strategy, and again, increasing your risk reward or improving your risk reward relationship, we think, is our objective here in what we've been able to accomplish.

The next question is from David Toti of Cantor Fitzgerald. David Toti - Cantor Fitzgerald & Co., Research Division: Quickly, I want to follow up on some of Eric's questions from a more strategic perspective on the development pipeline. Clearly, you feel there's an advantage to your timing and delivering a lot of these assets in the submarkets. What are some of the signals that you would look for to make -- sort of dial back on that volume, is my first question. And the second question is, based on your outlook, what does the development pipeline look like around year-end?

Again, this is Mike. We have pretty much concluded that we're going to be early- to mid-cycle developers, and we are going to -- and our format will change a little bit depending upon how much compensation we receive for risks that we take. And we believe in this world, we're better off trying to compress the time periods between when we commit and when we deliver a transaction. And so we've tried to focus on sort of the shovel-ready type of projects that are out there. And so as you've noticed, over the last several quarters, when we buy something and announce it, we are under construction on it the next day pretty much. And again, we're trying to squeeze that period because of the uncertainty inherent in the world. And -- but having said that, all these projects are going exceptionally well. And so we have -- clearly, we feel like maybe that we did leave something on the table, but you don't know that upfront. And I think overall, that strategy makes complete sense. We're very focused on this unfunded liability that is -- or unfunded exposure from everything but including, in particular, the development projects. So we have agreed that we're going to be early-, mid-cycle developers, and we're going to tailor off at the top of this cycle. We've done a lot of time -- spent a lot of time and -- looking at cycles and where we are in the cycle, and of course, none of us really know exactly where we are. But we certainly are going to take a shot at trying to get it right. And so I think that as time goes on, if we get another great year in Northern California, you'll probably see us decelerate on the development side there. There is a possibility that we will try to find some more transactions in Southern California. We fundamentally believe that as good as Northern California and actually Seattle have been, Southern California really hasn't caught on where rents didn't fall as far, but we haven't seen the recovery coming back the other way. And as all of us know, in a world that is 8% unemployed, if you get any change in that scenario, there could be a lot more demand for housing that would be generated by better employment scenario almost overnight in markets that are just chronically undersupplied. So I guess to answer your question, if we get another great year in Northern California, we'd probably scale back a little bit, but we could scale up a little bit in -- or maybe pretty substantially in Southern California. David Toti - Cantor Fitzgerald & Co., Research Division: Okay. That's helpful. And just as a follow-up, are you seeing any signs of inflationary trends either in the material side or the land side in your Shadow pipeline?

This is John Eudy. On the land side, there are a number of transactions that are out there that are really priced up that we won't be able to pursue or choose not to pursue. On materials, yes, there's been a little bit of movement at the beginning of summer. It backed off here in the last -- probably 30 days. On labor, there still seems to be where we are in our buyout sort of the last couple of announcements to be plenty of capacity even in Northern California. I do think by the middle part of next year, that will change with the pipeline that is scheduled to start in '13. But right now, as Mike said, we think that beginning in the middle part of the cycle, we're trying to catch the wave early and not be caught with runaway cost.

The next question is from Paul Morgan of Morgan Stanley.

Just on the cap offering, 10% cap on rents, can you talk a little bit more about kind of that decision to go from 15% to 10%? And maybe what's the adoption rate experienced when you have offered the 15% cap? And I mean, are these essentially economically neutral to you in a sense that the premium rent that you get roughly offsets the lack of upside at a various point of the cycle?

It can be a little bit different. I mean, this is something that we've done before. As we all know, especially the tech markets can be very frothy when it comes to rent growth. You look at the late '90s and other periods of time, and also just the political nature of obviously California and I'm sure other places around the country. If you look at the nominal numbers, it doesn't look like it has much of an impact. If you break it down into actual property-by-property impacts, it clearly does have an impact. But again, there's also quite a bit of resistance. Certainly, the CEO website and Erik, as I'm sure 100x, that -- in his direct involvement of people that just say we just simply -- no one can afford 15% increases 3 years in a row. And some of those magnitudes are certainly out there. So we think that, overall, the cost of the company, if you ignore some of the side benefits or if you make some assumptions about side benefits, it's probably $1 million to $2 million a year in revenue. And at that, we think it's a prudent thing to do. I mean, obviously, we're not going to get a lot of Christmas cards limiting rent increases to 10% because people will still view that as being excessive, but it's something and it's something that we will likely publicize because there are companies out there that are charging much, much more and trying to go after every nickel. And again, obviously, one company cannot completely change the political situation if there's gouging by 2 companies. And if 10 companies are showing some restraint, the politicians could still act upon a rent control type of measure, but there's little we can do about that. From my perspective, it's the right thing to do, it's a prudent thing to do. There will be some other side benefits to it, and I think it's an important thing. And I'll note also that the California Apartment Association has a task force that is trying to mediate large rent control disputes between people and landlords, and they're getting more and more activity in that. And again, where that fails, where all the processes to try to mediate and come to a normal resolution fail, I think, is where you potentially have some political exposure.

But am I correct that it's an option, it's not an automatic and it comes with a different starting rent?

Yes. So this is Erik. So as Mike said, there's always an option at 10%, and that option is anywhere from 10 to 13 months, depending on our lease expiration profile. And then there's an alternative that's offered at a different term, and of course, residents are always invited to let us know what's most important to them and we'll price that option for them as well. As Mike said, we're not getting very many thank you cards. However, what the sites tell us is that even though initially, it doesn't seem like that big of a deal, when people realize what the market rates are for their same floor plan and when they have done their shopping in the market, they realize there really is an economic benefit to them, and I think they generally feel better about it. So we have done or have accomplished, I think, what we're setting out to do, which is to defuse the issue, take a little wind out of the sail.

I think Swaroop has one question.

Yes, just actually following up on the development pipeline question. I noticed in S-15 San Jose, you expect 1,200 units coming online this year. My question is, what do you expect for 2013 and 2014? And how does that relate to your plans for the Cadence project, also given your decision for Phase 2 and 3. Does this impact your decision to maybe start the project earlier than expected or later?

Yes, this is John Lopez. We expect the buildup in North San Jose to probably peak later in the summer next year, somewhere around 2,500, 3,000 units in that range, which would put it -- there's about 225,000, 230,000 total units in the marketplace, so we're talking up potentially up to, I guess that's about 1.4%, 1.3%. And it will probably cap at that for a couple of years if you look at the -- if we look what that construction right now that can be delivered by 2014.

And actually, the other number that you gave out, John, it is 1.4% that we talked about in the past but amid very limited single-family housing production, right? So I think if you look at total housing production relative to stock, it's still in the under 1% range.

Because the single-family supply in Silicon Valley, in particular, is like 0.2%. And you've got to remember that in Silicon Valley, unlike San Francisco, 60% of the homes are single-family. So when you do your 1.4% plus 0.2%, it comes out to be about 0.5%, 0.6% for the total residential area, which we think is very manageable. If you drop me into a year and say you're getting 0.5%, 0.6%, then good job. I'd be a happy economist in that market.

Yes, so probably the issue obviously is that the job growth continues to be very strong in San Jose. So -- and as I recall, the number is now 3% projected for 2012 job growth in San Jose. So if the job growth continues, we don't think that, that supply will be an issue. It will be quickly absorbed.

And just one last point, Swaroop, because I think you're looking at the difference in this. If you look at previous cycles on total multi-family apartments and in condos, the only thing that's different here, this isn't going to be a peak year necessarily. It's just that a lot of it is coming into North San Jose, but that's also sort of indirectly where the jobs in the office construction in that light rail line is you just can't underestimate the impact to being on the light rail line.

So if we just add all the phases in Cadence and the Via project, how many units are we talking about that Essex will eventually build in San Jose?

The third phase of Cadence is 192. So -- I don't have it right in front of me.

So you're talking about on stabilized properties?

Yes.

Yes. So it's 569.

769.

Yes, 769.

The next question is from Jana Galan of Bank of America Merrill Lynch.

I guess following up on the prepared remarks regarding Hewlett-Packard and Cisco and Yahoo!, can you remind us how much of your portfolio is corporate leases in Northern California and Seattle? And have you noticed any changes in demand from that segment?

Yes, this is Erik. We have a very low exposure to the corporate business in our portfolio throughout. There are some properties that do more of that type of business, as you might expect, in Seattle, in San Jose and in Redmond. Overall, to answer your question specifically, the corporate exposure is 1.1% for the portfolio. And I think the most any one of the buildings have is 15%, and even that is a little deceiving because it's staggered. And we asked corporates to take some longer-term leases, and they're usually -- and they're used to taking, again, to protect our backside.

So completely under control. Appreciate it.

The next question is from Dave Bragg of Zelman & Associates. David Bragg - Zelman & Associates, Research Division: A couple of follow-up questions on this renewal policy. Mike, you mentioned the potential revenue loss, but you also mentioned potentially lower turnovers. So what's the offset on the expense line? How do you expect this to increase -- or decrease turnover? And just to put this into context for us, what percentage of your renewal notices that you have been sitting out were above 10%, anyways?

Dave, all these numbers within the context of what our total annual revenue is are pretty meaningless, so I think it's all fairly nominal. I think we've done some estimates of what the impact is, $1 million, $2 million, using assumptions with respect to what turnover might be and what -- because you'll have less turnover, you'll have less turnover costs, you'll have less vacancy and you will put more -- you'll have more ability to push rents on the other side because you have less availability as well. Obviously, those are not numbers you can plug into a model, you have to make assumptions on them. But with the total impact of somewhere between $1 million and $2 million, we think this is nominal. And to get more specific about it, I'm not sure we'd be really all that helpful. Erik, do you have anything to add to that?

No, other than the timing of the 10% increases, we just started doing the first offer, 60 days out a couple of weeks ago, that impact the October 1 and beyond -- or sorry, September 15, I think it is, and beyond. So we don't have any -- or many of the results back from that yet. And as Mike said, I would -- the impact that's hard -- or the offset that's hard to estimate is the lower availability and what that does to pricing on the new lease side. For whatever reason that we're able to reduce availability, net availability, we always see it increase in pricing on the new lease side. So that will certainly help us mitigate some of that. And as I commented, we're looking to get -- continue to grow revenue and are most comfortable doing it on the new side. David Bragg - Zelman & Associates, Research Division: Well, Erik, on that point, there seems to be a divergence between your renewal and new move-in gains in this third quarter of this year versus last year. Seems like you're doing better on new move-ins just based on your July metric and a good bit lower on renewals. Could you speak to that trend?

Well, I mean, I think these 2 periods, this summer and last summer, are different. As noted in the highlights, our net availability overall is lower this year than it is -- or than it was last year. And so again, I think that's helping us accelerate the pricing on the new side. So as long as those conditions hold up and as I reported on 30-day net availability, those are very much in control. I think we've said before that we're trying to manage around 6%, and only Seattle is at that level. Southern Cal and Northern California are lower. David Bragg - Zelman & Associates, Research Division: Right. And what do you think is driving the lower renewals?

What I think is driving the lower renewals? David Bragg - Zelman & Associates, Research Division: Versus last year.

Well, at this specific period of time, I would say that it's part of our aggressiveness last year compared to the balanced approach going into the fourth quarter this year.

[Operator Instructions] The next question is from Alexander Goldfarb with Sandler O'Neill. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Just want to go back to David Toti's question on Northern California versus Southern California. You guys, in the past, have been very good about switching markets. When you tell 1 market was peaking, jumping to another market that was picking up steam, it seems like this cycle, the Northern California market seems to have longer legs than the Southern California market is taking longer. But I thought you said that there may only be 1 more year Northern California before you switch to Southern California, given the pace of new development activity starts that you guys are doing. Just sort of wanting more color on your thoughts between investing in the 2 markets.

Alex, it's Mike. What we do operationally is rank our 30-some-odd submarkets by expected growth rate over the next 3 to 5 years. Mr. Lopez does that. And pretty clearly, the last several years, that is -- focuses more on Northern California and Seattle, not -- but that doesn't mean that we didn't like some parts of Southern California as well, it's just you can only buy so much and build so much in Northern California and Seattle. The markets are only so big, and it didn't mean that we wanted to essentially not look at Southern California. But as time has gone on, you have now a pretty significant amount of rent growth in Northern California, 20-plus percent, a similar number in Seattle. And so as we looked at the market rankings, there is greater parity. We think Northern California -- and it varies a little bit by location, but Northern California, as a general statement, is about a parity with respect to projected growth rate as Southern California. And so you will see a more balanced approach, I think, from an acquisition standpoint between North and South. As to development, development is a little different because what happens at the top of the cycle is the contractors are busy, they want bigger profit margins when they're busy, costs tend to spike a bit at the top. So as the comments I was making earlier were really more from a development standpoint, trying to keep our development earlier in the cycle to avoid the potential for costs spiking that can happen toward the top of the cycle. And so moving more of our development interest into Southern California would therefore be something, I think, will happen and will be advantageous to us.

And Alex, this is John Lopez. I know we made a comment last quarter that it might be sometime in the midpoint next year where -- when the crossover between rental growth rates might occur. But I think if we look at what's going on in the Northern California and Seattle economies, that is probably not going to be the case where before '14, that the rates in Southern California will greatly exceed Northern California. So although Southern California will pick up and pass Northern California, it's probably not going to be the case where the gaps are as big as they are, say, a year ago between North and South, if you get that. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay, that makes sense. And then going to your development program, the $1 billion that you outlined and met in the supplemental, that's a gross number, right? That's not your pro rata, correct?

Yes, that's correct. Of the deals that are under construction, worth about half, between 50% and 55% ownership of those. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. So like Avalon Bay has outlined a sort of target limit relative to their asset size and such, do you guys have a limit that you're looking to keep the development program under?

We don't have an express limit. We've typically been in the 10% to 20% of our activities develop -- or capital, let's say, in development. So that would an imply an $8 billion -- $800 million will be 10% to $1.6 billion will be the absolute maximum we would consider. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: Okay. And then just the final question is just going back to the rent control. Given that part of what causes the rents to spike is making it very difficult for developers to build, as you hear various politicians speak about rent control, is there -- do they give any like sort of acceptance to the need that they need to make development easier to also alleviate the burden of rents or it's the typical sort of let's limit rent growth -- I mean, let's limit rent and not talk about the other side of the equation?

You're being way too rational, Alex. So no, we do not hear those 2 concepts being spoken about together. And in fact, I'd say that because the local governments are under so much financial pressure, that there will be more pressure with respect to city fees and other costs, not less pressure going forward. It will become more difficult to build and probably not easier. Alexander David Goldfarb - Sandler O'Neill + Partners, L.P., Research Division: So as you speak to local politicians, it doesn't seem to be anyone who's amenable to hearing the development side of the picture?

That's maybe a little bit too tough, too. No, I think that -- I think some of the politicians are very aware of the issue, and -- but unfortunately, the political will, as a general rule, I don't think is there. So I think our expectation, and as we've seen in the past, California can be very undersupplied with respect to housing from time to time. And I believe that we're going into one of those periods of time, I'm not 100% sure. But I know it's difficult and it takes a lot of time and effort, and there are a lot of obstacles to producing housing here and I don't think that changes.

The next question is from Jeffrey Donnelly of Wells Fargo.

Just building on Alex's question about market rotation, how significantly do you think you guys could shift your NOI contribution around California to reweigh your exposure? Because arguably, that was easier a few years ago when Essex was a slightly smaller company.

Yes, that's a very good question. We don't think we're going to change -- make any huge changes to the concentrations. I think that Southern California got up to about 50% to low 60% range of our portfolio a couple of years ago. Now it's down, we've been pushing more in the north, and it's become closer to 50%. So I think that those types of magnitude are what you're going to see. So we're not talking about wholesale changes in the company. We try to find properties in locations that are solid locations for the long haul. This is a long-term business, not a short-term business. And so I think you will see us make plus or minus 5% to 10% moves in terms of our allocation over time. I don't -- I suspect it won't become larger than that.

And just a few housekeeping questions. Concerning Skyline, and I apologize if I missed this, but can you talk a little bit about how the NOI that project has performed versus your original performance? I guess I'm just trying to figure out how much of the appreciation that asset stems from performance versus this cap rate compression over the last 2 years.

Over the last couple of years, most of it was cap rate compression. So to give you a little bit of history, we bought it for $128 million, but we needed to complete a lease-up. It was 100% completed, but it was vacant. And so that lease-up cost probably took cost from $128 million to maybe $100 million -- low $130 million range. And I think that rents increased by somewhere in the neighborhood of 2% to 3% over that period of time, not great, obscured maybe a little bit by what was the impact of the concessions at the initial lease-up. But close as we can determine, it was somewhere in the 2% to 3%, and then the rest of that value was really cap rate compression. We bought it at about a 5.25% type cap rate, and the partner buyout was in the low 4% cap rate range.

That's helpful. Is it fair to say though that, that project still is on pace with your original underwriting?

Yes, I mean, operationally, we were ahead of our underwriting. I know in the first year, we've filled it up faster than we thought. And more recently, actually, it's performed better as well. So yes, I think it's achieving our estimates. We had hoped for a little bit more rent growth in Orange County, and that has lagged. So I think from the rent growth expectation, we did not hit the rents that we had hoped for. But obviously, we re-underwrote it. We still think that, that rent growth is -- that rent growth potential is still there, and we believe that we'll be able to see that in the next couple of years.

And how do you think about the timing of -- or I guess do you think about the time of selling these inevitably as condos because I think your new basis is probably about $425,000 a unit? What point does it pencil out to explore a sale of these because with interest rates probably 200 basis points lower than when you bought it, does it make it easier for consumers to get this master work? I don't know where the condo market is in that particular part of Orange County today, but...

Yes, we track the condo market, and we believe that this is a better condo than it is an apartment building. And therefore, it's simply a matter of time that -- in terms of realizing that value. And -- but having said that, the condo market is not strong. And for a lot of different reasons, clearly, there was an overbuilding of for-sale that happened as you're giving people mortgage -- mortgages they can't afford, the homes that they're buying. And then in the process, a lot of people destroy their credit. And so now you look at it a couple of years later, you've got a normalizing homeownership rate, you have people that have -- don't have the credit that they need to get a mortgage, don't have the downpayments you need to get a mortgage and therefore, you haven't seen a big resurgence in terms of values on this type of product. And therefore, I don't think we're even close to where we think condo prices would need to be in order to lead to a sale of Skyline. I think it's still several years off.

And just a last question is, do you guys have an estimate you can share with us around what the promote could ultimately be in Fund II?

We obviously do have estimates of that. I think it's preliminary to talk about it. I can say it's pretty comfortably in excess of $10 million, but I don't want to go farther than that.

The next question is from Mike Salinsky of RBC Capital Markets.

First question, just an update on dispositions. It seems like it's been pretty slow here the first half of the year. And also, as you look at development and acquisition, I mean, typically, you match fund. Is there any impetus given current valuations to give a little bit more pre-funding of the investment there?

Yes, Mike, it's Mike. We sold a couple of assets in San Diego, and at least at this point in time, our focus is trying to market and sell the half of the Fund II portfolio that is on the market now. So I think our disposition focus is pretty much right there. As we approach the end of the year, there may be a couple of other properties that we put on the market, and there will be a culling process over time within the company from that point on. So as of right now, we have our hands full with respect to the sale of those assets, and we don't want to dilute that. And at the same time, obviously, we had a very active quarter both in development and acquisitions, so we want to keep our time and effort focused on the things that are most important and not take on too much. So it's a balanced program as it always was. And then you had a second part to the question. Do you guys remember what that was? Mike, what was the second part?

Second part was just talking about funding. I mean, several of your peers have moved to more kind of a pre-funding model where they started development, they're issuing the equity to fund it completely upfront as opposed to match funding.

Right, right. Yes. Well, that number is an important number to us. The forward commitment to fund our development pipeline is somewhere around $375 million. And we have -- we're trying to reserve liquidity within our line and other places in the balance sheet to fund that if we need to. So we will -- we may look at pre-funding some of it. But the nice thing about the co-investment program is those forward funding obligations are not as large as they otherwise would be, obviously. That's why we do it. And so we don't have to, but if we can opportunistically pre-fund some of it, we will.

And related to that comment, is there any plans to cap the current development exposure?

Other than what I said earlier, probably, we've operated at 10% to 20% of capital. We're a little -- on a net basis, we're not even at 10%, so I think we have some room to go there. But we will transition out of Northern California development at some point in time, likely in the next year. I'm expecting, again, good market rent growth that would have to happen to make that occur, and then we may transition a little bit to Southern California. We're going to start delivering some of these development deals as well. Expo obviously later this year, but after that, we'll start having some deliveries. And so we'll look to try to recycle some of the development programs going forward as well.

And Erik, just a final bookkeeping question. The renewals that you guys talked about being sent out, how much do you -- what is the actual achieved rate usually versus what's sent out? How much negotiation is in there?

Yes, so I talked about this a little bit last quarter. And what we've sent out for the second quarter was in the 6% range, and what was achieved was 5.4%. So it ends up being pretty close to what we send out. The difference is usually end up being mostly related to people wanting different terms. There are some negotiations, if you will, again, mostly related to turn -- sorry, to term, because by giving them a limit, we already figured we've given them -- or by capping, I should say, our increase, we've already given them a best price, if you will. So what ends up happening a little bit is, I'd like to get that rate, but I'd like to have it on a 9-month basis because I'm moving after that. And so sometimes we'll split the difference with them. They don't get the same best rate. But that's our expectation.

The next question is from Paula Poskon of Robert W. Baird. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: Could you give us a little more color on the Valley Village project? And what do you think the opportunities [indiscernible] is for similar pre-sale-type development deals.

It's a small deal, 121 units. We were working on it for about 8 months with the developer. And there aren't that many out there that makes sense, and the reason is, the developer has to come to the table with a lot of cash to get his deal financed. We're the take-out basically for it because a combination of a developer with a take-out isn't going to be enough to get a deal financed. In this case, they own the land for a long time, there's a substantial amount of equity in it but not quite enough to get it over the line. And that's where our presale helped to get it financed with Wells Fargo and deliveries roughly 18 months out. And there aren't many of those opportunities. We've looked at other pre-sale opportunities. The problem is, if the developer has a deal, wants somebody to pre-sale contract to do it, it's not going to get done. Otherwise, there will be a lot more out there. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: And clearly, you have a long track record of success in being opportunistic with capital deployment. Do you ever think about the friction between acting that opportunistically and trying to maintain a high level of visibility into your earnings streams for investors? Or is that just not something that enters your calculus?

It's -- Paula, it's a good question. We're not here to manage same-store revenue. We're not here to manage same-store NOI. We would make different decisions if we were focused on those metrics exclusively. For example, you would sell more at the bottom edge of your portfolio to make those metrics look better and/or you would buy more aggressively at lower cap rates, in other words, in order to buy the higher growth assets. So those are not things that we are per se interested in. We are interested in a combination of growth impacts on net asset value and cap rate or accretion over our existing cash flow of our own portfolio, which generates positive returns. I think that's why we have been able to be as successful as we have been as we're very careful about the total picture of what we're trying to accomplish and not focused on -- not overfocused on any one metric. Paula J. Poskon - Robert W. Baird & Co. Incorporated, Research Division: And then just finally, you mentioned, I know, Yahoo! in your prepared remarks. Clearly, the challenges for the new CEO have been beaten to death in the national press. What are you guys hearing out there in your proverbial backyard of what the prognosis is for Yahoo!?

I don't know, Paula. I'm not sure that we have anything that's going to be helpful in terms of that transition of leadership, and it's a very significant company, obviously. And as I said in my comments, these restructurings are normal and necessary parts of the technology world because the product is an intellectual product. In many cases, it's not a -- well, in the case, I guess an iPhone is more than an intellectual product, it's actually a product, too. But it's some combination of intellectual assets and other types of assets. And so again, when you get into these situations where companies don't perform, this is the normal process, and they tend to evolve until they come back to a winning scenario. So whether this transition is the right one, we'll know. If it's not, there will be another transition afterwards. We've seen it a thousand times out here. And it's, I think, the healthy part of this market in that it's very dynamic. And whereas some companies that have products don't innovate, everyone out here is forced to innovate. And this is the process that forces innovation. So again, I don't know anything specific about the current situation, but the process is ongoing. And I hope it's successful at Yahoo!, but if it's not, the next one may be. So I think that's what will happen.

And our final question comes from Rich Anderson of BMO Capital Markets.

So I have a suggestion. Maybe if you drop the rent cap to 9.9%, you'll start to get some thank you notices.

Rich, we were wondering where you were, so I'm happy you joined the call. Appreciate the thought.

So just on that topic, really, can you just -- is it a public relations thing primarily? Is it something a little bit more selfish in the sense, and not in a bad way, but you want to kind of keep the engine going a little bit longer over a longer period of time? What is -- is that playing into your decision to provide this lower option?

It really isn't to keep the engine going longer. That is not the motivation. The motivation is a -- it's partially -- look at my constituencies. I have the investment community, I have the Essex employees and I have the residents. It's trying to balance the constituencies appropriately, and this is what we think is appropriate. We think that this will give us a defensible position with respect to the local leaders as it relates to some of these -- some of the stuff that's gone on out there, which can be pretty egregious. I mean, we're talking about 15%, but there are 20% and 25% rent increases going on out there and they are not well-received. And in the world of Facebook and electronic media and the ability to publicize these types of situations that are really pretty tough to accept in the normal world, I think there's real exposure. So again, my feeling about the thing is that the apartment world should exercise some normal self-restraint, and I give California Apartment Association kudos for trying to do that with this mediation process. Or you've got to be regulated. I mean, I think that's pretty clear. I mean, we've all seen that in a hundred different ways in other areas, so I don't know why we'd expect housing and apartments to be any different. So [indiscernible] motivation.

So this isn't -- in your mind, if you owned a national portfolio, you might be doing the same thing?

Yes, although it could be different. It's different from locale to locale. So I mean, we'll be sensitive to the local political situation. But again, I mean, if -- I'm telling you, 20%, 25% rent increases, they are not accepted. If you publicize them, we're going to look as an industry as not -- as something we don't like. So again, we're really trying to balance the 3 constituencies and make the right longer-term decision for the benefit of the company's reputation and its long-term health.

I think you're right. I mean, we've said this before that you guys have been the winner in an otherwise losing environment in terms of the economy, and I think it's the right and appropriate step to take. So I just wanted to give you a little credit for that.

We have no further questions at this time. I would like to turn the floor back over to management for closing remarks.

Thank you, operator. Well, on closing, I just appreciate your participation on the call. Obviously, we're pleased with the progress made during the quarter and believe that our outlook remains bright. And we look forward to hearing from all of you on the next quarter call. Thank you again.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.