Why did net income more than double in 2004, and is that growth sustainable?

Net income rose to $79.7 million from $35.1 million mainly because of non-recurring items: equity income of about $59.5 million, which includes roughly $39.2 million in gains from the Fund I dispositions and $18.3 million in promote income, plus a $7.9 million gain on the sale of The Essex at Lake Merritt. Excluding these, underlying earnings growth was modest, so investors should not expect the 2004 level to recur.

How is the core operating business performing?

Same-property revenue rose 0.9% to $179.5 million. Southern California grew 3.6% on rent increases, Pacific Northwest grew 1.4%, and Northern California fell 4.0%. Average financial occupancy was about 96%, and operating expenses rose, with same-property operating expenses per unit up to $331 per month from $325. Much of the total revenue growth came from acquisitions rather than organic growth.

What are the main balance sheet and refinancing risks?

Total debt reached about $1.32 billion, including $438.3 million of variable rate debt, of which $285.6 million was not hedged. Interest coverage fell to 3.1x. Scheduled maturities include $280.7 million in 2007 and $698.5 million in 2010 and beyond, and management acknowledges it may not be able to refinance on favorable terms, which could raise interest costs or lead to property losses.

What does the Fund II investment mean for Essex?

Essex committed $75.0 million, a 28.2% general and limited partner interest, to Essex Apartment Value Fund II, which has $265.9 million of total commitments and plans about 65% leverage. Fund II is Essex's exclusive investment vehicle until October 2006 (or earlier if capital is deployed), and Essex earns management, development, and potential promote fees, which could add fee income but also adds co-investment and partner risk.

What governance and legal issues should investors consider?

Chairman George Marcus controls more than 50% of operating partnership units, giving him a blocking position over partnership actions, and his affiliates may compete with Essex for acquisitions. Essex also faces a putative class action filed in April 2004 by maintenance employees over on-call pager wages, and it has been sued over mold-related claims. Management says it intends to defend these claims vigorously, but outcomes are uncertain.

ESS 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 31, 2005. Cited figures are marked; the original filing is the authoritative source.

Essex Property Trust (NYSE: ESS) ended 2004 as a West Coast-focused multifamily REIT with 120 consolidated and co-invested properties totaling 25,518 apartment units, about 96%^a average financial occupancy, and 99% of property revenues from multifamily assets.

Total property revenues rose 12.7% to $283.5 million^b, but the headline net income of $79.7 million (up from $35.1 million) was inflated by non-recurring gains: roughly $39.2 million from co-investment sales in Fund I, $18.3 million of promote income, and a $7.9 million gain on The Essex at Lake Merritt. Same-property revenue grew only 0.9%, with Southern California (+3.6%) offset by Northern California (-4.0%), so underlying organic growth was modest. Funds from operations was $114.4 million for 2004, which includes the one-time gains, so investors should look at core FFO and same-store trends rather than the headline figures.

Balance sheet leverage increased meaningfully. Total property indebtedness rose to about $1.32 billion^c from $989 million, driven by acquisitions and the assumption of mortgages, and the company reported a debt-to-total-market-capitalization ratio of about 36.4%. Interest coverage declined to 3.1x from 3.2x in 2003 and 4.1x in 2000.

Refinancing risk is significant: roughly $280.7 million^d matures in 2007 and $698.5 million falls in 2010 or later. Management is expanding its fee-earning co-investment platform through Essex Apartment Value Fund II, in which Essex has committed $75.0 million for a 28.2% interest, while the company is also seeking growth in Southern California and the Pacific Northwest.

Key risks for investors include geographic concentration in California (90 of 120 properties), a litigation exposure from a putative class action over on-call pager wages, mold and environmental liabilities, and governance concentration, since Chairman George Marcus controls over 50% of the operating partnership units. Dividends were $3.16 per share for 2004, up from $3.12 in 2003, and were partially characterized as capital gains for tax purposes.

02—Key points

Key Highlights

Total property revenues increased 12.7% to $283.5 million, but same-property revenue grew only 0.9%, with Northern California down 4.0%
Net income more than doubled to $79.7 million, boosted by roughly $39.2 million in co-investment gains and $18.3 million in Fund I promote income that are non-recurring
Funds from operations totaled $114.4 million for 2004, including one-time gains from the Fund I dispositions
Total property indebtedness grew to about $1.32 billion from $989 million, with debt-to-total-market-capitalization of about 36.4% and interest coverage down to 3.1x
Approximately $280.7 million of debt matures in 2007 and $698.5 million in 2010 or later, creating meaningful refinancing exposure
Dividend increased to $3.16 per share in 2004 from $3.12 in 2003; the company committed $75.0 million (28.2%) to Essex Apartment Value Fund II
Portfolio is heavily concentrated in California (90 of 120 properties), and Chairman George Marcus controls over 50% of operating partnership units

03—Questions

Frequently Asked Questions

Why did net income more than double in 2004, and is that growth sustainable?
Net income rose to $79.7 million from $35.1 million mainly because of non-recurring items: equity income of about $59.5 million, which includes roughly $39.2 million in gains from the Fund I dispositions and $18.3 million in promote income, plus a $7.9 million gain on the sale of The Essex at Lake Merritt. Excluding these, underlying earnings growth was modest, so investors should not expect the 2004 level to recur.
How is the core operating business performing?
Same-property revenue rose 0.9% to $179.5 million. Southern California grew 3.6% on rent increases, Pacific Northwest grew 1.4%, and Northern California fell 4.0%. Average financial occupancy was about 96%, and operating expenses rose, with same-property operating expenses per unit up to $331 per month from $325. Much of the total revenue growth came from acquisitions rather than organic growth.
What are the main balance sheet and refinancing risks?
Total debt reached about $1.32 billion, including $438.3 million of variable rate debt, of which $285.6 million was not hedged. Interest coverage fell to 3.1x. Scheduled maturities include $280.7 million in 2007 and $698.5 million in 2010 and beyond, and management acknowledges it may not be able to refinance on favorable terms, which could raise interest costs or lead to property losses.
What does the Fund II investment mean for Essex?
Essex committed $75.0 million, a 28.2% general and limited partner interest, to Essex Apartment Value Fund II, which has $265.9 million of total commitments and plans about 65% leverage. Fund II is Essex's exclusive investment vehicle until October 2006 (or earlier if capital is deployed), and Essex earns management, development, and potential promote fees, which could add fee income but also adds co-investment and partner risk.
What governance and legal issues should investors consider?
Chairman George Marcus controls more than 50% of operating partnership units, giving him a blocking position over partnership actions, and his affiliates may compete with Essex for acquisitions. Essex also faces a putative class action filed in April 2004 by maintenance employees over on-call pager wages, and it has been sued over mold-related claims. Management says it intends to defend these claims vigorously, but outcomes are uncertain.

04—Continue

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