How much of Essex's 2005 net income is repeatable from core operations?

Not all of it. Net income of $79.7 million included about $28.3 million from discontinued operations, mainly the gain on the Eastridge Apartments sale, and $18.1 million of gains from co-investment property sales in Fund I. Income from continuing operations was $51.4 million, and the company's own FFO measure was $115.1 million. Investors typically focus on FFO and same-property growth rather than headline net income for a REIT like this.

Is Essex's leverage risky, and what are the main debt maturities?

Leverage is moderate by the company's stated measure, with debt-to-total-market-capitalization of about 35% against a 50% policy ceiling. However, interest coverage weakened to 2.8x, and the company said it does not expect operating cash flow to cover all balloon payments. Scheduled principal is $26.2 million in 2006, $82.0 million in 2007, $155.7 million in 2008, $34.4 million in 2009, $159.3 million in 2010, and $872.2 million thereafter. Refinancing at higher rates is the key risk.

What drove the growth in revenues and what is the outlook for 2006?

Revenue growth came mainly from acquisitions. Non-same-property revenue rose 42.8% to $89.0 million, and same-property revenue rose 4.1%, helped by rent growth and higher occupancy. Management expects 2006 rent growth of about 3.5% to 4.0% across regions, and it plans continued acquisitions and development, including three projects totaling 505 units with about $96.6 million left to spend.

What are the key risks to common stockholders?

The main risks include concentration in California, which accounts for 73% of properties, and exposure to high-tech economic cycles. Dilution could come from the exchangeable notes and the redemption rights on preferred securities. Chairman George Marcus holds about 7.6% of common shares and significant influence over the board, and he has affiliate businesses that may compete with Essex. The company also faces ongoing mold litigation and a wage-and-hour class action, with a $1.5 million settlement accrued.

How does Essex fund growth and what is Fund II?

Essex funds growth through operating cash flow, unsecured and secured borrowings, equity issuance under existing shelf registrations, and asset sales. Fund II is a value-added co-investment vehicle with $265.9 million of combined partner commitments, of which Essex committed $75.0 million for a 28.2% interest. Essex earns management, development, and promote fees from the fund, and the fund is expected to use leverage of about 65% of property value. Its investment period runs until October 31, 2006, or until capital is fully invested.

ESS 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 14, 2006. Cited figures are marked; the original filing is the authoritative source.

Essex Property Trust (NYSE: ESS) enters 2006 as a West Coast-focused apartment REIT with 126 multifamily communities totaling 26,587 units, roughly 50%^a in Southern California, 25% in Northern California, and 24% in the Pacific Northwest.

Same-Property financial occupancy rose to 96.9% in 2005 from 96.0%, and Same-Property revenues grew 4.1%, driven by Southern California rent growth of 5.3%. Total property revenues rose 12.7% to $316.3 million^b, largely from acquisitions. Net income was $79.7 million, but roughly $28.3 million of that came from discontinued operations (mainly the Eastridge sale), and 2005 included $18.1 million of co-investment gains, so the recurring earnings base is weaker than headline net income suggests.

Net income available to common stockholders was $3.32^c per diluted share, versus $3.36 in 2004, which benefited from larger Fund I promote income. Balance sheet leverage is moderate but rising in absolute terms. Total property indebtedness reached $1.35 billion, and management cites a debt-to-total-market-capitalization ratio of about 35% against a 50% policy ceiling.

Interest coverage declined to 2.8x from 3.1x as interest expense rose 17% on higher LIBOR and the fourth-quarter $225 million^d 3.625% exchangeable notes. Lines of credit were cut sharply, with $135 million repaid, and the company bought back $25 million of common stock. Significant near-term refinancing needs exist, with $155.7 million of principal due in 2008 and $159.3 million in 2010, and roughly $186.7 million of variable-rate tax-exempt bonds, of which $152.7 million is capped.

The outlook points to continued acquisition and development activity, funded in part by Fund II, which has $265.9 million of partner commitments and a planned Essex commitment of $75 million. The company also plans a 2006 dividend increase, raising the quarterly rate to $0.84 from $0.81. Key investor risks include concentration in California (73% of properties), potential dilution from exchangeable notes and preferred redemption rights, significant influence by Chairman George Marcus, and ongoing mold and wage-and-hour litigation.

02—Key points

Key Highlights

Portfolio of 126 multifamily communities (26,587 units) with 97% average same-property occupancy, concentrated in Southern California (50%), Northern California (25%), and the Pacific Northwest (24%).
Same-Property revenues grew 4.1% in 2005, led by 5.3% growth in Southern California; total property revenues rose 12.7% to $316.3 million.
Net income of $79.7 million includes about $28.3 million from discontinued operations and $18.1 million of co-investment gains, so recurring earnings are lower than headline results.
Diluted EPS of $3.32 in 2005 versus $3.36 in 2004; interest coverage fell to 2.8x from 3.1x as interest expense rose 17% to $73.6 million.
Total property indebtedness of $1.35 billion; debt-to-total-market-capitalization of about 35% versus a 50% policy limit, with $225 million of 3.625% exchangeable senior notes issued in late 2005.
Near-term refinancing exposure: $155.7 million due in 2008 and $159.3 million in 2010, plus $186.7 million of variable-rate tax-exempt bonds (only $152.7 million capped).
Quarterly dividend increased to $0.84 per share for Q1 2006 (from $0.81), with 2005 dividends totaling $3.24 per share; the stock closed 2005 at $92.20 and was $105.50 on March 10, 2006.

03—Questions

Frequently Asked Questions

How much of Essex's 2005 net income is repeatable from core operations?
Not all of it. Net income of $79.7 million included about $28.3 million from discontinued operations, mainly the gain on the Eastridge Apartments sale, and $18.1 million of gains from co-investment property sales in Fund I. Income from continuing operations was $51.4 million, and the company's own FFO measure was $115.1 million. Investors typically focus on FFO and same-property growth rather than headline net income for a REIT like this.
Is Essex's leverage risky, and what are the main debt maturities?
Leverage is moderate by the company's stated measure, with debt-to-total-market-capitalization of about 35% against a 50% policy ceiling. However, interest coverage weakened to 2.8x, and the company said it does not expect operating cash flow to cover all balloon payments. Scheduled principal is $26.2 million in 2006, $82.0 million in 2007, $155.7 million in 2008, $34.4 million in 2009, $159.3 million in 2010, and $872.2 million thereafter. Refinancing at higher rates is the key risk.
What drove the growth in revenues and what is the outlook for 2006?
Revenue growth came mainly from acquisitions. Non-same-property revenue rose 42.8% to $89.0 million, and same-property revenue rose 4.1%, helped by rent growth and higher occupancy. Management expects 2006 rent growth of about 3.5% to 4.0% across regions, and it plans continued acquisitions and development, including three projects totaling 505 units with about $96.6 million left to spend.
What are the key risks to common stockholders?
The main risks include concentration in California, which accounts for 73% of properties, and exposure to high-tech economic cycles. Dilution could come from the exchangeable notes and the redemption rights on preferred securities. Chairman George Marcus holds about 7.6% of common shares and significant influence over the board, and he has affiliate businesses that may compete with Essex. The company also faces ongoing mold litigation and a wage-and-hour class action, with a $1.5 million settlement accrued.
How does Essex fund growth and what is Fund II?
Essex funds growth through operating cash flow, unsecured and secured borrowings, equity issuance under existing shelf registrations, and asset sales. Fund II is a value-added co-investment vehicle with $265.9 million of combined partner commitments, of which Essex committed $75.0 million for a 28.2% interest. Essex earns management, development, and promote fees from the fund, and the fund is expected to use leverage of about 65% of property value. Its investment period runs until October 31, 2006, or until capital is fully invested.

04—Continue

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