Value Line has initiated coverage of Essex Property Trust (ESS) in its flagship product, The Value Line Investment Survey. Essex is an apartment real estate investment trust (REIT) that is focused on the West Coast. As of April 1, 2014, 47% of Essex’s revenues were generated in southern California, 34% in northern California, 18% in Seattle, and 1% elsewhere. Essex is the third-largest apartment REIT, behind only Equity Residential (EQR) and AvalonBay Communities (AVB), and is the 13th-largest publicly traded REIT. The company’s headquarters are in Palo Alto, California, and it has four regional offices in California and Washington.
In 1971, a real estate entrepreneur, George Marcus, formed Essex Property Corporation. (Mr. Marcus is still chairman of the board of directors.) The company went public on the New York Stock Exchange as Essex Property Trust in 1994. At the time, the REIT had a portfolio of 16 multifamily communities. Essex completed a major deal on April 1, 2014 when it acquired BRE Properties for almost $4.9 billion in cash and stock. Following the BRE transaction, Essex became the West Coast leader with more than 53,000 units (a 54% increase), nearly 10,000 more than Equity Residential. As of early June, this number was up to 55,000.
Essex is benefiting from its presence on the West Coast. Job growth there has been better than in the United States as a whole. Northern California, in particular, is a strong spot. The economy there, driven by Silicon Valley, has created a situation where the demand for housing has outpaced supply. This gives property owners such as Essex the ability to increase rents at a healthy pace. Indeed, Essex’s same-property revenues in northern California climbed 9.5% in the March quarter. (BRE’s properties in the region saw revenues advance by 8.5% in the same period.) Seattle is also a strong market, but there is much more housing development there than in northern California, so rent growth (while still solid) isn’t as high. Southern California has been slow to recover from the recession, so it is Essex’s weakest region. Overall, revenue growth for the first quarter was 7.2%, which led apartment REITs.
The BRE deal should wind up benefiting Essex more than just by increasing the size of the company. Already, management has raised the occupancy rate of BRE’s properties by a percentage point. Essex wants to make other changes, such as adopting its pricing philosophy for the properties it acquired in the deal. In recent years, Essex’s occupancy has been 1% higher, and turnover 10% lower, than BRE’s. Lower turnover reduces operating costs, and Essex’s larger scale operation, combined with the benefits of being in proximity to BRE’s properties, should produce further improvement in expenses.
Essex makes much smaller purchases, too. In the second quarter, it bought Piedmont Apartments for $76.8 million. But acquiring properties is by no means the only way for Essex to grow. The REIT has $1.4 billion of development (more than 3,000 units) in the pipeline that will be leased in 2014. Essex also redevelops properties on occasion. Access to capital isn’t likely to be a problem, and the REIT’s securities have investment-grade ratings from the credit-rating agencies. Note that Essex also sells properties from time to time.
As a REIT, Essex must pay out at least 90% of its taxable income as dividends. Accordingly, most REIT stocks have dividend yields that are above the market average. Essex stock has been yielding just under 3% of late, which is low for a REIT. In June, the board of directors raised the quarterly payout by $0.09 a share (7.4%), to $1.30. Even during the most recent recession, Essex maintained its history of dividend growth.
Essex stock has fared very well in 2014, having risen more than 25% year to date. However, investors should be aware of some risk factors. Naturally, any downturn in the economy in a region where Essex operates would hurt. During the recession five years ago, rents declined. The company’s focus on the West Coast gives it less geographic diversity than apartment REITs that have a national presence. Finally, a rise in interest rates would raise Essex’s cost of capital.
For a more thorough look at Essex Property Trust, and the particular investment merits of its stock, subscribers should examine our full report in The Value Line Investment Survey.
At the time of this article’s writing, the author did not have positions in any of the stocks mentioned.