Today I want to take a look at the residential REIT Essex Property Trust (NYSE:ESS). I last covered the stock in late July, using second-quarter 2023 results.I A Buy rating because I believe the company’s exposure to California, while significant, is not a reason to be afraid and actually brings investment when everyone is worried about people moving to Texas Chance. This hasn’t changed, and there are a number of reasons I’ll explain why this is still a strength of ESS.However, the price has dropped by 7% since then, so in this post I wanted to review their Third quarter results and assess how ESS has performed and still reiterate my buy rating The company has been performing well on an operational level and I believe it remains well-positioned and can capitalize on the location of its properties.
First, let’s introduce the background of ESS. They have approximately 62,0000 apartments in 8 major markets. 84% of their properties are located in suburban areas and 16% are located in cities. As I mentioned before, their investments in the California market are really significant, with 42% of their portfolio in Southern California and 41% in Northern California. The rest are located in Seattle. There are many reasons why this exposure may be beneficial for ESS.
1. California is a technology hub, and with the rise of artificial intelligence, this has created many new job opportunities, attracting people to move to California.
2. ESS can take advantage of a small amount of new supply in its market, which is expected to remain at 0.5% of current supply by 2024. This is due to the high barriers to entry as the costs are really high and it takes a long time to process and approve new projects.
3. Renting has become much cheaper than buying, especially in ESS markets, where owning a home is now 2.6 times more expensive than renting, forcing many people to rent.
Third quarter results
Same-property revenue increased 3.2% year-over-year and 4.9% year-to-date. Although the full-year growth rate started to slow down from 7.6% in the first quarter and 4% in the second quarter. Still, their revenue growth was in line with full-year 2023 guidance. The financial occupancy rate in the third quarter was 96.4%, down 0.2% from the previous quarter. The slight decrease was due to improvements in delinquency rates for condominium units. ESS is able to reduce long-term lease delinquencies from an average of 3.6% in 2022 to 2.2% in 2023.
The guidance calls for a core FFO midpoint of $15. Last year’s FFO was $14.97, which was at the bottom of this year’s revised range ($14.94-$15-06). In addition, revenue growth is expected to be around 4.4%, and NOI growth is expected to be around 4.5%. At the same time, operating expenses are expected to increase by 4%. Looking at these numbers, the ESS isn’t doing poorly at all. They’re not growing very fast, but we can still see improvements, which only proves that their location isn’t an issue at the moment.
The company is rated BBB+ and has net debt to adjusted EBITDA of 5.5 times. Their weighted average interest rate is 3.4%. They have quite a few maturities to repay over the next few years, but they have $1.7 billion in liquidity, which should be enough to sustain them for a while.
ESS has a long history of increasing dividends spanning 29 years. The cumulative growth rate since the IPO is 453%. Therefore, I see no reason to stop this and expect the company to raise its dividend. Especially since the FFO payout ratio is 62%. The current dividend is $9.24 per share annually, which equates to a dividend yield of 4.2%.
When I last wrote about the company, it was trading at around 16x P/FFO, and I predict it will probably get back to around 18x. Today’s trading price is 14.74x, and the historical average is 20.13x. On an operational level, the company has not made major changes and has delivered on its guidance so far, but growth appears to be slowing. I believe the company can still reach this multiple, but with interest rates rising, it may take longer than I originally expected.
By the end of 2025, I expect it to return to 16.5x, which would still leave ~12% upside due to multiple expansion. Beyond that, I expect FFO to grow about 3% annually, which would give us FFO of about $15.9 by the end of 2025. The two combined could take us to about $260, or nearly 20% upside, on this time frame. Add in dividends, and that represents a double-digit return of around 12%. While not the highest, the returns are decent, and considering the company isn’t very risky, I expect it to be pretty stable, which is why I rate ESS a Buy.
Besides interest rate risk, I think the biggest risk ESS faces is concentration risk in California. Obviously, no one knows exactly what’s going to happen, and that’s not going to be good for the company. However, available data so far suggest otherwise.