ESSEX PROPERTY TRUST, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-K)
The following discussion and analysis should be read in conjunction with the accompanying consolidated financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature. OVERVIEW
Essexis a self-administered and self-managed REIT that acquires, develops, redevelops, and manages apartment communities in selected residential areas located on the West Coastof the United States. Essexowns all of its interests in its real estate investments, directly or indirectly, through the Operating Partnership. Essexis the sole general partner of the Operating Partnershipand, as of December 31, 2021, had an approximately 96.6% general partner interest in the Operating Partnership. The Company's investment strategy has two components: constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth. The Company's strong financial condition supports its investment strategy by enhancing its ability to quickly shift acquisition, development, redevelopment, and disposition activities to markets that will optimize the performance of the Company's portfolio. As of December 31, 2021, the Company owned or had ownership interests in 252 operating apartment communities, comprising 61,911 apartment homes, excluding the Company's ownership in preferred equity co-investments, loan investments, three operating commercial buildings, and a development pipeline comprised of one consolidated project and one unconsolidated joint venture project.
The Company’s apartment communities are primarily located in the following major regions:
Southern California(primarily Los Angeles, Orange, San Diego, and Venturacounties) Northern California(the San Francisco Bay Area) SeattleMetro ( Seattlemetropolitan area) As of December 31, 2021, the Company's development pipeline was comprised of one consolidated project under development, one unconsolidated joint venture project under development, and various predevelopment projects aggregating 371 apartment homes, with total incurred costs of $156.0 million, and estimated remaining project costs of approximately $61.0 million, $32.6 millionof which represents the Company's estimated remaining costs, for total estimated project costs of $217.0 million.
By region, the Company's operating results for 2021 and 2020 and projection for 2022 new housing supply (defined as new multifamily apartment homes and single family homes, excluding developments with fewer than 50 apartment homes as well as student, senior and 100% affordable housing), projection for 2022 job growth, and 2022 estimated Same-Property revenue growth are as follows:
Southern California Region: As of December 31, 2021, this region represented 43% of the Company's consolidated operating apartment homes. Revenues for "2021 Same-Properties" (as defined below), or "Same-Property revenues," increased 3.2% in 2021 as compared to 2020. In 2022, the Company projects new residential supply of 31,750 apartment homes and single family homes, which represents 0.5% of the total housing stock. The Company projects an increase of 310,000 jobs or 4.0% in the Southern Californiaregion. Northern California Region: As of December 31, 2021, this region represented 37% of the Company's consolidated operating apartment homes. Same-Property revenues decreased 5.6% in 2021 as compared to 2020. In 2022, the Company projects new residential supply of 18,250 apartment homes and single family homes, which represents 0.8% of the total housing stock. The Company projects an increase of 157,000 jobs or 4.7% in the Northern Californiaregion. Seattle Metro Region: As of December 31, 2021, this region represented 20% of the Company's consolidated operating apartment homes. Same-Property revenues decreased 1.7% in 2021 as compared to 2020. In 2022, the Company projects new residential supply of 14,800 apartment homes and single family homes, which represents 1.1% of the total housing stock. The Company projects an increase of 63,000 jobs or 3.6% in the Seattle Metro region. 43 -------------------------------------------------------------------------------- Table of Contents In total, the Company projects an increase in 2022 Same-Property revenues of between 7.0% to 8.5%. Same-Property operating expenses are projected to increase in 2022 by 3.5% to 4.5%.
The Company’s consolidated operating communities are as follows:
As of As of December 31, 2021 December 31, 2020 Apartment Homes % Apartment Homes %
Southern California 22,190 43 % 22,560 43 % Northern California 19,123 37 % 19,319 37 % Seattle Metro 10,341 20 % 10,217 20 % Total 51,654 100 % 52,096 100 % Co-investments, including Wesco I, Wesco III, Wesco IV, Wesco V, Wesco VI, BEXAEW,
BEX II, BEX IV, and 500 Folsom communities, developments under construction, and preferred equity interest co-investment communities are not included in the table presented above for both periods. A community previously held in the BEX III co-investment was consolidated in the second quarter of 2021 and is excluded from the December 31, 2020table but included in the December 31, 2021table. The COVID-19 Pandemic The United Statesand other countries around the world are continuing to experience impacts related to the COVID-19 pandemic and its related variants which has created considerable instability, disruption, and uncertainty. Governmental authorities in impacted regions are taking extraordinary steps in an effort to slow down the spread of the viruses and mitigate its impact on affected populations. Federal, state and local jurisdictions have implemented varying forms of requirements related to sponsors and patrons of public gatherings and required businesses to make changes to their operations in a manner that negatively affects profitability, resulting in job losses and related financial impacts that may affect future operations to an unknown extent. While the Californiaeviction moratorium sunsetted during the third quarter of 2021, other state and local eviction moratoriums and laws that limit rent increases during times of emergency and prohibit the ability to collect unpaid rent during certain timeframes continue to be in effect in various formats at various regions in which Essex'scommunities are located, impacting Essexand its properties. The Company is working to comply with the stated intent of local, county, state and federal laws. In that regard, the Company has implemented a wide range of practices to protect and support its employees and residents. Such measures include instituting a hybrid work model for corporate associates to work at the Company's corporate offices and remotely, and transitioning many public interactions with leasing staff to on-line and telephonic communications; Due to the COVID-19 pandemic, some of the Company's residents, their health, their employment, and, thus, their ability to pay rent, have been and may continue to be impacted. To support residents, the Company has implemented the following steps, including, but not limited to: •assembling a Resident Response Teamto effectively and efficiently respond to resident needs and concerns with respect to the pandemic; •structuring payment plans for residents who are unable to pay their rent as a result of the outbreak and waiving late fees where required or applicable for those residents; and •establishing the Essex Cares fund for the purpose of supporting the Company's residents and communities that are experiencing financial hardships caused by the COVID-19 pandemic. The impact of the COVID-19 pandemic on the U.S.and world economies generally, and on the Company's results in particular, has been, and may continue to be significant. The long-term impact will largely depend on future developments, which are highly uncertain and cannot be predicted, including, but not limited to, whether employees and employers will continue to promote remote work if and when the pandemic concludes. This includes new information which may emerge concerning the severity of COVID-19 and related variants, the success of actions taken to contain or treat COVID-19, future laws that may be enacted, the impact on job growth and the broader economy, and reactions by consumers, companies, governmental entities and capital markets. The labor shortage due partly to various government mandates and vaccine requirements implemented during the COVID-19 pandemic and supply chain disruptions may negatively impact the Company's results of operations. Primarily as a result of the impact of the COVID-19 pandemic, the Company's cash delinquencies as a percentage of scheduled rental income for the Company's stabilized apartment communities or "Same-Property" (stabilized properties consolidated by the Company for the years ended December 31, 2021and 2020) remained higher than the pre-pandemic period but improved from 2.5% for 2020 to 1.9% for 2021. The Company has executed some payment plans and will continue to work with residents 44 -------------------------------------------------------------------------------- Table of Contents to collect such cash delinquencies. As a result of continued analysis of the collectability of delinquencies, reported delinquencies as a percentage of scheduled rent for the Company's Same-Property portfolio was 2.0% for the year ended December 31, 2021. As of December 31, 2021, the delinquencies have not had a material adverse impact to the Company's liquidity position. The COVID-19 pandemic has not negatively impacted the Company's ability to access traditional funding sources on the same or reasonably similar terms as were available in recent periods prior to the pandemic, as demonstrated by the Company's financing activity during the year ended December 31, 2021discussed in the "Liquidity and Capital Resources" section below. The Company is not at material risk of not meeting the covenants in its credit agreements and is able to timely service its debt and other obligations. RESULTS OF OPERATIONS
Year Ended Comparison
The Company's average financial occupancy for the Company's stabilized apartment communities or "2021 Same-Property" (stabilized properties consolidated by the Company for the years ended
December 31, 2021and 2020) increased 40 basis points to 96.4% in 2021 from 96.0% in 2020. Financial occupancy is defined as the percentage resulting from dividing actual rental income by total scheduled rental income. Actual rental income represents contractual rental income pursuant to leases without considering delinquency and concessions. Total scheduled rental income represents the value of all apartment homes, with occupied apartment homes valued at contractual rental rates pursuant to leases and vacant apartment homes valued at estimated market rents. The Company believes that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant apartment home at its estimated market rate. Market rates are determined using the recently signed effective rates on new leases at the property and are used as the starting point in the determination of the market rates of vacant apartment homes. The Company may increase or decrease these rates based on a variety of factors, including overall supply and demand for housing, concentration of new apartment deliveries within the same submarket which can cause periodic disruption due to greater rental concessions to increase leasing velocity, and rental affordability. Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates, and the Company's calculation of financial occupancy may not be comparable to financial occupancy disclosed by other REITs. The Company does not take into account delinquency and concessions to calculate actual rent for occupied apartment homes and market rents for vacant apartment homes. The calculation of financial occupancy compares contractual rates for occupied apartment homes to estimated market rents for unoccupied apartment homes, and thus the calculation compares the gross value of all apartment homes excluding delinquency and concessions. For apartment communities that are development properties in lease-up without stabilized occupancy figures, the Company believes the physical occupancy rate is the appropriate performance metric. While an apartment community is in the lease-up phase, the Company's primary motivation is to stabilize the property, which may entail the use of rent concessions and other incentives, and thus financial occupancy, which is based on contractual income is not considered the best metric to quantify occupancy. The regional breakdown of the Company's 2021 Same-Property portfolio for financial occupancy for the years ended December 31, 2021and 2020 is as follows: Years ended December 31, 2021 2020 Southern California 96.8 % 96.0 % Northern California 96.2 % 96.1 % Seattle Metro 96.2 % 96.0 %
The following table provides a breakdown of revenue amounts, including revenue attributable to 2021 comparable properties.
Table of Contents Years Ended Number of Apartment December 31, Dollar Percentage Property Revenues ($ in thousands) Homes 2021 2020 Change Change 2021 Same-Properties: Southern California 20,800
$ 557,906 $ 540,771 $ 17,1353.2 % Northern California 16,072 490,513 519,746 (29,233) (5.6) % Seattle Metro 10,218 239,819 243,900 (4,081) (1.7) % Total 2021 Same-Property Revenues 47,090 1,288,238 1,304,417 (16,179) (1.2) % 2021 Non-Same Property Revenues 143,180 181,733 (38,553) (21.2) % Total Property Revenues $ 1,431,418 $ 1,486,150 $ (54,732)(3.7) % 2021 Same-Property Revenues decreased by $16.2 millionor 1.2% to $1.3 billionfor 2021. The decrease was primarily attributable to an additional $5.3 millionof cash concessions and $1.2 millionin delinquencies compared to the prior year and due to a decrease of 1.5% in average rental rates from $2,349for 2020 to $2,313for 2021. 2021 Non-Same Property Revenues decreased by $38.6 millionor 21.2% to $143.2 millionin 2021 compared to $181.7 millionin 2020. The decrease was primarily due to property dispositions in 2020 and the sale of Hidden Valley, Axis 2300, Park 20, and Devonshire Apartmentsin 2021 partially offset by the acquisition of The Village at Toluca Lake. Management and other fees from affiliates decreased by $0.5 millionor 5.2% to $9.1 millionin 2021 from $9.6 millionin 2020. The decrease was primarily due to a decrease in revenues used to calculate management fees as well as a decrease of the management fee rate for one of the joint ventures. Property operating expenses, excluding real estate taxes increased by $1.5 millionor 0.6% to $264.9 millionin 2021 compared to $263.4 millionin 2020, primarily due to an increase of $3.8 millionin utilities expenses offset by a $2.4 milliondecrease in administrative expenses. 2021 Same-Property operating expenses, excluding real estate taxes, increased by $5.3 millionor 2.2% to $241.8 millionin 2021 compared to $236.5 millionin 2020, primarily due to increases of $4.1 millionin utilities expenses, $2.2 millionin insurance and other expenses, and $1.2 millionin maintenance and repairs expenses, offset by a decrease of $2.2 millionin administrative expenses. Real estate taxes increased by $3.4 millionor 1.9% to $180.4 millionin 2021 compared to $177.0 millionin 2020, primarily due to increases in assessed valuations and tax rates. 2021 Same-Property real estate taxes increased by $3.6 millionor 2.4% to $155.0 millionin 2021 compared to $151.4 millionin 2020 primarily due to increases in assessed valuations and tax rates.
Enterprise-level property management spending increased by
Depreciation and amortization expense decreased by
$5.4 millionor 1.0% to $520.1 millionin 2021 compared to $525.5 millionin 2020, primarily due to a decrease in amortization expense resulting from certain lease intangibles becoming fully amortized during 2020 and the sale of Hidden Valley, Axis 2300, Park 20, and Devonshire Apartmentsduring 2021. Gain on sale of real estate and land of $143.0 millionin 2021 was attributable to the sale of Hidden Valley, Axis 2300, Park 20, and Devonshire Apartmentsduring 2021. The Company's $65.0 milliongain on sale of real estate and land in 2020 was primarily attributable to the portfolio sale of One South Market and Museum Park, and the sales of Delanoand 416 on Broadwayduring 2020. Interest expense decreased by $17.5 millionor 7.9% to $203.1 millionin 2021 compared to $220.6 millionin 2020, primarily due to various debt that was paid off, matured, or regular principal payments during and after 2020, and lower average interest rates, which resulted in a decrease in interest expense of $49.8 millionfor 2021. These decreases in interest expense were partially offset by the issuance of new senior unsecured notes which resulted in an increase of $23.8 millioninterest expense for 2021 as compared to 2020. Additionally, there was a $8.5 milliondecrease in capitalized interest in 2021, due to a decrease in development activity as compared to the same period in 2020.
Total income from yield swaps of
46 -------------------------------------------------------------------------------- Table of Contents Interest and other income increased by
$57.7 millionor 140.7% to $98.7 millionin 2021 compared to $41.0 millionin 2020, primarily due to increases of $34.3 millionin insurance reimbursements, legal settlements and other driven by a one-time legal settlement claim, $20.6 millionin unrealized gains on marketable securities, $7.9 millionin marketable securities and other income, $4.9 millionin income from early redemption of notes receivable, and $1.3 millionin gain on sale of marketable securities. These increases were offset by a $11.8 milliondecrease in interest income resulting from the maturity of a mortgage backed security investment in 2020. Equity income from co-investments increased by $45.2 millionor 68.0% to $111.7 millionin 2021 compared to $66.5 millionin 2020, primarily due to increases of $50.3 millionin equity income from non-core co-investments and $11.6 millionin income from preferred equity investments including income from early redemptions. These increases were offset by decreases of $8.8 millionin equity income from co-investments and $6.5 millionin co-investment promote income. Deferred tax expense on unrealized gain on unconsolidated co-investment of $15.7 millionin 2021 resulted from a net unrealized gain of $53.7 millionfrom an unconsolidated co-investments. Loss on early retirement of debt, net of $19.0 millionin 2021 was primarily due to the early termination of the Company's five interest rate swap contracts in conjunction with the partial repayment of the Company's unsecured term debt and the early repayment of $300.0 millionof senior unsecured notes. Gain on remeasurement of co-investment of $2.3 millionin 2021 resulted from the Company's purchase of BEX III's50.0% interest in The Village at Toluca Lakecommunity in the second quarter of 2021. Gain on remeasurement of $234.7 millionin 2020 resulted from the Company's purchase of Canada Pension Plan Investment Board's("CPPIB") 45.0% co-investment interests during the first quarter of 2020.
Year Ended Comparison
For the comparison of the years ended
December 31, 2020and December 31, 2019, refer to Part II, Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" on Form 10-K for the fiscal year ended December 31, 2020, filed with the SECon February 19, 2021under the subheading "Comparison of Year Ended December 31, 2020to the Year Ended December 31, 2019."
Cash and capital resources
The following table sets forth the Company's cash flows for 2021, 2020 and 2019 ($ in thousands): For the year ended December 31, 2021 2020 2019 Cash flow provided by (used in): Operating activities
$ 905,259 $ 803,108 $ 919,079Investing activities $ (397,397) $ (416,900) $ (527,691)Financing activities $ (533,265) $ (383,261) $ (461,689) Essex'sbusiness is operated primarily through the Operating Partnership. Essexissues public equity from time to time, but does not otherwise generate any capital itself or conduct any business itself, other than incurring certain expenses from operating as a public company which are fully reimbursed by the Operating Partnership. Essexitself does not hold any indebtedness, and its only material asset is its ownership of partnership interests of the Operating Partnership. Essex'sprincipal funding requirement is the payment of dividends on its common stock and preferred stock. Essex'ssole source of funding for its dividend payments is distributions it receives from the Operating Partnership.
The liquidity of
Essexis dependent on the Operating Partnership'sability to make sufficient distributions to Essex. The primary cash requirement of Essexis its payment of dividends to its stockholders. Essexalso guarantees some of the Operating Partnership'sdebt, as discussed further in Notes 7 and 8 to our consolidated financial statements included in Part IV, Item 15 of this Annual Report on Form 10- K. Ifthe Operating Partnershipfails to fulfill certain of its debt requirements, which trigger Essex'sguarantee obligations, then Essexwill be required to fulfill its cash payment commitments under such guarantees. However, Essex'sonly significant asset is its investment in the Operating Partnership. 47
Essexto maintain its qualification as a REIT, it must pay dividends to its stockholders aggregating annually at least 90% of its REIT taxable income, excluding net capital gains. While historically Essexhas satisfied this distribution requirement by making cash distributions to its stockholders, it may choose to satisfy this requirement by making distributions of other property, including, in limited circumstances, Essex'sown stock. As a result of this distribution requirement, the Operating Partnershipcannot rely on retained earnings to fund its ongoing operations to the same extent that other companies whose parent companies are not REITs can. Essexmay need to continue to raise capital in the equity markets to fund the Operating Partnership'sworking capital needs, acquisitions and developments. At December 31, 2021, the Company had $48.4 millionof unrestricted cash and cash equivalents and $191.8 millionin marketable securities. The Company believes that cash flows generated by its operations, existing cash and cash equivalents, marketable securities balances and availability under existing lines of credit are sufficient to meet all of its anticipated cash needs during 2022. Additionally, the capital markets continue to be available and the Company is able to generate cash from the disposition of real estate assets to finance additional cash flow needs, including continued development and select acquisitions. In the event that conditions become further exacerbated due to the COVID-19 pandemic and related economic disruptions or otherwise, the Company may further utilize other resources such as its cash reserves, lines of credit, or decreased investment in redevelopment activities to supplement operating cash flows. The Company is carefully monitoring and managing its cash position in light of ongoing conditions and levels of operations. The timing, source and amounts of cash flows provided by financing activities and used in investing activities are sensitive to changes in interest rates and other fluctuations in the capital markets environment, which can affect the Company's plans for acquisitions, dispositions, development and redevelopment activities. As of December 31, 2021, the Company had $5.4 billionof fixed rate public bonds outstanding at an average interest rate of 3.3% with maturity dates ranging from 2023 to 2050. As of December 31, 2021, the Company's mortgage notes payable totaled $639.0 million, net of unamortized premiums and debt issuance costs, which consisted of $415.4 millionin fixed rate debt at an average interest rate of 3.5% and maturity dates ranging from 2022 to 2028 and $223.6 millionof tax-exempt variable rate demand notes with a weighted average interest rate of 1.1%. The tax-exempt variable rate demand notes have maturity dates ranging from 2027 to 2046. $224.4 millionis subject to total return swaps. As of December 31, 2021, the Company had two unsecured lines of credit aggregating $1.24 billion, including a $1.2 billionunsecured line of credit and a $35.0 millionworking capital unsecured line of credit. As of December 31, 2021, there was $340.0 millionamount outstanding on the $1.2 billionunsecured line of credit. The interest rate is based on a tiered rate structure tied to the Company's credit ratings and was LIBOR plus 0.775% as of December 31, 2021. There was $1.3 millionoutstanding on the Company's $35.0 millionworking capital unsecured line of credit as of December 31, 2021. The interest rate on the amended line is based on a tiered rate structure tied to the Company's credit ratings and is currently at LIBOR plus 0.775%. The Company's unsecured lines of credit and unsecured debt agreements contain debt covenants related to limitations on indebtedness and liabilities and maintenance of minimum levels of consolidated earnings before depreciation, interest and amortization. The Company was in compliance with the debt covenants as of December 31, 2021and 2020. The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Company primarily in investment grade securities held available for sale or is used by the Company to reduce balances outstanding under its lines of credit.
The Company uses interest rate swaps, interest rate caps, and total return swap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps and total return swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. 48 -------------------------------------------------------------------------------- Table of Contents The Company has four total return swap contracts, with an aggregate notional amount of
$224.4 million, that effectively converts $224.4 millionof mortgage notes payable to a floating interest rate based on the Securities Industry and Financial Markets Association Municipal Swap Index ("SIFMA") plus a spread. The total return swaps provide fair market value protection on the mortgage notes payable to our counterparties during the initial period of the total return swap until the Company's option to call the mortgage notes at par can be exercised. The Company can currently call all four of the total return swaps, with $224.4 millionof the outstanding debt at par. These derivatives do not qualify for hedge accounting. As of December 31, 2021and 2020, the aggregate carrying value of the interest rate swap contracts was a liability of zero and $2.4 million, respectively. As of December 31, 2021and 2020, the swap contracts were presented in the consolidated balance sheets as a liability of zero and $2.4 million, respectively, and were included in other liabilities on the consolidated balance sheets. The aggregate carrying and fair value of the total return swaps was zero at both December 31, 2021and 2020. Hedge ineffectiveness related to cash flow hedges, which is reported in current year income as interest expense, net was zero, zero, and a loss of $0.2 million, for the years ended December 31, 2021, 2020, and 2019, respectively.
Issue of common shares
September 2021, the Company entered into the 2021 ATM Program, a new equity distribution agreement pursuant to which the Company may offer and sell shares of its common stock having an aggregate gross sales price of up to $900.0 million. In connection with the 2021 ATM Program, the Company may also enter into related forward sale agreements, and may sell shares of its common stock pursuant to these agreements. The use of a forward sale agreement would allow the Company to lock in a share price on the sale of shares of its common stock at the time the agreement is executed, but defer receipt of the proceeds from the sale of shares until a later date should the Company elect to settle such forward sale agreement, in whole or in part, in shares of common stock. The 2021 ATM Program replaces the prior equity distribution agreement entered into in September 2018(the "2018 ATM Program"), which was terminated upon the establishment of the 2021 ATM Program. For the year ended December 31, 2021, the Company did not sell any shares of its common stock through the 2021 ATM Program or through the 2018 ATM Program. As of December 31, 2021, there were no outstanding forward purchase agreements, and $900.0 millionof shares remain available to be sold under the 2021 ATM Program. For the year ended December 31, 2020, the Company did not issue any shares of its common stock through the 2018 ATM Program. For the year ended December 31, 2019, the Company issued 228,271 shares of common stock through the 2018 ATM Program at an average price of $321.56per share for proceeds of $73.4 million.
Non-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property. For the year ended
December 31, 2021, non-revenue generating capital expenditures totaled approximately $1,914per apartment home. These expenditures do not include expenditures for deferred maintenance on acquisition properties, expenditures for property renovations and improvements which are expected to generate additional revenue or cost savings, and do not include expenditures incurred due to changes in government regulations that the Company would not have incurred otherwise, costs related to the COVID-19 pandemic, retail, furniture and fixtures, or expenditures for which the Company expects to be reimbursed. The Company expects that cash from operations and/or its lines of credit will fund such expenditures.
Development and pre-development pipeline
The Company defines development projects as new communities that are being constructed, or are newly constructed and are in a phase of lease-up and have not yet reached stabilized operations. As of
December 31, 2021, the Company's development pipeline was comprised of one consolidated project under development, one unconsolidated joint venture project under development and various consolidated predevelopment projects, aggregating 371 apartment homes, with total incurred costs of $156.0 million, and estimated remaining project costs of approximately $61.0 million, $32.6 millionof which represents the Company's estimated remaining costs, for total estimated project costs of $217.0 million. The Company defines predevelopment projects as proposed communities in negotiation or in the entitlement process with an expected high likelihood of becoming entitled development projects. The Company may also acquire land for future development purposes or sale. 49 -------------------------------------------------------------------------------- Table of Contents The Company expects to fund the development and predevelopment communities by using a combination of some or all of the following sources: its working capital, amounts available on its lines of credit, construction loans, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of assets, if any.
Other sources of capital
The Company utilizes co-investments as an alternative source of capital for acquisitions of both operating and development communities. As of
December 31, 2021, the Company had an interest in 264 apartment homes in communities actively under development with joint ventures for total estimated costs of $102.0 million. Total estimated remaining costs total approximately $58.0 million, of which the Company estimates that its remaining investment in these development joint ventures will be approximately $29.6 million. In addition, the Company had an interest in 10,257 apartment homes in operating communities with joint ventures and other investments for a total book value of $565.3 million.
Real estate and other commitments
The following table summarizes the Company’s unfunded real estate and other future commitments as of
Remaining Number of Properties Investment Commitment Joint ventures (1): Preferred equity investments 4
$ 128,000 $ 27,867Mezzanine loans 2 140,000 52,734 Non-core co-investments - 37,000 16,020 Consolidated: Real estate under development 1 91,162 3,000 $ 396,162 $ 99,621
(1) Excludes approximately
Variable interest entities
In accordance with accounting standards for consolidation of variable interest entities ("VIEs"), the Company consolidates the
Operating Partnership, 18 DownREIT entities (comprising nine communities) and six co-investments as of December 31, 2021. As of December 31, 2020, the Company consolidated the Operating Partnership, 17 DownREIT entities (comprising nine communities), and five co-investments. The Company consolidates these entities because it is deemed the primary beneficiary. Essexhas no assets or liabilities other than its investment in the Operating Partnership. The consolidated total assets and liabilities related to the above consolidated co-investments and DownREIT entities, net of intercompany eliminations, were approximately $909.3 millionand $320.1 million, respectively, as of December 31, 2021, and $898.5 millionand $326.8 million, respectively, as of December 31, 2020. Noncontrolling interests in these entities were $122.4 millionand $120.8 millionas of December 31, 2021and 2020, respectively. The Company's financial risk in each VIE is limited to its equity investment in the VIE. As of December 31, 2021, the Company did not have any other VIEs of which it was deemed to be the primary beneficiary and did not have any VIEs of which it was not deemed to be the primary beneficiary.
Critical accounting estimates
The preparation of consolidated financial statements, in accordance with
U.S.GAAP, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The Company defines critical accounting estimates as those estimates that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the Company. The Company's critical accounting estimates relate principally to the following key areas: (i) accounting for the acquisition of investments in real estate (specifically, the allocation between land and buildings during the 50
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The Company accounts for its acquisitions of investments in real estate by assessing each acquisition to determine if it meets the definition of a business or if it qualifies as an asset acquisition. We expect that acquisitions of individual operating communities will generally be viewed as asset acquisitions, and result in the capitalization of acquisition costs, and the allocation of purchase price to the assets acquired and liabilities assumed based on the relative fair value of the respective assets and liabilities. In making estimates of fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent land appraisals which consider comparable market transactions, its own analysis of recently acquired or developed comparable properties in our portfolio for land comparables and building replacement costs, and other publicly available market data. In calculating the fair value of identified intangible assets of an acquired property, the in-place leases are valued based on in-place rent rates and amortized over the average remaining term of all acquired leases. The allocation of the total consideration exchanged for a real estate acquisition between the identifiable assets and liabilities and the depreciation we recognize over the estimated useful life of the asset could be impacted by different assumptions and estimates used in the calculation. The reasonable likelihood that the estimate could have a material impact on the financial condition of the Company is based on the total consideration exchanged for real estate during any given year. The allocation of the value between land and building was a critical accounting estimate during the year ended
December 31, 2020as result of the potential material impact of the Company's acquisition of a land parcel and six communities for a total purchase price of $463.4 million. The Company periodically assesses the carrying value of its real estate investments for indicators of impairment. The judgments regarding the existence of impairment indicators are based on monitoring investment market conditions and performance for operating properties including the net operating income for the most recent 12 month period, monitoring estimated costs for properties under development, the Company's ability to hold and its intent with regard to each asset, and each property's remaining useful life. Although each of these may result in an impairment indicator, the shortening of an expected holding period due to the potential sale of a property is the most likely impairment indicator. Whenever events or changes in circumstances indicate that the carrying amount of a property held for investment may not be fully recoverable, the carrying amount is evaluated. If the sum of the property's expected future cash flows (undiscounted and without interest charges) is less than the carrying amount of the property, then the Company will recognize an impairment loss equal to the excess of the carrying amount over the fair value of the property. Changes in operating and market conditions may result in a change of our intent to hold the property through the end of its useful life and may impact the assumptions utilized to determine the future cash flows of the real estate investment.
The Company bases its accounting estimates on historical experience and various other assumptions believed to be reasonable under the circumstances. Actual results may differ from these estimates and these estimates may differ under different assumptions or conditions.
Funds from operations
Funds from Operations ("FFO") is a financial measure that is commonly used in the REIT industry. The Company presents FFO and FFO excluding non-core items (referred to as "Core FFO") as supplemental operating performance measures. FFO and Core FFO are not used by the Company as, nor should they be considered to be, alternatives to net income computed under
U.S.GAAP as an indicator of the Company's operating performance or as alternatives to cash from operating activities computed under U.S.GAAP as an indicator of the Company's ability to fund its cash needs. FFO and Core FFO are not meant to represent a comprehensive system of financial reporting and do not present, nor do they intend to present, a complete picture of the Company's financial condition and operating performance. The Company believes that net income computed under U.S.GAAP is the primary measure of performance and that FFO and Core FFO are only meaningful when they are used in conjunction with net income. The Company considers FFO and Core FFO to be useful financial performance measurements of an equity REIT because, together with net income and cash flows, FFO and Core FFO provide investors with additional bases to evaluate operating performance and ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures and to pay dividends. By excluding gains or losses related to sales of depreciated operating properties and excluding real estate depreciation (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO can help investors compare the operating performance of a real estate company between periods or as compared to different companies. By further adjusting for items that are not considered part of the Company's core business operations, Core FFO allows investors to compare the core 51 -------------------------------------------------------------------------------- Table of Contents operating performance of the Company to its performance in prior reporting periods and to the operating performance of other real estate companies without the effect of items that by their nature are not comparable from period to period and tend to obscure the Company's actual operating results. The Company believes that its consolidated financial statements, prepared in accordance with U.S.GAAP, provide the most meaningful picture of its financial condition and its operating performance.
In calculating FFO, the Company follows the definition of this measure published by NAREIT, which is the leading association for the REIT industry. The Company believes that, under the NAREIT FFO definition, the two most significant adjustments to net income are (i) the exclusion of amortization at historical cost and (ii) the exclusion of gains and losses from sale of previously depreciated properties. The Company agrees that these two NAREIT adjustments are useful to investors for the following reasons:
(a)historical cost accounting for real estate assets in accordance with
U.S.GAAP assumes, through depreciation charges, that the value of real estate assets diminishes predictably over time. NAREIT stated in its White Paper on Funds from Operations "since real estate asset values have historically risen or fallen with market conditions, many industry investors have considered presentations of operating results for real estate companies that use historical cost accounting to be insufficient by themselves." Consequently, NAREIT's definition of FFO reflects the fact that real estate, as an asset class, generally appreciates over time and depreciation charges required by U.S.GAAP do not reflect the underlying economic realities. (b)REITs were created as a legal form of organization in order to encourage public ownership of real estate as an asset class through investment in firms that were in the business of long-term ownership and management of real estate. The exclusion, in NAREIT's definition of FFO, of gains and losses from the sales of previously depreciated operating real estate assets allows investors and analysts to readily identify the operating results of the long-term assets that form the core of a REIT's activity and assists in comparing those operating results between periods. Management believes that it has consistently applied the NAREIT definition of FFO to all periods presented. However, there is judgment involved and other REITs' calculation of FFO may vary from the NAREIT definition for this measure, and thus their disclosure of FFO may not be comparable to the Company's calculation.
The table below is a reconciliation of net income available to common shareholders to FFO and base FFO for the years ended
from and for the years ended
2021 2020 2019 ($ in thousands, except per share amounts) OTHER DATA: Funds from operations attributable to common stockholders and unitholders: Net income available to common stockholders
$ 488,554 $ 568,870 $ 439,286Adjustments: Depreciation and amortization 520,066 525,497 483,750 Gains not included in FFO attributable to common stockholders and unitholders (145,253) (301,886) (79,468) Impairment loss - 1,825 7,105 Impairment loss from unconsolidated co-investments - - 11,484 Depreciation and amortization from unconsolidated co-investments 61,059 51,594 60,655
Minority interests related to
17,191 19,912 15,343
Depreciation attributable to third-party ownership and other
(571) (539) (1,805) Funds from operations attributable to common stockholders and unitholders
$ 941,046 $ 865,273 $ 936,350Non-core items: Expensed acquisition and investment related costs 203 1,591 168 Deferred tax expense on unrealized gain on unconsolidated co-investment (1) 15,668 1,531 1,457 Gain on sale of marketable securities (3,400) (2,131) (1,271) Unrealized gains on marketable securities (33,104) (12,515) (5,710) Provision for credit losses 141 687 - Equity income from non-core co-investment (2) (55,602) (5,289) (4,143) Interest rate hedge ineffectiveness - - 181 Loss (gain) on early retirement of debt, net 19,010 22,883 (3,717) Loss (gain) on early retirement of debt from unconsolidated co-investment 25 (38) - Co-investment promote income - (6,455) (809) Income from early redemption of preferred equity investments (8,469) (210) (3,562)
Accelerated interest income from the maturity of the investment in mortgage-backed securities
- (11,753) (7,032) General and administrative and other, net 1,026 14,958 1,181
Insurance reimbursements, legal and other settlements, net
(35,234) (81) (858) Core funds from operations attributable to common stockholders and unitholders $
Weighted average number of shares outstanding, diluted (FFO) (3)
67,335 67,726 68,199 Funds from operations attributable to common stockholders and unitholders per share - diluted $ 13.98
$ 12.78 $ 13.73Core funds from operations attributable to common stockholders and unitholders per share - diluted $
(1)Represents deferred tax expense related to net unrealized gains on technology co-investments. (2)Represents the Company's share of co-investment income from technology co-investments. (3)Assumes conversion of all outstanding OP Units into shares of the Company's common stock and excludes DownREIT units. 53 -------------------------------------------------------------------------------- Table of Contents Net Operating Income Net operating income ("NOI") and Same-Property NOI are considered by management to be important supplemental performance measures to earnings from operations included in the Company's consolidated statements of income. The presentation of Same-Property NOI assists with the presentation of the Company's operations prior to the allocation of depreciation and any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual communities or groups of communities. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. The Company defines Same-Property NOI as Same-Property revenues less Same-Property operating expenses, including property taxes. Please see the reconciliation of earnings from operations to NOI and Same-Property NOI, which in the table below is the NOI for stabilized properties consolidated by the Company for the periods presented ($ in thousands): 2021 2020 2019 Earnings from operations
$ 529,995 $ 491,441 $ 481,112Adjustments: Corporate-level property management expenses 36,188 34,573 34,067 Depreciation and amortization 520,066 525,497 483,750 Management and other fees from affiliates (9,138) (9,598) (9,527) General and administrative 51,838 65,388 54,262 Merger and integration expenses - - -
Acquisition and investment costs expensed 203 1,591
168 Impairment loss - 1,825 7,105 (Gain) Loss on sale of real estate and land (142,993) (64,967) 3,164 NOI 986,159 1,045,750 1,054,101 Less: Non Same-Property NOI (94,755) (129,158) (77,204) Same-Property NOI
$ 891,404 $ 916,592 $ 976,897Forward-Looking Statements Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this Annual Report on Form 10-K which are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the Securities Act") and Section 21E of the Exchange Act, including statements regarding the Company's expectations, estimates, assumptions, hopes, intentions, beliefs and strategies regarding the future. Words such as "expects," "assumes," "anticipates," "may," "will," "intends," "plans," "projects," "believes," "seeks," "future," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such forward-looking statements include, among other things, statements regarding the Company's expectations related to the continued impact of the COVID-19 pandemic and related variants on the Company's business, financial condition and results of operations and the impact of any additional measures taken to mitigate the impact of the pandemic, the Company's intent, beliefs or expectations with respect to the timing of completion of current development and redevelopment projects and the stabilization of such projects, the timing of lease-up and occupancy of its apartment communities, the anticipated operating performance of its apartment communities, the total projected costs of development and redevelopment projects, co-investment activities, qualification as a REIT under the Internal Revenue Code of 1986, as amended, 2022 Same-Property revenue and operating expenses generally and in specific regions, the real estate markets in the geographies in which the Company's properties are located and in the United Statesin general, the adequacy of future cash flows to meet anticipated cash needs, its financing activities and the use of proceeds from such activities, the availability of debt and equity financing, general economic conditions including the potential impacts from such economic conditions, including as a result of the COVID-19 pandemic and governmental measures intended to prevent its spread, trends affecting the Company's financial condition or results of operations, changes to U.S.tax laws and regulations in general or specifically related to REITs or real estate, changes to laws and regulations in jurisdictions in which communities the Company owns are located, and other information that is not historical information. While the Company's management believes the assumptions underlying its forward-looking statements are reasonable, such forward-looking statements involve known and unknown risks, uncertainties and other factors, many of which are beyond the Company's control, which could cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. The 54
Table of Contents Company cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect the Company's current expectations of the approximate outcomes of the matters discussed. Factors that might cause the Company's actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to, the following: the continued impact of the COVID-19 pandemic and related variants, which remains inherently uncertain as to duration and severity, and any additional governmental measures taken to limit its spread, and other potential future outbreaks of infectious diseases or other health concerns, which could continue to adversely affect the Company's business and its tenants, and cause a significant downturn in general economic conditions, the real estate industry, and the markets in which the Company's communities are located; uncertainty regarding ongoing hostility between
Russiaand the Ukraineand the related impact on macroeconomic conditions as a result of such conflict; the Company may fail to achieve its business objectives; the actual completion of development and redevelopment projects may be subject to delays; the stabilization dates of such projects may be delayed; the Company may abandon or defer development or redevelopment projects for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development, increases in the cost of capital or lack of capital availability, resulting in losses; the total projected costs of current development and redevelopment projects may exceed expectations; such development and redevelopment projects may not be completed; development and redevelopment projects and acquisitions may fail to meet expectations; estimates of future income from an acquired property may prove to be inaccurate; occupancy rates and rental demand may be adversely affected by competition and local economic and market conditions; there may be increased interest rates and operating costs; the Company may be unsuccessful in the management of its relationships with its co-investment partners; future cash flows may be inadequate to meet operating requirements and/or may be insufficient to provide for dividend payments in accordance with REIT requirements; changes in laws or regulations; the terms of any refinancing may not be as favorable as the terms of existing indebtedness; unexpected difficulties in leasing of development projects; volatility in financial and securities markets; the Company's failure to successfully operate acquired properties; unforeseen consequences from cyber-intrusion; the Company's inability to maintain our investment grade credit rating with the rating agencies; government approvals, actions and initiatives, including the need for compliance with environmental requirements; and those further risks, special considerations, and other factors discussed in Item 1A, Risk Factors, of this Form 10-K, and those risk factors and special considerations set forth in the Company's other filings with the SECwhich may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Additionally, the risks, uncertainties and other factors set forth above or otherwise referred to in this Annual Report on Form 10-K and the other reports that the Company has filed with the SECmay be further amplified by the global impact of the COVID-19 pandemic and related variants. All forward-looking statements are made as of the date hereof, the Company assumes no obligation to update or supplement this information for any reason, and therefore, they may not represent the Company's estimates and assumptions after the date of this report.
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