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Bay Area apartments show surprise weakness as new landlords chop rents, Essex execs say

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Bay Area apartments show surprise weakness as new landlords chop rents, Essex execs say

The NorthernCalifornia apartment market was weaker than expected in the first quarter, in partbecause owners of newly developed properties have been offering rent discounts toattract tenants, Essex Property TrustInc. executives said in an April 29 earnings conference call.

The BayArea, long a boon to Essex's business, has caused headaches lately. Besides concernover new supply and the health of the technology sector, several localities areconsidering new regulations to restrict rents. Essex executives said the rent regulationswill have minimal impact and tech employment appears strong, even as some hiringmay be shifting north to the Seattle area, possibly as a result of San Francisco'stight housing market. Still, they added, competition from new buildings is a concern.

The companylowered its economic rent growth forecast to 6.5% from 7.5%, President and CEO MikeSchall said in the call, citing new supply in San Francisco, on the peninsula southof the city and in San Jose. In those markets, new landlords have been offeringconcessions equal to six to eight weeks of rent in a bid to draw tenants — an increasefrom the one-month concessions that previously were typical.

"Ifyou look at the overall numbers, going from jobs and job growth to household formationto supply, it would not indicate that we should have weakness in the apartment area,"Schall said, adding that market tightness would not seem to point to greater landlordconcessions.

"Butyet here we are," he added. "And so we're trying to make sense out ofwhy that is occurring. We don't have anything at this point."

Schallnoted that every extra month of free rent is a roughly 8% reduction in an apartment'sannual price. Owners of new buildings have incentive to accept such cuts, however.

"Obviously,if you deliver a new building, you have zero dollars coming in on your vacant units,"he said. "And so you're highly motivated to rent them. And many of those ownersare saying, 'Hey, rather than leaving it vacant, I'll try to hit really high absorptionnumbers and increase my cash flow.'"

On thetenant side, "People are looking for opportunity," Schall said.

"Peopleare smart," he added. "They figure the opportunities in the marketplace,and they go after them. Many of the renters just don't have that much furniture,and so moving is not that big a deal. And so if you give them another 8% off theirrent in the form of a concession, they are all over it. And so it's a very fluidmarketplace."

Schallpredicted that the effect of concessions will fade later in 2016 as new constructionpulls back. Still, company executives said there are other factors at play in theBay Area. More Bay Area tenants are choosing to share apartments, they said, orto rent single-family homes, which enable a greater number of roommates to sharethe rent.

Askedwhether the company's Southern California portfolio could outperform its NorthernCalifornia properties sometime in 2016, John Burkart, senior executive vice presidentof asset management, replied, "It's hard to tell."

NorthernCalifornia should be a strength for landlords based on seasonal patterns and supply-demanddynamics, Burkart said.

"Buthonestly," he added, "it's not necessarily working out that way."