Toggle SGML Header (+)


Section 1: 10-Q (10-Q)

Document
                                

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
ý QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2018

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 001-13106 (Essex Property Trust, Inc.)
Commission file number 333-44467-01 (Essex Portfolio, L.P.)

ESSEX PROPERTY TRUST, INC.
ESSEX PORTFOLIO, L.P.
(Exact name of Registrant as Specified in its Charter)
Maryland (Essex Property Trust, Inc.)
California (Essex Portfolio, L.P.)
 
77-0369576 (Essex Property Trust, Inc.)
77-0369575 (Essex Portfolio, L.P.)
 
 
 
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)
1100 Park Place, Suite 200
San Mateo, California 94403
(Address of Principal Executive Offices, Including Zip Code)

(650) 655-7800
(Registrant's Telephone Number, Including Area Code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days.
Essex Property Trust, Inc.    Yes x   No o
Essex Portfolio, L.P.     Yes x   No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Essex Property Trust, Inc.    Yes x   No o
Essex Portfolio, L.P.     Yes x   No o


i


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

Essex Property Trust, Inc.:
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o   (Do not check if a smaller reporting company)
Smaller reporting company o
 
 
 
Emerging growth company o


Essex Portfolio, L.P.:
Large accelerated filer o
Accelerated filer o
Non-accelerated filer x   (Do not check if a smaller reporting company)
Smaller reporting company o
 
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Essex Property Trust, Inc.    o  
Essex Portfolio, L.P.     o  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Essex Property Trust, Inc.    Yes o   No x
Essex Portfolio, L.P.     Yes o   No x
 
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 66,050,101 shares of Common Stock ($0.0001 par value) of Essex Property Trust, Inc. were outstanding as of July 31, 2018.
 

ii


EXPLANATORY NOTE

This report combines the reports on Form 10-Q for the three and six month periods ended June 30, 2018 of Essex Property Trust, Inc., a Maryland corporation, and Essex Portfolio, L.P., a Delaware limited partnership of which Essex Property Trust, Inc. is the sole general partner.

Unless stated otherwise or the context otherwise requires, references to the “Company,” “we,” “us” or “our” mean collectively Essex Property Trust, Inc. and those entities/subsidiaries owned or controlled by Essex Property Trust, Inc., including Essex Portfolio, L.P., and references to the “Operating Partnership” mean Essex Portfolio, L.P. and those entities/subsidiaries owned or controlled by Essex Portfolio, L.P. Unless stated otherwise or the context otherwise requires, references to “Essex” mean Essex Property Trust, Inc., not including any of its subsidiaries.

Essex operates as a self-administered and self-managed real estate investment trust (“REIT”), and is the sole general partner of the Operating Partnership. As the sole general partner of the Operating Partnership, Essex has exclusive control of the Operating Partnership's day-to-day management.

The Company is structured as an umbrella partnership REIT (“UPREIT”) and Essex contributes all net proceeds from its various equity offerings to the Operating Partnership. In return for those contributions, Essex receives a number of Operating Partnership limited partnership units (“OP Units,” and the holders of such OP Units, “Unitholders”) equal to the number of shares of common stock it has issued in the equity offering. Contributions of properties to the Company can be structured as tax-deferred transactions through the issuance of OP Units, which is one of the reasons why the Company is structured in the manner outlined above. Based on the terms of the Operating Partnership's partnership agreement, OP Units can be exchanged into Essex common stock on a one-for-one basis. The Company maintains a one-for-one relationship between the OP Units issued to Essex and shares of common stock.

The Company believes that combining the reports on Form 10-Q of Essex and the Operating Partnership into this single report provides the following benefits:

enhances investors' understanding of Essex and the Operating Partnership by enabling investors to view the business as a whole in the same manner as management views and operates the business;
eliminates duplicative disclosure and provides a more streamlined and readable presentation since a substantial portion of the disclosure applies to both Essex and the Operating Partnership; and
creates time and cost efficiencies through the preparation of one combined report instead of two separate reports.

Management operates Essex and the Operating Partnership as one business. The management of Essex consists of the same members as the management of the Operating Partnership.

All of the Company's property ownership, development, and related business operations are conducted through the Operating Partnership and Essex has no material assets, other than its investment in the Operating Partnership. Essex's primary function is acting as the general partner of the Operating Partnership. As general partner with control of the Operating Partnership, Essex consolidates the Operating Partnership for financial reporting purposes. Therefore, the assets and liabilities of Essex and the Operating Partnership are the same on their respective financial statements. Essex also issues equity from time to time and guarantees certain debt of the Operating Partnership, as disclosed in this report. The Operating Partnership holds substantially all of the assets of the Company, including the Company's ownership interests in its joint ventures. The Operating Partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity. Except for the net proceeds from equity offerings by the Company, which are contributed to the capital of the Operating Partnership in exchange for OP Units (on a one-for-one share of common stock per OP Unit basis), the Operating Partnership generates all remaining capital required by the Company's business. These sources of capital include the Operating Partnership's working capital, net cash provided by operating activities, borrowings under its revolving credit facilities, the issuance of secured and unsecured debt and equity securities and proceeds received from disposition of certain properties and joint ventures.

The Company believes it is important to understand the few differences between Essex and the Operating Partnership in the context of how Essex and the Operating Partnership operate as a consolidated company. Stockholders' equity, partners' capital and noncontrolling interest are the main areas of difference between the condensed consolidated financial statements of Essex and those of the Operating Partnership. The limited partners of the Operating Partnership are accounted for as partners' capital in the Operating Partnership's condensed consolidated financial statements and as noncontrolling interest in Essex’s condensed consolidated financial statements. The noncontrolling interest in the Operating Partnership's consolidated financial statements include the interest of unaffiliated partners in various condensed consolidated partnerships and joint venture partners. The noncontrolling interest in Essex's consolidated financial statements include (i) the same noncontrolling interest as presented in

iii


the Operating Partnership’s consolidated financial statements and (ii) OP Unit holders. The differences between stockholders' equity and partners' capital result from differences in the equity issued at Essex and Operating Partnership levels.
 
To help investors understand the significant differences between Essex and the Operating Partnership, this report on Form 10-Q provides separate consolidated financial statements for Essex and the Operating Partnership; a single set of consolidated notes to such financial statements that includes separate discussions of stockholders' equity or partners' capital, and earnings per share/unit, as applicable; and a combined Management's Discussion and Analysis of Financial Condition and Results of Operations.

This report on Form 10-Q also includes separate Part I, Item 4. Controls and Procedures sections and separate Exhibits 31 and 32 certifications for each of Essex and the Operating Partnership in order to establish that the requisite certifications have been made and that Essex and the Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934 (the “Exchange Act”) and 18 U.S.C. §1350.

In order to highlight the differences between Essex and the Operating Partnership, the separate sections in this report on Form 10-Q for Essex and the Operating Partnership specifically refer to Essex and the Operating Partnership. In the sections that combine disclosure of Essex and the Operating Partnership, this report refers to actions or holdings as being actions or holdings of the Company. Although the Operating Partnership is generally the entity that directly or indirectly enters into contracts and joint ventures and holds assets and debt, reference to the Company is appropriate because the Company is one business and the Company operates that business through the Operating Partnership. The separate discussions of Essex and the Operating Partnership in this report should be read in conjunction with each other to understand the results of the Company on a consolidated basis and how management operates the Company.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of income and comprehensive income, equity, capital, and cash flows of the Company and the Operating Partnership reflect all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein. Additionally, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2017.

iv


ESSEX PROPERTY TRUST, INC.
ESSEX PORTFOLIO, L.P.
FORM 10-Q
INDEX

PART I. FINANCIAL INFORMATION
Page No.
 
 
 
Item 1.
Condensed Consolidated Financial Statements of Essex Property Trust, Inc. (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Condensed Consolidated Financial Statements of Essex Portfolio, L.P. (Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 

1


Part I – Financial Information

Item 1. Condensed Consolidated Financial Statements

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except parenthetical and share amounts)
ASSETS
June 30, 2018
 
December 31, 2017
Real estate:
 
 
 
Rental properties:
 
 
 
Land and land improvements
$
2,710,139

 
$
2,719,064

Buildings and improvements
10,693,682

 
10,639,108

 
13,403,821

 
13,358,172

Less: accumulated depreciation
(2,992,819
)
 
(2,769,297
)
 
10,411,002

 
10,588,875

Real estate under development
343,841

 
355,735

Co-investments
1,291,320

 
1,155,984

 
12,046,163

 
12,100,594

Cash and cash equivalents-unrestricted
160,902

 
44,620

Cash and cash equivalents-restricted
16,674

 
16,506

Marketable securities
207,191

 
190,004

Notes and other receivables (includes related party receivables of $10.8 million and $41.2 million as of June 30, 2018 and December 31, 2017, respectively)
68,386

 
100,926

Prepaid expenses and other assets
56,338

 
43,056

Total assets
$
12,555,654

 
$
12,495,706

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Unsecured debt, net
$
3,798,097

 
$
3,501,709

Mortgage notes payable, net
1,890,326

 
2,008,417

Lines of credit
2,670

 
179,000

Accounts payable and accrued liabilities
132,796

 
127,501

Construction payable
58,321

 
51,770

Dividends payable
129,007

 
121,420

Distributions in excess of investments in co-investments

 
36,726

Other liabilities
33,497

 
33,132

Total liabilities
6,044,714

 
6,059,675

Commitments and contingencies


 


Redeemable noncontrolling interest
36,257

 
39,206

Equity:
 

 
 

Common stock; $0.0001 par value, 670,000,000 shares authorized; 66,049,618 and 66,054,399 shares issued and outstanding, respectively
7

 
7

Additional paid-in capital
7,131,809

 
7,129,571

Distributions in excess of accumulated earnings
(766,193
)
 
(833,726
)
Accumulated other comprehensive loss, net
(11,438
)
 
(18,446
)
Total stockholders' equity
6,354,185

 
6,277,406

Noncontrolling interest
120,498

 
119,419

Total equity
6,474,683

 
6,396,825

Total liabilities and equity
$
12,555,654

 
$
12,495,706


See accompanying notes to the unaudited condensed consolidated financial statements.

2



ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Income and Comprehensive Income
(Unaudited)
(In thousands, except share and per share amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Rental and other property
$
346,526

 
$
336,766

 
$
691,473

 
$
669,934

Management and other fees from affiliates
2,197

 
2,296

 
4,505

 
4,532

 
348,723

 
339,062

 
695,978

 
674,466

Expenses:
 

 
 

 
 
 
 
Property operating, excluding real estate taxes
58,156

 
55,859

 
115,406

 
111,995

Real estate taxes
35,990

 
34,884

 
73,703

 
70,752

Corporate-level property management expenses
7,782

 
7,522

 
15,552

 
15,031

Depreciation and amortization
119,330

 
117,939

 
238,435

 
233,442

General and administrative
11,125

 
10,337

 
25,938

 
20,938

Expensed acquisition and investment related costs
68

 
274

 
125

 
830

 
232,451

 
226,815

 
469,159

 
452,988

Earnings from operations
116,272

 
112,247

 
226,819

 
221,478

Interest expense
(56,278
)
 
(56,812
)
 
(111,139
)
 
(111,395
)
Total return swap income
2,228

 
2,531

 
4,498

 
5,115

Interest and other income
6,895

 
5,362

 
12,804

 
12,126

Equity income from co-investments
15,049

 
10,308

 
47,823

 
21,207

Gain on sale of real estate and land
22,244

 

 
22,244

 
26,174

Gain on remeasurement of co-investment

 
2,159

 

 
88,641

Net income
106,410

 
75,795

 
203,049

 
263,346

Net income attributable to noncontrolling interest
(5,970
)
 
(5,036
)
 
(11,691
)
 
(13,623
)
Net income available to common stockholders
$
100,440

 
$
70,759

 
$
191,358

 
$
249,723

Comprehensive income
$
109,793

 
$
77,468

 
$
212,608

 
$
267,232

Comprehensive income attributable to noncontrolling interest
(6,082
)
 
(5,091
)
 
(12,008
)
 
(13,752
)
Comprehensive income attributable to controlling interest
$
103,711

 
$
72,377

 
$
200,600

 
$
253,480

Per share data:
 

 
 

 
 
 
 
Basic:
 

 
 

 
 
 
 
Net income available to common stockholders
$
1.52

 
$
1.08

 
$
2.90

 
$
3.80

Weighted average number of shares outstanding during the period
66,047,751

 
65,729,074

 
66,045,897

 
65,639,775

Diluted:
 

 
 

 
 
 
 
Net income available to common stockholders
$
1.52

 
$
1.08

 
$
2.90

 
$
3.80

Weighted average number of shares outstanding during the period
66,096,349

 
65,819,694

 
66,088,803

 
65,942,018

Dividend per common share
$
1.86

 
$
1.75

 
$
3.72

 
$
3.50


See accompanying notes to the unaudited condensed consolidated financial statements.

3


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Equity for the six months ended June 30, 2018
(Unaudited)
(In thousands)
 
 
Common stock
 
Additional paid-in capital
 
Distributions
in excess of accumulated earnings
 
Accumulated
other
comprehensive loss, net
 
Noncontrolling Interest
 
 
 
 
Shares
 
Amount
 
 
 
 
 
Total
Balances at December 31, 2017
 
66,054

 
$
7

 
$
7,129,571

 
$
(833,726
)
 
$
(18,446
)
 
$
119,419

 
$
6,396,825

Net income
 

 

 

 
191,358

 

 
11,691

 
203,049

Reversal of unrealized losses upon the sale of marketable debt securities
 

 

 

 

 
2

 

 
2

Change in fair value of derivatives and amortization of swap settlements
 

 

 

 

 
9,335

 
321

 
9,656

Change in fair value of marketable debt securities, net
 

 

 

 

 
(95
)
 
(4
)
 
(99
)
Issuance of common stock under:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

Stock option and restricted stock plans, net
 
12

 

 
1,864

 

 

 

 
1,864

Sale of common stock, net
 

 

 
(353
)
 

 

 

 
(353
)
Equity based compensation costs
 

 

 
6,201

 

 

 
613

 
6,814

Retirement of common stock, net
 
(17
)
 

 
(3,774
)
 

 

 

 
(3,774
)
Cumulative effect upon adoption of ASU 2016-01
 

 

 

 
2,234

 
(2,234
)
 

 

Cumulative effect upon adoption of ASU 2017-05
 

 

 

 
119,651

 

 
4,057

 
123,708

Changes in the redemption value of redeemable noncontrolling interest
 

 

 
(1,646
)
 

 

 
(199
)
 
(1,845
)
Distributions to noncontrolling interest
 

 

 

 

 

 
(15,397
)
 
(15,397
)
Redemptions of noncontrolling interest
 
1

 

 
(54
)
 

 

 
(3
)
 
(57
)
Common stock dividends
 

 

 

 
(245,710
)
 

 

 
(245,710
)
Balances at June 30, 2018
 
66,050

 
$
7

 
$
7,131,809

 
$
(766,193
)
 
$
(11,438
)
 
$
120,498

 
$
6,474,683


See accompanying notes to the unaudited condensed consolidated financial statements.

4


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands) 
 
Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
203,049

 
$
263,346

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
238,435

 
233,442

Amortization of discount on marketable securities
(8,469
)
 
(7,270
)
Amortization of (premium) discount and debt financing costs, net
(1,352
)
 
(4,317
)
Gain on sale of marketable securities and other investments
(549
)
 
(1,618
)
Unrealized loss on equity securities recognized through income
754

 

Earnings from co-investments
(47,823
)
 
(21,207
)
Operating distributions from co-investments
61,107

 
27,451

Accrued interest from notes and other receivables
(2,633
)
 
(1,575
)
Gain on the sale of real estate and land
(22,244
)
 
(26,174
)
Equity-based compensation
5,906

 
3,361

Gain on remeasurement of co-investment

 
(88,641
)
Changes in operating assets and liabilities:
 
 
 
   Prepaid expenses, receivables and other assets
(6,078
)
 
(1,751
)
Accounts payable and accrued liabilities
2,839

 
(3,169
)
Other liabilities
579

 
646

Net cash provided by operating activities
423,521

 
372,524

Cash flows from investing activities:
 

 
 

Additions to real estate:
 

 
 

Acquisitions of real estate and acquisition related capital expenditures
(5,476
)
 
(193,527
)
Redevelopment
(36,466
)
 
(30,509
)
Development acquisitions of and additions to real estate under development
(75,303
)
 
(51,563
)
Capital expenditures on rental properties
(30,975
)
 
(25,648
)
Investments in notes receivable

 
(12,750
)
Collections of notes receivable
29,500

 

Proceeds from insurance for property losses
917

 
435

Proceeds from dispositions of real estate
130,730

 
131,230

Contributions to co-investments
(97,826
)
 
(144,599
)
Changes in refundable deposits
(3,785
)
 
467

Purchases of marketable securities
(27,995
)
 
(33,615
)
Sales and maturities of marketable securities
18,975

 
28,766

Non-operating distributions from co-investments
38,696

 
67,674

Net cash used in investing activities
(59,008
)
 
(263,639
)
Cash flows from financing activities:
 

 
 

Proceeds from unsecured debt and mortgage notes
298,773

 
597,981

Payments on unsecured debt and mortgage notes
(110,829
)
 
(412,653
)
Proceeds from lines of credit
438,528

 
467,313

Repayments of lines of credit
(614,858
)
 
(592,313
)
Retirement of common stock
(3,774
)
 

Additions to deferred charges
(3,771
)
 
(3,890
)
Net proceeds from issuance of common stock
(353
)
 
80,565

Net proceeds from stock options exercised
1,864

 
22,041

Payments related to tax withholding for share-based compensation
(23
)
 
(118
)
Distributions to noncontrolling interest
(15,066
)
 
(14,371
)
Redemption of noncontrolling interest
(57
)
 
(3,528
)

5


 
Six Months Ended June 30,
 
2018
 
2017
Redemption of redeemable noncontrolling interest
(43
)
 
(720
)
Common and preferred stock dividends paid
(238,454
)
 
(219,618
)
Net cash used in financing activities
(248,063
)
 
(79,311
)
Net increase (decrease) in unrestricted and restricted cash and cash equivalents
116,450

 
29,574

Unrestricted and restricted cash and cash equivalents at beginning of period
61,126

 
170,302

Unrestricted and restricted cash and cash equivalents at end of period
$
177,576

 
$
199,876

 
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest, net of $8.4 million and $6.6 million capitalized in 2018 and 2017, respectively
$
100,496

 
$
106,448

Supplemental disclosure of noncash investing and financing activities:
 

 
 

Issuance of DownREIT units in connection with acquisition of real estate
$

 
$
22,506

Transfers between real estate under development to rental properties, net
$
98,318

 
$
1,540

Transfer from real estate under development to co-investments
$
640

 
$
3,340

Reclassifications to redeemable noncontrolling interest from additional paid in capital and noncontrolling interest
$
1,845

 
$
1,117

Redemption of redeemable noncontrolling interest via reduction of note receivable
$
4,751

 
$

Debt assumed in connection with acquisition
$

 
$
51,882


See accompanying notes to the unaudited condensed consolidated financial statements.


6


ESSEX PORTFOLIO, L.P.  AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(In thousands, except parenthetical and unit amounts)
 
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Real estate:
 
 
 
Rental properties:
 
 
 
Land and land improvements
$
2,710,139

 
$
2,719,064

Buildings and improvements
10,693,682

 
10,639,108

 
13,403,821

 
13,358,172

Less: accumulated depreciation
(2,992,819
)
 
(2,769,297
)
 
10,411,002

 
10,588,875

Real estate under development
343,841

 
355,735

Co-investments
1,291,320

 
1,155,984

 
12,046,163

 
12,100,594

Cash and cash equivalents-unrestricted
160,902

 
44,620

Cash and cash equivalents-restricted
16,674

 
16,506

Marketable securities
207,191

 
190,004

Notes and other receivables (includes related party receivables of $10.8 million and $41.2 million as of June 30, 2018 and December 31, 2017, respectively)
68,386

 
100,926

Prepaid expenses and other assets
56,338

 
43,056

Total assets
$
12,555,654


$
12,495,706

 
 
 
 
LIABILITIES AND CAPITAL
 

 
 

Unsecured debt, net
$
3,798,097

 
$
3,501,709

Mortgage notes payable, net
1,890,326

 
2,008,417

Lines of credit
2,670

 
179,000

Accounts payable and accrued liabilities
132,796

 
127,501

Construction payable
58,321

 
51,770

Distributions payable
129,007

 
121,420

Distributions in excess of investments in co-investments

 
36,726

Other liabilities
33,497

 
33,132

Total liabilities
6,044,714


6,059,675

Commitments and contingencies


 


Redeemable noncontrolling interest
36,257

 
39,206

Capital:
 

 
 

General Partner:
 
 
 
Common equity (66,049,618 and 66,054,399 units issued and outstanding, respectively)
6,365,623

 
6,295,852

 
6,365,623


6,295,852

Limited Partners:
 
 
 
Common equity (2,272,983 and 2,268,114 units issued and outstanding, respectively)
52,339

 
49,792

    Accumulated other comprehensive loss
(7,898
)
 
(15,229
)
Total partners' capital
6,410,064


6,330,415

Noncontrolling interest
64,619

 
66,410

Total capital
6,474,683


6,396,825

Total liabilities and capital
$
12,555,654


$
12,495,706


See accompanying notes to the unaudited condensed consolidated financial statements.

7


ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Income and Comprehensive Income
(Unaudited)
(In thousands, except unit and per unit amounts)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Rental and other property
$
346,526

 
$
336,766

 
$
691,473

 
$
669,934

Management and other fees from affiliates
2,197

 
2,296

 
4,505

 
4,532

 
348,723

 
339,062

 
695,978

 
674,466

Expenses:
 

 
 

 
 
 
 
Property operating, excluding real estate taxes
58,156

 
55,859

 
115,406

 
111,995

Real estate taxes
35,990

 
34,884

 
73,703

 
70,752

Corporate-level property management expenses
7,782

 
7,522

 
15,552

 
15,031

Depreciation and amortization
119,330

 
117,939

 
238,435

 
233,442

General and administrative
11,125

 
10,337

 
25,938

 
20,938

Expensed acquisition and investment related costs
68

 
274

 
125

 
830

 
232,451

 
226,815

 
469,159

 
452,988

Earnings from operations
116,272

 
112,247

 
226,819

 
221,478

Interest expense
(56,278
)
 
(56,812
)
 
(111,139
)
 
(111,395
)
Total return swap income
2,228

 
2,531

 
4,498

 
5,115

Interest and other income
6,895

 
5,362

 
12,804

 
12,126

Equity income from co-investments
15,049

 
10,308

 
47,823

 
21,207

Gain on sale of real estate and land
22,244

 

 
22,244

 
26,174

Gain on remeasurement of co-investment

 
2,159

 

 
88,641

Net income
106,410

 
75,795

 
203,049

 
263,346

Net income attributable to noncontrolling interest
(2,510
)
 
(2,614
)
 
(5,099
)
 
(5,055
)
Net income available to common unitholders
$
103,900

 
$
73,181

 
$
197,950

 
$
258,291

Comprehensive income
$
109,793

 
$
77,468

 
$
212,608

 
$
267,232

Comprehensive income attributable to noncontrolling interest
(2,510
)
 
(2,614
)
 
(5,099
)
 
(5,055
)
Comprehensive income attributable to controlling interest
$
107,283

 
$
74,854

 
$
207,509

 
$
262,177

Per unit data:
 

 
 

 
 
 
 
Basic:
 

 
 

 
 
 
 
Net income available to common unitholders
$
1.52

 
$
1.08

 
$
2.90

 
$
3.80

Weighted average number of common units outstanding during the period
68,320,849

 
67,980,761

 
68,319,151

 
67,891,734

Diluted:
 
 
 
 
 
 
 
Net income available to common unitholders
$
1.52

 
$
1.08

 
$
2.90

 
$
3.80

Weighted average number of common units outstanding during the period
68,369,447

 
68,071,381

 
68,362,057

 
68,193,977

Distribution per common unit
$
1.86

 
$
1.75

 
$
3.72

 
$
3.50


See accompanying notes to the unaudited condensed consolidated financial statements.

8


ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statement of Capital for the six months ended June 30, 2018
(Unaudited)
(In thousands)
 
General Partner
 
Limited Partners
 
Accumulated other comprehensive loss
 
 
 
 
 
Common Equity
 
Common Equity
 
 
Noncontrolling Interest
 
 
 
Units
 
Amount
 
Units
 
Amount
 
 
 
Total
Balances at December 31, 2017
66,054

 
$
6,295,852

 
2,268

 
$
49,792

 
$
(15,229
)
 
$
66,410

 
$
6,396,825

Net income

 
191,358

 

 
6,592

 

 
5,099

 
203,049

Reversal of unrealized losses upon the sale of marketable debt securities

 

 

 

 
2

 

 
2

Change in fair value of derivatives and amortization of swap settlements

 

 

 

 
9,656

 

 
9,656

Change in fair value of marketable debt securities, net

 

 

 

 
(99
)
 

 
(99
)
Issuance of common units under:
 

 
 

 
 

 
 

 
 

 
 

 
 

General partner's stock based compensation, net
12

 
1,864

 

 

 

 

 
1,864

Sale of common stock by general partner, net

 
(353
)
 

 

 

 

 
(353
)
Equity based compensation costs

 
6,201

 
5

 
613

 

 

 
6,814

Retirement of common units, net
(17
)
 
(3,774
)
 

 

 

 

 
(3,774
)
Cumulative effect upon adoption of ASU 2016-01

 
2,234

 

 
(6
)
 
(2,228
)
 

 

Cumulative effect upon adoption of ASU 2017-05

 
119,651

 

 
4,057

 

 

 
123,708

Changes in redemption value of redeemable noncontrolling interest

 
(1,646
)
 

 
(199
)
 

 

 
(1,845
)
Distributions to noncontrolling interest

 

 

 

 

 
(6,890
)
 
(6,890
)
Redemptions
1

 
(54
)
 

 
(3
)
 

 

 
(57
)
Distributions declared

 
(245,710
)
 

 
(8,507
)
 

 

 
(254,217
)
Balances at June 30, 2018
66,050

 
$
6,365,623

 
2,273

 
$
52,339

 
$
(7,898
)
 
$
64,619

 
$
6,474,683


See accompanying notes to the unaudited condensed consolidated financial statements.

9


ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)
 
Six Months Ended June 30,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
203,049

 
$
263,346

Adjustments to reconcile net income to net cash provided by operating activities:
 

 
 

Depreciation and amortization
238,435

 
233,442

Amortization of discount on marketable securities
(8,469
)
 
(7,270
)
Amortization of (premium) discount and debt financing costs, net
(1,352
)
 
(4,317
)
Gain on sale of marketable securities and other investments
(549
)
 
(1,618
)
Unrealized loss on equity securities recognized through income
754

 

Earnings from co-investments
(47,823
)
 
(21,207
)
Operating distributions from co-investments
61,107

 
27,451

Accrued interest from notes and other receivables
(2,633
)
 
(1,575
)
Gain on the sale of real estate and land
(22,244
)
 
(26,174
)
Equity-based compensation
5,906

 
3,361

Gain on remeasurement of co-investment

 
(88,641
)
Changes in operating assets and liabilities:
 

 
 

Prepaid expense, receivables and other assets
(6,078
)
 
(1,751
)
Accounts payable and accrued liabilities
2,839

 
(3,169
)
Other liabilities
579

 
646

Net cash provided by operating activities
423,521

 
372,524

Cash flows from investing activities:
 

 
 

Additions to real estate:
 

 
 

Acquisitions of real estate and acquisition related capital expenditures
(5,476
)
 
(193,527
)
Redevelopment
(36,466
)
 
(30,509
)
Development acquisitions of and additions to real estate under development
(75,303
)
 
(51,563
)
Capital expenditures on rental properties
(30,975
)
 
(25,648
)
Investments in notes receivable

 
(12,750
)
Collections of notes receivable
29,500

 

Proceeds from insurance for property losses
917

 
435

Proceeds from dispositions of real estate
130,730

 
131,230

Contributions to co-investments
(97,826
)
 
(144,599
)
Changes in refundable deposits
(3,785
)
 
467

Purchases of marketable securities
(27,995
)
 
(33,615
)
Sales and maturities of marketable securities
18,975

 
28,766

Non-operating distributions from co-investments
38,696

 
67,674

Net cash used in investing activities
(59,008
)
 
(263,639
)
Cash flows from financing activities:
 

 
 

Proceeds from unsecured debt and mortgage notes
298,773

 
597,981

Payments on unsecured debt and mortgage notes
(110,829
)
 
(412,653
)
Proceeds from lines of credit
438,528

 
467,313

Repayments of lines of credit
(614,858
)
 
(592,313
)
Retirement of common units
(3,774
)
 

Additions to deferred charges
(3,771
)
 
(3,890
)
Net proceeds from issuance of common units
(353
)
 
80,565

Net proceeds from stock options exercised
1,864

 
22,041

Payments related to tax withholding for share-based compensation
(23
)
 
(118
)
Distributions to noncontrolling interest
(4,460
)
 
(3,600
)
Redemption of noncontrolling interest
(57
)
 
(3,528
)

10


 
Six Months Ended June 30,
 
2018
 
2017
Redemption of redeemable noncontrolling interest
(43
)
 
(720
)
Common and preferred units and preferred interest distributions paid
(249,060
)
 
(230,389
)
Net cash used in financing activities
(248,063
)
 
(79,311
)
Net increase (decrease) in unrestricted and restricted cash and cash equivalents
116,450

 
29,574

Unrestricted and restricted cash and cash equivalents at beginning of period
61,126

 
170,302

Unrestricted and restricted cash and cash equivalents at end of period
$
177,576

 
$
199,876

  
 
 
 
Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest, net of $8.4 million and $6.6 million capitalized in 2018 and 2017, respectively
$
100,496

 
$
106,448

Supplemental disclosure of noncash investing and financing activities:
 

 
 

Issuance of DownREIT units in connection with acquisition of real estate
$

 
$
22,506

Transfers between real estate under development to rental properties, net
$
98,318

 
$
1,540

Transfer from real estate under development to co-investments
$
640

 
$
3,340

Reclassifications to redeemable noncontrolling interest from general partner capital and noncontrolling interest
$
1,845

 
$
1,117

Redemption of redeemable noncontrolling interest via reduction of note receivable
$
4,571

 
$

  Debt assumed in connection with acquisition
$

 
$
51,882


See accompanying notes to the unaudited condensed consolidated financial statements.

11


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

(1) Organization and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements present the accounts of Essex Property Trust, Inc. (“Essex” or the “Company”), which include the accounts of the Company and Essex Portfolio, L.P. and its subsidiaries (the “Operating Partnership,” which holds the operating assets of the Company), prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q. In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations, and cash flows for the periods presented have been included and are normal and recurring in nature. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2017.

All significant intercompany accounts and transactions have been eliminated in the unaudited condensed consolidated financial statements. Certain reclassifications have been made to conform to the current year’s presentation, including the reclassification of corporate-level property management expenses out of property operating, excluding real estate taxes to its own line item on the Company's condensed consolidated statements of income and comprehensive income. Additionally, $10.0 million and $9.3 million has been reclassified out of other assets and into building and improvements on the Company's condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017, respectively.

The unaudited condensed consolidated financial statements for the three and six months ended June 30, 2018 and 2017 include the accounts of the Company and the Operating Partnership. Essex is the sole general partner of the Operating Partnership, with a 96.7% general partnership interest as of both June 30, 2018 and December 31, 2017. Total Operating Partnership limited partnership units (“OP Units,” and the holders of such OP Units, “Unitholders”) outstanding were 2,272,983 and 2,268,114 as of June 30, 2018 and December 31, 2017, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled approximately $543.4 million and $547.5 million as of June 30, 2018 and December 31, 2017, respectively.

As of June 30, 2018, the Company owned or had ownership interests in 247 operating apartment communities, comprising 59,982 apartment homes, excluding the Company’s ownership in preferred equity interest co-investments, one operating commercial building, six active developments and three loan investments. The operating apartment communities are located in Southern California (Los Angeles, Orange, San Diego, and Ventura counties), Northern California (the San Francisco Bay Area) and the Seattle metropolitan areas.

Accounting Pronouncements Adopted in the Current Year

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09 “Revenue from Contracts with Customers.” The new standard provides a single comprehensive revenue recognition model for contracts with customers (excluding certain contracts, such as lease contracts) to improve comparability within industries. The new standard requires an entity to recognize revenue to reflect the transfer of goods or services to customers at an amount the entity expects to be paid in exchange for those goods and services and provide enhanced disclosures, all to provide more comprehensive guidance for transactions such as service revenue and contract modifications. The new standard is effective for interim and annual periods beginning after December 15, 2017. The new standard may be applied using either a full retrospective or a modified approach upon adoption. The Company adopted ASU No. 2014-09 as of January 1, 2018 using the modified retrospective approach. See Note 3, Revenues, for further details.

In January 2016, the FASB issued ASU No. 2016-01 “Recognition and Measurement of Financial Assets and Financial Liabilities,” which requires changes to the classification and measurement of investments in certain equity securities and to the presentation of certain fair value changes for financial liabilities measured at fair value. The new standard is effective for interim and annual periods beginning after December 15, 2017. The Company adopted ASU No. 2016-01 as of January 1, 2018 using the modified retrospective method by applying a cumulative effect adjustment to retained earnings and partners' capital of $2.2 million, representing accumulated net unrealized gains of certain equity securities held by the Company. Furthermore, as a result of the adoption of this standard, the Company will recognize changes in the fair value of equity investments with readily determinable fair values through net income as opposed to comprehensive income.


12


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

In August 2016, the FASB issued ASU No. 2016-15 “Classification of Certain Cash Receipts and Cash Payments,” which requires entities to adhere to a uniform classification and presentation of certain cash receipts and cash payments in the statement of cash flows. The amendments in this update provide guidance on eight specific cash flow issues. The new standard is effective for interim and annual periods beginning after December 15, 2017. The Company adopted ASU No. 2016-15 as of January 1, 2018 using the retrospective transition method. This amendment did not have a material impact on the Company's consolidated results of operations or financial position.

In November 2016, the FASB issued ASU No. 2016-18 “Statement of Cash Flows,” which requires entities to include restricted cash and restricted cash equivalents in the reconciliation of beginning-of-period to the end-of-period of cash and cash equivalents in the statement of cash flows. This new standard seeks to eliminate the current diversity in practice in how changes in restricted cash and restricted cash equivalents is presented in the statement of cash flows. The new standard is effective for interim and annual periods beginning after December 15, 2017. The Company adopted ASU No. 2016-18 as of January 1, 2018 using the retrospective transition method. This amendment did not have a material impact on the Company's consolidated results of operations or financial position.

In January 2017, the FASB issued ASU No. 2017-01 “Business Combinations: Clarifying the Definition of a Business,” which provides a new framework for determining whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. Previously, U.S. GAAP did not specify the minimum inputs and processes required for an integrated set of assets and activities to meet the definition of a business, causing a broad interpretation of the definition of a business. The new standard is effective for interim and annual periods beginning after December 15, 2017. The Company adopted ASU No. 2017-01 as of January 1, 2018 prospectively. The Company expects that substantially all of its acquisitions of communities will qualify as asset acquisitions and transaction costs related to these acquisitions will be capitalized upon adoption.

In February 2017, the FASB issued ASU No. 2017-05 “Other Income - Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets,” which adds guidance for partial sales of nonfinancial assets, including partial sales of real estate. Historically, U.S. GAAP contained several different accounting models to evaluate whether the transfer of certain assets qualified for sale treatment. This new standard reduces the number of potential accounting models that might apply and clarifies which model does apply in various circumstances. Partial sales of nonfinancial assets are common in the real estate industry and include transactions in which the seller retains an equity interest in the entity that owns the assets or has an equity interest in the buyer. The new standard is effective for interim and annual periods beginning after December 15, 2017. Management performed an evaluation of all of the Company's contracts that may be affected by the new standard. The Company adopted ASU No. 2017-05 concurrently with the adoption of ASU No. 2014-09 “Revenue from Contracts with Customers” as of January 1, 2018 using the modified-retrospective method by applying a cumulative effect adjustment to retained earnings and partners' capital of $123.7 million, representing the partial sale of its membership interest in BEX II, LLC (“BEX II”) during the fourth quarter of 2016.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU No. 2016-02 “Leases,” which requires an entity that is a lessee to classify leases as either finance or operating and to recognize a lease liability and a right-of-use asset for all leases that have a duration of greater than 12 months. Leases of 12 months or less will be accounted for similar to existing guidance for operating leases today. For lessors, accounting for leases under the new standard will be substantially the same as existing guidance for sales-type leases, direct financing leases, and operating leases, but eliminates current real estate specific provisions and changes the treatment of initial direct costs. The new standard will be effective for the Company beginning on January 1, 2019 and early adoption is permitted, including adoption in an interim period. The Company currently anticipates adopting the new standard on the effective date. The Company expects that its residential and commercial leases, where it is the lessor, will continue to be accounted for as operating leases under the new standard. As a result, the Company does not currently expect significant changes in the accounting for its lease revenues. For leases where the Company is the lessee, which includes various corporate office and ground leases, the Company will be required to recognize a right of use asset and related lease liability on its consolidated balance sheets upon adoption. The Company expects that its corporate office leases, where it is the lessee, will continue to be accounted for as operating leases. The Company also expects to elect a package of practical expedients, under which the Company would not be required to reassess the classification of existing ground leases. The Company is continuing to evaluate the impact of this amendment on its consolidated results of operations and financial position.


13


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

In June 2016, the FASB issued ASU No. 2016-13 “Measurement of Credit Losses on Financial Instruments,” which amends the current approach to estimate credit losses on certain financial assets, including trade and other receivables, available-for-sale securities, and other financial instruments. Generally, this amendment requires entities to establish a valuation allowance for the expected lifetime losses of these certain financial assets. Subsequent changes in the valuation allowance are recorded in current earnings and reversal of previous losses are permitted. Currently, U.S. GAAP requires entities to write down credit losses only when losses are probable and loss reversals are not permitted. The new standard will be effective for the Company beginning on January 1, 2020 and early adoption is permitted. The Company is currently evaluating the impact of this amendment on its consolidated results of operations and financial position.

In August 2017, the FASB issued ASU No. 2017-12 “Derivatives and Hedging - Targeted Improvements to Accounting for Hedging Activities,” which, among other things, requires entities to present the earnings effect of hedging instruments in the same income statement line item in which the earnings effect of the hedged item is reported. The new standard also adds new disclosure requirements. This new standard will be effective for the Company beginning January 1, 2019 and early adoption is permitted. The Company is currently evaluating the impact of this amendment on its consolidated results of operations and financial position.

Marketable Securities

The Company reports its equity securities and available for sale debt securities at fair value, based on quoted market prices (Level 1 for the common stock and investment funds, Level 2 for the unsecured bonds and Level 3 for investments in mortgage backed securities, as defined by the FASB standard for fair value measurements). Any unrealized gain or loss in debt securities classified as available for sale is recorded as other comprehensive income. Unrealized gains and losses in equity securities, realized gains and losses in debt securities, interest income, and amortization of purchase discounts are included in interest and other income on the condensed consolidated statements of income and comprehensive income.

As of June 30, 2018 and December 31, 2017, equity securities and available for sale debt securities consisted primarily of investment-grade unsecured bonds, common stock and stock funds, investments in mortgage backed securities, and investment funds that invest in U.S. treasury or agency securities. As of June 30, 2018 and December 31, 2017, the Company classified its investments in mortgage backed securities, which mature in November 2019 and September 2020, as held to maturity, and accordingly, these securities are stated at their amortized cost. The discount on the mortgage backed securities is being amortized to interest income based on an estimated yield and the maturity date of the securities.

As of June 30, 2018 and December 31, 2017, marketable securities consist of the following ($ in thousands):

 
June 30, 2018
 
Amortized
Cost
 
Gross
Unrealized
Gain (Loss)
 
Carrying Value
Equity securities:
 
 
 
 
 
Investment funds - debt securities
$
31,852

 
$
(371
)
 
$
31,481

Investment funds - U.S. treasuries
11,250

 
(85
)
 
11,165

Common stock and stock funds
39,680

 
2,591

 
42,271

 
 
 
 
 
 
Debt securities:
 
 
 
 
 
Available for sale
 
 
 
 
 
Investment-grade unsecured bonds
4,379

 
(137
)
 
4,242

Held to maturity
 
 
 

 
 

Mortgage backed securities
118,032

 

 
118,032

Total - Marketable securities
$
205,193

 
$
1,998

 
$
207,191



14


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

 
December 31, 2017
 
Amortized
Cost
 
Gross
Unrealized
Gain (Loss)
 
Carrying Value
Equity securities:
 
 
 
 
 
Investment funds - debt securities
$
27,914

 
$
(29
)
 
$
27,885

Investment funds - U.S. treasuries
10,999

 
(55
)
 
10,944

Common stock and stock funds
34,329

 
2,973

 
37,302

 
 
 
 
 


Debt securities:
 
 
 
 
 
Available for sale
 
 
 
 
 
Investment-grade unsecured bonds
4,365

 
(40
)
 
4,325

Held to maturity
 

 
 

 
 

Mortgage backed securities
109,548

 

 
109,548

Total - Marketable securities
$
187,155

 
$
2,849

 
$
190,004


The Company uses the specific identification method to determine the cost basis of a debt security sold and to reclassify amounts from accumulated other comprehensive income for such securities. 

For the three months ended June 30, 2018 and 2017, the proceeds from sales and maturities of marketable securities totaled $9.4 million and $3.9 million, respectively, which resulted in $0.2 million in realized loss and $13,000 in realized gains, respectively, for such periods. For the six months ended June 30, 2018 and 2017, the proceeds from sales and maturities of marketable securities totaled $19.0 million and $28.8 million, respectively, which resulted in $0.5 million and $1.6 million in realized gains, respectively, for such periods.

For the three and six months ended June 30, 2018, the portion of equity security unrealized gains and losses that were recognized in income totaled $0.1 million in unrecognized gains and $0.8 million in unrealized losses and is included in interest and other income on the Company's condensed consolidated statements of income and comprehensive income.

Variable Interest Entities

In accordance with accounting standards for consolidation of variable interest entities (“VIEs”), the Company consolidates the Operating Partnership, 16 limited partnerships, comprising eight communities, (the “DownREIT limited partnerships,”) and eight co-investments as of June 30, 2018. The Company consolidates these entities because it is deemed the primary beneficiary. The Company has no assets or liabilities other than its investment in the Operating Partnership. The consolidated total assets and liabilities related to the eight consolidated co-investments and 16 DownREIT limited partnerships, net of intercompany eliminations, were approximately $835.2 million and $262.9 million, respectively, as of June 30, 2018 and $837.7 million and $265.5 million, respectively, as of December 31, 2017. Noncontrolling interests in these entities were $64.9 million and $66.7 million as of June 30, 2018 and December 31, 2017, respectively. The Company's financial risk in each VIE is limited to its equity investment in the VIE. As of June 30, 2018 and December 31, 2017, 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.

Equity-based Compensation

The cost of share- and unit-based compensation awards is measured at the grant date based on the estimated fair value of the awards. The estimated fair value of stock options and restricted stock granted by the Company are being amortized over the vesting period. The estimated grant date fair values of the long term incentive plan units (discussed in Note 12, “Equity Based Compensation Plans,” in the Company’s annual report on Form 10-K for the year ended December 31, 2017) are being amortized over the expected service periods.


15


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

Fair Value of Financial Instruments

Management believes that the carrying amounts of the outstanding balances under its lines of credit, and notes and other receivables approximate fair value as of June 30, 2018 and December 31, 2017, because interest rates, yields, and other terms for these instruments are consistent with yields and other terms currently available for similar instruments. Management has estimated that the fair value of the Company’s fixed rate debt with a carrying value of $5.1 billion and $4.9 billion, including premiums, discounts and debt financing costs, at June 30, 2018 and December 31, 2017, respectively, was approximately $5.1 billion and $5.0 billion. Management has estimated that the fair value of the Company’s $615.1 million and $792.9 million of variable rate debt, net of debt financing costs, at June 30, 2018 and December 31, 2017, respectively, was approximately $618.2 million and $793.9 million based on the terms of existing mortgage notes payable, unsecured debt, and variable rate demand notes compared to those available in the marketplace. Management believes that the carrying amounts of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities, construction payables, other liabilities, and dividends payable approximate fair value as of June 30, 2018 and December 31, 2017 due to the short-term maturity of these instruments. Marketable securities, except mortgage backed securities, and derivatives are carried at fair value as of June 30, 2018 and December 31, 2017.

At June 30, 2018, the Company’s investments in mortgage backed securities had a carrying value of $118.0 million and the Company estimated the fair value to be approximately $127.2 million. At December 31, 2017, the Company’s investments in mortgage backed securities had a carrying value of $109.5 million and the Company estimated the fair value to be approximately $120.7 million. The Company determines the fair value of the mortgage backed securities based on unobservable inputs (level 3 of the fair value hierarchy) considering the assumptions that market participants would make in valuing these securities. Assumptions such as estimated default rates and discount rates are used to determine the expected discounted cash flows to estimate fair value.
 
Capitalization of Costs

The Company’s capitalized internal costs related to development and redevelopment projects were comprised primarily of employee compensation and totaled $4.5 million and $4.6 million during the three months ended June 30, 2018 and 2017, respectively, and $9.5 million and $9.4 million for the six months ended June 30, 2018 and 2017, respectively. The Company capitalizes leasing commissions associated with the lease-up of development communities and amortizes the costs over the life of the leases. The amounts capitalized for leasing commissions are immaterial for all periods presented.

Co-investments

The Company owns investments in joint ventures (“co-investments”) in which it has significant influence, but its ownership interest does not meet the criteria for consolidation in accordance with U.S. GAAP. Therefore, the Company accounts for co-investments using the equity method of accounting. Under the equity method of accounting, the investment is carried at the cost of assets contributed, plus the Company's equity in earnings less distributions received and the Company's share of losses. The significant accounting policies of the Company’s co-investment entities are consistent with those of the Company in all material respects.

Upon the acquisition of a controlling interest of a co-investment, the co-investment entity is consolidated and the transaction will be accounted for as a business combination if the entity meets the definition of a business pursuant to ASU No. 2017-01, or an asset acquisition if the entity is not determined to be a business. A majority of the co-investments, excluding the preferred equity investments, compensate the Company for its asset management services and some of these investments may provide promote income if certain financial return benchmarks are achieved. Asset management fees are recognized when earned, and promote fees are recognized when the earnings events have occurred and the amount is determinable and collectible. Any promote fees are reflected in equity income from co-investments.

The Company reports investments in co-investments where accumulated distributions have exceeded the Company’s investment as distributions in excess of investments in co-investments in the accompanying condensed consolidated balance sheets. As of December 31, 2017, the net investment of one of the Company’s co-investments was less than zero as a result of financing distributions in excess of the Company's investment in that co-investment. As a result of the Company's adoption of ASU No. 2017-05 on January 1, 2018, the carrying value of this co-investment was greater than zero as of June 30, 2018.


16


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

Changes in Accumulated Other Comprehensive Loss, Net by Component

Essex Property Trust, Inc.
($ in thousands):
 
Change in fair
value and amortization
of swap settlements
 
Unrealized
gains/(losses) on
available for sale securities
 
Total
Balance at December 31, 2017
$
(20,641
)
 
$
2,195

 
$
(18,446
)
Cumulative effect upon adoption of ASU 2016-01

 
(2,234
)
 
(2,234
)
Other comprehensive income before reclassification
13,263

 
(95
)
 
13,168

Amounts reclassified from accumulated other comprehensive loss
(3,928
)
 
2

 
(3,926
)
Other comprehensive income
9,335

 
(2,327
)
 
7,008

Balance at June 30, 2018
$
(11,306
)
 
$
(132
)
 
$
(11,438
)

Changes in Accumulated Other Comprehensive Loss, by Component

Essex Portfolio, L.P.
($ in thousands):
 
Change in fair
value and amortization
of swap settlements
 
Unrealized
gains/(losses) on
available for sale securities
 
Total
Balance at December 31, 2017
$
(17,417
)
 
$
2,188

 
$
(15,229
)
Cumulative effect upon adoption of ASU 2016-01

 
(2,228
)
 
(2,228
)
Other comprehensive income before reclassification
13,719

 
(99
)
 
13,620

Amounts reclassified from accumulated other comprehensive loss
(4,063
)
 
2

 
(4,061
)
Other comprehensive income
9,656

 
(2,325
)
 
7,331

Balance at June 30, 2018
$
(7,761
)
 
$
(137
)
 
$
(7,898
)

Amounts reclassified from accumulated other comprehensive loss in connection with derivatives are recorded in interest expense on the condensed consolidated statements of income and comprehensive income. Realized gains and losses on available for sale debt securities are included in interest and other income on the condensed consolidated statements of income and comprehensive income.

Redeemable Noncontrolling Interest

The carrying value of redeemable noncontrolling interest in the accompanying condensed consolidated balance sheets was $36.3 million and $39.2 million as of June 30, 2018 and December 31, 2017, respectively. The limited partners may redeem their noncontrolling interests for cash in certain circumstances.

The changes to the redemption value of redeemable noncontrolling interests for the six months ended June 30, 2018 is as follows ($ in thousands):
Balance at December 31, 2017
$
39,206

Reclassification due to change in redemption value and other
1,845

Redemptions
(4,794
)
Balance at June 30, 2018
$
36,257



17


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

Cash, Cash Equivalents and Restricted Cash

Highly liquid investments with original maturities of three months or less when purchased are classified as cash equivalents. Restricted cash balances relate primarily to reserve requirements for capital replacement at certain communities in connection with the Company’s mortgage debt.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the condensed consolidated balance sheets that sum to the total of the same such amounts shown in the condensed consolidated statements of cash flows ($ in thousands):
 
June 30, 2018
 
December 31, 2017
 
June 30, 2017
 
December 31, 2016
Cash and cash equivalents - unrestricted
$
160,902

 
$
44,620

 
$
183,885

 
$
64,921

Cash and cash equivalents - restricted
16,674

 
16,506

 
15,991

 
105,381

Total unrestricted and restricted cash and cash equivalents shown in the condensed consolidated statement of cash flows
$
177,576

 
$
61,126

 
$
199,876

 
$
170,302


Accounting Estimates

The preparation of condensed 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. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate portfolio, its investments in and advances to joint ventures and affiliates, its notes receivables, and its qualification as a real estate investment trust (“REIT”). The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.

(2)  Significant Transactions During The Six Months Ended 2018 and Subsequent Events

Significant Transactions

Dispositions

In June 2018, the Company sold Domain, a 379 apartment home community located in San Diego, CA, for $132.0 million, resulting in a gain of $22.2 million.

Preferred Equity Investments

In January 2018, the Company received cash of $2.4 million for the full redemption of a preferred equity investment in a co-investment that holds property in Seattle, WA.

In May 2018, the Company made a commitment to fund a $26.5 million preferred equity investment in an entity whose sponsors include a related party. The entity wholly owns a 400 apartment home community located in Ventura, CA. This investment will accrue interest based on a 10.25% preferred return. The investment is scheduled to mature in May 2023. As of June 30, 2018, the Company had funded $20.4 million of the commitment. The remaining committed amount will be funded if and when requested by the sponsors. See Note 6, Related Party Transactions, for additional details.

In June 2018, the Company received cash of $26.5 million for the full redemption of a preferred equity investment in an entity that holds property in Seattle, WA. The Company recognized a gain of $1.6 million as a result of this early redemption, which is included in equity income from co-investments in the condensed consolidated statement of income and comprehensive income.




18


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

Notes Receivable

In January 2018, the Village at Toluca Lake, a property located in Burbank, CA and owned by BEX III, LLC (“BEX III”), a Company co-investment, paid off a $29.5 million bridge loan provided by the Company in November 2017. See Note 6, Related Party Transactions, for additional details related to the related party bridge loan.

Co-Investments

In March 2018, the BEXAEW, LLC (“BEXAEW”) joint venture operating agreement was amended, and the joint venture was extended. Under the amendment, the Company received a cash payment for promote income of $20.5 million, which is included in equity income from co-investments on the condensed consolidated statements of income and comprehensive income.

Senior Unsecured Debt

In March 2018, the Company issued $300.0 million of 30-year 4.500% senior unsecured notes. The interest is paid semi-annually in arrears on March 15 and September 15 of each year commencing on September 15, 2018 until the maturity date of March 15, 2048. The Company used the net proceeds of this offering to repay indebtedness under its unsecured lines of credit and for other general corporate and working capital purposes.

Common Stock

In January 2018, the Company repurchased and retired 16,834 shares totaling $3.8 million, including commissions. As of June 30, 2018, the Company had $245.2 million of purchase authority remaining under the stock repurchase plan authorized by the Company's board of directors.

Subsequent Events

None.

(3)  Revenues

On January 1, 2018, the Company adopted ASU 2014-09, “Revenue from Contracts with Customers” using a modified retrospective transition method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods after January 1, 2018 are presented under the new standard, while prior period amounts are not adjusted and continue to be reported in accordance with the old revenue recognition standard.

Based on a full analysis of applicable contracts, the Company determined that the new standard did not have an impact to reported revenues from prior or current periods.

Revenue Recognition

Revenue from Leasing

The Company generates revenues primarily from leasing apartment homes to tenants. Such leasing revenues are recorded when due from tenants and are recognized monthly as they are earned, which is not materially different than on a straight-line basis. Apartment homes are rented under short-term leases (generally, lease terms of 6 to 12 months). Revenues from tenants leasing commercial space are recorded on a straight-line basis over the life of the respective lease.

The Company also generates other property-related revenue through the leasing of apartment homes, including storage income, pet rent, and other miscellaneous revenue. Similar to rental income, such revenues are recorded when due from tenants and recognized monthly as they are earned.




19


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

Revenue from Contracts with Customers

Apart from rental and other property-related revenue, revenues from contracts with customers are recognized as control of the promised services is passed to the customer.

For customer contracts related to management and other fees from affiliates (which includes asset management and property management), the transaction price and amount of revenue to be recognized is determined each quarter based on the management fee calculated and earned for that month or quarter. The contract will contain a description of the service and the fee percentage for management services. Payments from such services are one month or one quarter in arrears of the service performed.

Disaggregated Revenue

The following table presents the Company’s revenues disaggregated by revenue source ($ in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Rental
$
323,020

 
$
314,546

 
$
644,681

 
$
624,668

Other property leasing revenue
23,506

 
22,220

 
46,792

 
45,266

Management and other fees from affiliates
2,197

 
2,296

 
4,505

 
4,532

Total revenues
$
348,723

 
$
339,062

 
$
695,978

 
$
674,466


The following table presents the Company’s rental and other property-related revenues disaggregated by geographic operating segment ($ in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Southern California
$
150,431

 
$
145,600

 
300,200

 
290,504

Northern California
129,590

 
126,550

 
258,212

 
249,858

Seattle Metro
58,795

 
57,087

 
117,509

 
113,279

Other real estate assets (1)
7,710

 
7,529

 
15,552

 
16,293

Total rental and other property leasing revenues
$
346,526

 
$
336,766

 
$
691,473

 
$
669,934


(1) Other real estate assets consists of revenue generated from retail space, commercial properties, held for sale properties, and disposition properties. Executive management does not evaluate such operating performance geographically.

The following table presents the Company’s rental and other property-related revenues disaggregated by current property category status ($ in thousands):
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Same-property (1)
$
321,283

 
$
312,629

 
$
641,378

 
$
622,460

Acquisitions (2)
10,501

 
10,170

 
20,884

 
18,356

Development (3)
450

 

 
469

 

Redevelopment
5,036

 
4,909

 
10,060

 
9,723

Non-residential/other, net (4)
9,256

 
9,058

 
18,682

 
19,395

Total rental and other property revenues
$
346,526

 
$
336,766

 
$
691,473

 
$
669,934


(1) Stabilized properties consolidated by the Company for the three and six months ended June 30, 2018 and 2017.
(2) Acquisitions includes properties acquired which did not have comparable stabilized results as of January 1, 2017.

20


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
June 30, 2018 and 2017
(Unaudited)

(3) Development includes properties developed which did not have stabilized results as of January 1, 2017.
(4) Non-residential/other, net consists of revenue generated from retail space, commercial properties, held for sale properties, disposition properties and student housing.

Deferred Revenues and Remaining Performance Obligations

When cash payments are received or due in advance of the Company’s performance of contracts with customers, deferred revenue is recorded. The total deferred revenue balance related to such contracts was $7.7 million and $9.3 million as of June 30, 2018 and December 31, 2017, respectively, and was included in accounts payable and accrued liabilities within the accompanying consolidated balance sheets. The amount of revenue recognized for the six months ended June 30, 2018 that was included in the December 31, 2017 deferred revenue balance was $1.6 million, which was included in interest and other income within the condensed consolidated statements of income and comprehensive income.

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer, and is the unit of account in the new revenue accounting standard. As of June 30, 2018, the Company had $7.7 million of remaining performance obligations. The Company expects to recognize approximately 20% of these remaining performance obligations in 2018, an additional 39% through 2020, and the remaining balance thereafter.

Practical Expedients

The Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less or when variable consideration is allocated entirely to a wholly unsatisfied performance obligation.

(4) Co-investments

The Company has joint ventures and preferred equity investments in co-investments which are accounted for under the equity method. The co-investments own, operate, and develop apartment communities. In addition to the Company's joint ventures with BEXAEW, BEX II, and BEX III, the Company has joint venture investments with the Canadian Pension Plan Investment Board (“CPPIB”), Wesco I, LLC (“Wesco I”), Wesco III, LLC (“Wesco III”), Wesco IV, LLC (“Wesco IV”), and Wesco V, LLC (“Wesco V”). The carrying values of the Company's co-investments as of June 30, 2018 and December 31, 2017 are as follows ($ in thousands, except parenthetical amounts):
 
Weighted Average Company Ownership Percentage (1)
 
June 30, 2018
 
December 31, 2017
Ownership interest in:
 
 
 
 
 
CPPIB
54
%
 
$
492,382

 
$
500,287

Wesco I, Wesco III, Wesco IV, and Wesco V
53
%
 
211,574

 
214,408

BEXAEW, BEX II and BEX III (2)
50
%
 
120,788

 
13,827

Other
52
%
 
47,367

 
51,810

Total operating and other co-investments, net
 
 
872,111

 
780,332

Total development co-investments, net
50
%
 
76,525

 
73,770

Total preferred interest co-investments (includes related party investments of $36.4 million and $15.7 million as of June 30, 2018 and December 31, 2017, respectively)
 
 
342,684

 
265,156

Total co-investments, net
 
 
$
1,291,320

 
$
1,119,258

 
(1) Weighted average Company ownership percentages are as of June 30, 2018.
(2) As of December 31, 2017, the Company's investment in BEX II was classified as a liability of $36.7 million.

21


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES