ESS - Essex Property Trust: A Growth REIT With An Attractive Yield

2024-01-15 04:28:58 ET

Summary

• Essex Property Trust is a promising long-term investment for passive income investors due to its concentrated property portfolio.
• The trust invests primarily in economically vibrant markets with strong potential for value appreciation.
• Essex Property Trust's focus on high-cost, high-barrier to entry markets suggests above-average long-term revenue growth.

Essex Property Trust ( ESS ) is a West Coast-focused multi-family real estate investment trust whose concentrated property portfolio makes it a promising long-term investment for passive income investors, in my view.

Essex Property Trust’s real estate history goes way back, to the early 1970s, and the trust is producing solid funds from operations and dividend growth.

What I think is particularly valuable for passive income investors is that the real estate investment trust invests primarily in economically-vibrant markets that have a strong chance to see considerable value appreciation in the long haul.

Furthermore, Essex Property Trust’s operational focus on high-cost, high-barrier to entry markets points to above-average long-term revenue growth.

My Rating History

I gave an initial overview of Essex Property Trust in my presentation Essex Property's 4.1% Dividend Yield Is Top Value that highlighted the trust’s attractive value proposition for passive income investors.

The trust’s funds from operations potential is very attractive and, in the long run, passive income investors have reason to expect above-average dividend growth. Furthermore, Essex Property Trust profits from declining housing affordability.

Concentrated, High-Potential Real Estate Portfolio In Supply-Limited Markets

The underlying value of Essex Property Trust is the real estate portfolio which is, as opposed to more broadly positioned real estate investment trusts, very much limited and concentrated. The portfolio consists primarily of apartment homes in three areas, Southern and Northern California as well as Seattle which is where Essex Property Trust owns more than 62,000 apartment units.

Most of Essex Property Trust’s assets can be found in a small number of metropolitan areas such as Los Angeles, Orange County and Santa Clara, which are population centers and have favorable demand-supply dynamics in the sense that new construction is hard to come by which in turn acts as a barrier of entry.

Essex Property Trust profits from something else besides being active in supply-constricted markets: the declining affordability of buying a home. In major cities, housing is becoming more and more expensive which is driving the rental population upwards.

With Essex Property Trust’s key markets, particularly in California, being among the most expensive real estate locations in the country, house prices and rents are likely to remain on an upward trajectory in the future. This, of course, bodes well for the real estate investment trusts’ funds from operations as well as dividend growth.

Taking into account the location of the trust’s real estate, Essex Property Trust offers passive income investors the opportunity to profit from above-average rental growth. The ability to charge tenants high rental rates, which flows from the trust’s asset locations, is therefore a key asset that I would think underpins the value proposition here for Essex Property Trust.

The overview of market-specific same-property revenue growth in the following table shows mid-single digit revenue growth in Essex Property Trust’s three key markets. Properties located in Southern California profited from a 5.5% increase in revenues, on a same-property basis, in 2023 compared to the year-ago period. All markets and properties considered, Essex Property Trust saw a 4.9% YoY increase in sales.

FFO Multiple, Pay-Out Ratio, Dividend Growth

Essex Property Trust anticipates to record $15.10-15.22 per share in funds from operations in 2023, based on the most recent forecast, which reflects back to us a 16.4x funds from operations multiple.

The funds from operations multiple really hasn’t changed much at all over the last year due to the real estate investment trust growing its funds from operations and some stock price appreciation to the tune of 14%.

Last year, when I first presented Essex Property Trust, the trust’s stock was selling at a funds from operations multiple of 15.9x. I think that the location of the real estate portfolio makes Essex Property Trust and the potential for robust funds from operations/revenue/dividend growth makes the trust a solid Buy for passive income investors, particularly those that are already in retirement and seek to purchase a reliable and growing dividend stream.

The present funds from operations midpoint of Essex Property Trust’s guidance for 2023 is $15.16 and since the real estate investment trust has paid $9.24 per share in dividends so we can calculate a pretty good approximation of the pay-out ratio even before full year earnings are released.

Thus, the implied pay-out ratio in 2023 was 61% which gives Essex Property Trust a pretty high margin of dividend safety. The dividend has therefore also considerable room to grow and a 5% raise in the dividend in 2024 is totally realistic (as the trust raised its dividend by the same amount in both 2023 and 2022).

Concentration Also Implies Risk

Essex Property Trust is concentrated in a few markets which comes with its fair share of opportunities, but not without risk. A real estate recession in California would hurt the real estate investment trust’s funds from operations and dividend prospects more than a broadly-positioned trust with assets in other markets. The dividend itself is well-covered and not risky, in my view.

My Conclusion

Essex Property Trust is growing quickly and the trust’s focus on a relatively small number of key markets is a unique element that I happen to like.

The portfolio is not as diversified as one would wish, but Essex Property Trust’s funds from operations are growing. The focus on multi-family assets in supply-limited markets on the West Coast offers passive income investors the opportunity to participate in the growth of these cities.

What’s more, Essex Property Trust offers passive income investors a fast-growing dividend as well as a 3.7% dividend yield that is also going to rise moving forward.

Though not cheap, based on funds from operations, I think the location of the real estate portfolio is ultimately Essex Property Trust’s key value proposition. Thus, I see Essex Property Trust as a Buy for passive income investors.

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