Mike Schall may have a new role as CEO of Palo Alto, Calif.-based Essex Property Trust, but he is certainly no stranger to the company. Schall has served under outgoing CEO Keith R.Guericke for 24 years. When the company went public in 1994, he was CFO. Five years ago, he moved over to the COO role. Now, he's in the top spot. Thankfully, Schall won’t be going at it alone. Guericke will stay on as a consultant and 20-year-plus executives like John Eudy and Craig Zimmerman will stay on board.
These same executives have also helped spur an aggressive acquisition pace at the company. This year, Essex bought 10 new deals for approximately $460 million, which exceeded its expected acquisition volume for the year by $160 million. With an ability to close quickly, the company has been able to secure a number of projects owned by banks but built as condos. Most recently, it bought Muse, a 152-unit community under development in the North Hollywood Arts District of Los Angeles, as well as Magnolia Nest, a 97-unit condominium development located in the Valley Village district of Los Angeles for $29.9 million. Schall took some time to talk with Multifamily Executive senior editor Les Shaver about the company’s acquisitions, future growth, and his new role.
MFE: Was this the succession plan for a while at Essex?
SCHALL: Succession was not a high priority at Essex until the last three or four years, at which time it became a serious endeavor. I never actually thought Keith would retire, and certainly not so soon. I expected to be in this position for a long time. Ultimately, it was a bit of a surprise.
MFE: Essex is a pretty well regarded REIT in the apartment sector. Because of that, are you planning to keep the ship sailing in the same direction it has been for the past few years?
SCHALL: If I can keep up with Keith, I will be happy. Green Street said that over the past 15 years, Essex has beat average REIT returns by about 6 percent per year. We generated a compounded annual return of around 18 percent, while the index returned about 12 percent. From my perspective, that’s enormous outperformance. That is the precedent, and my challenge. It also sets high expectations for continued superior performance. Sometimes, I think you may be better off going into a difficult leadership situation and turning it around. In this case, I’m following someone that I consider to be one of the most respected and successful REIT executives out there.
MFE: Essex has been really actively recently. Will that continue?
SCHALL: We’ve been on acquisition spree. There are some very interesting properties that we have acquired. We bought two buildings that were brand-new, unoccupied buildings in Southern California in the past 60 days. They were bought from institutions that are finally starting to sell non-performing loans and REO after holding it for a prolonged period. A couple of years ago, we recognized that there would be several bank-related transactions that would be the natural fallout of the recession, resulting from a complete repricing of condos and apartments on the West Coast. We’ve been waiting for these transactions to hit the market for over a year. Now it appears that more property is starting to hit the market. Not that there’s a whole lot of it, but rather a few deals here and thre. But we’ve been building relationships and tracking transactions for a long time, and they make for very interesting and profitable acquisitions.
MFE: What do you think is driving the institutions to sell? Is it cap rate compression?
SCHALL: Many factors aligned in these institutional transactions: First, valuations have recovered from lower cap rates and recent market rent growth. Second, banks have established reserves so that losses have been recognized. Finally, they worked with the borrower to foreclose or have worked out other arrangements. And that's when you have the table set for a good transaction environment. Historically, banks are not great owners of real estate property. They need to hire managers and other professionals to work through loan issues and maintain the property after foreclosure. That is an expensive process. I think that they are always looking for an appropriate exit mechanism with respect to all of real estate owned. And now the timing is finally good. Clearly, market values have increased to the point where they think the market is appropriately valuing property, and there are plenty of willing buyers waiting to transact.
MFE: Do you expect new opportunities from institutions as we go into 2011?
SCHALL: I think that a few of these lender-driven transactions will be available in the future. I also believe that we will see the return of a more traditional marketplace. Since the beginning of the recession, transaction volumes dried up almost completely. In the coastal markets, these transaction are typically not distressed, and therefore owners have chosen to hold property. As we know, some owners always have reasons to sell, such as partnerships breaking up or people getting older. These typical motivations to sell should re-emerge, leading to a more normal transaction market. I am excited about the return of this market, because it is our specialty—well-located properties in selected coastal communities near the major job centers.
In the near future, I think there will be limited development opportunities. Land sellers have good memories, and remember what they thought their land was worth three years ago and are reluctant to accept less. We also see and are pursuing joint venture opportunities, where the land seller can contribute land to a venture, creating a financeable entity based on Essex’s balance sheet. It’s really the best of both worlds—the land owner can still realize appreciation as market conditions recover, while no longer holding a volatile and low-yielding asset.
MFE: I know Essex had interest in moving beyond the West Coast in the past. Are you still looking at the East Coast?
SCHALL: We looked at a company on the East Coast a few years ago. We realize that there are markets on the East Coast that have similar characteristics as our West Coast markets. From a broad perspective, we would like to be in those markets and active at some point in time. However, timing is critical, and it really comes down to market rent growth of new vs. our existing markets. Our view is that rents have been depressed to a much greater extent on the West Coast. For that reason alone, we’ll continue to focus on the West Coast for the forseeable future. We will always be looking for opportunities elsewhere, and we’ll certainly monitor the East Coast markets that have similar dynamics as the West Coast markets.