United Dominion Realty Trust (UDR)

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Michael Francis

Will Leung

Kryssia Uraguchi

United Dominion Realty Trust (NYSE:UDR) owns and rents multi-family residential apartment communities. ^[1] The company's properties generally target the middle-market of apartment lessees.^[2][3]In 2010, UDR reported a total revenue of $632M and a net loss of $106.6M primarily due to increased depreciation and amortization costs. ^[1]

UDR is intricately tied to interest rate tides, which have several important effects: While the company competes for tenants with other apartment operators, it also competes on the relative attractiveness of owning a home versus renting an apartment. When home prices are high, renting becomes more attractive (and vice versa). Interest rates determine the attractiveness of mortgage financing. When interest rates are high, renting becomes more appealing as financing a mortgage becomes more expensive. It is also important to note that UDR operates as a real estate investment trust (REIT). As such, the company must distribute at least 90% of its cash flow to shareholders every year in the form of a dividend. When interest rates rise, so do demands for investment yields on dividends, which can depress a REIT's stock price.

Business Overview

UDR is real estate trust that owns, acquires, renovates, develops and manages apartment communities nationwide. It operates through its subsidiaries, which include two operating partnerships, Heritage Communities L.P. and Union Dominion Realty, L.P and RE3, a subsidiary which focuses on development, land entitlement and short-term hold investments.

The company's primary objective is to maximize economic returns of the apartment communities which its owns to provide stockholders with highest possible total return. The company strives to accomplish this objective through three main strategies:

Managing/Strengthening its Portfolio

UDR focuses on increasing its presence in markets with favorable job formation, low-single family affordability and a favorable demand/supply ratio for multifamily housing in order to ensure that the communities which its owns, develops, and operates have a growing source of consumers willing and able to rent them. Approximately 56.8% of the Company's same store net operating income was provided by its communities located in California, Metropolitan Washington, D.C., Oregon, and Washington State. UDR manages/strengthens its portfolio of properties through acquisitions, development, redevelopment, and joint-venture activities.

Improving Operations

UDR works to improve its property management operations in order to obtain the highest return in the form of rental/lease payments from its apartment communities. The company has been automating its business in order to better meet the needs of its residents.

Maintaining Access to Low-Cost Capital

In order for the company to acquire, develop and operate its real-estate properties, access to low-cost capital is essential. Since the real estate trust industry is very capital intensive, the profitability of the company is directly impacted by changing costs of capital.

Financial and Operating Metrics

The company has been able to steadily increase its rental revenue per apartment unit over time, fighting inflation and driving organic growth. It has lowered its total apartment base over the previous three years, selling off more properties (at a gain) than it has redeployed into purchasing new units. This "recycling" of capital is a standard opportunistic practice of REITs, which most believe allow them to take advantage and mitigate the risks of the real estate cycle. It also leads to somewhat large income line items from "discontinued operations."

Trends and Forces

Expanding market share through acquisitions

UDR has been concentrating on Southern and Northern California, Florida, Washington DC, and Washington state for its long-term strategy.^[4] UDR believes that these areas will be the most profitable because it has already established itself in those areas and have formed high and unfavorable barriers to entry for its competitors.^[4] In addition, these metropolitan areas have favorable job opportunities for its residents, as well as already affordable single-family units.

Concentration in these five areas allows them to leverage scale in these regions, but also exposes them to more geographic, local risk for these properties. More than half of its apartments are within these five areas and the local economies and real estate markets are important drivers for the companies ability to attract and retain tenants while being able to increase rents over time. Historically, UDR has been able to maintain a high occupancy rate.

UDR has pursued agreements with groups like the Witkoff Group to increase the company's reach and total size.^[5]

National and Local Employment

The strength of the labor market has important implications for the company.^[6] Jobs fuel demand for all types of housing, including multi-family/apartment dwellings. Strong job growth can drive higher occupancy rates and lead to increased unit rental revenue. High unemployment and slow job growth, on the other hand, can hamper the apartment rental market and, when job growth is negative, the company can experience falling occupancy rates and lower revenue per unit, which leads to less efficient apartment buildings as the utilization of the complex falls. The rate of population growth in the company's operating regions is another key determinant of the company's success. In towns whose populations are rapidly increasing, limited housing supply and/or the lag time in building houses leads to greater demand for the company's apartment units. The growth in local population is also closely correlated to the rate of job growth.

The Housing Market and New Home Construction

Factors driving the non-apartment, alternative housing market can have a substantial impact on the company. In the past, falling housing prices in the company’s key markets, coupled with decreasing new home construction and the rising cost of financing mortgages increased demand for apartments relative to houses and other living alternatives. However, if housing prices continue to fall, houses can become more attractive to purchasers, and they may substitute away from apartments and opt for single-family housing instead.

Interest Rates

Rising interest rates have several effects on this company and other apartment REITs:

1. Other investments become more attractive, thereby hampering demand for apartment investors. This, in turn, decreases the market prices of the company’s properties.
2. Available and existing financing becomes less attractive. Getting favorable terms on any new debt to finance building purchases becomes more difficult. The company’s interest expense on its floating rate debt increases, pressuring margins and increasing financial risk.
3. The stock price can fall as investor’s demand a greater dividend yield. As a REIT, the company must, by law, distribute at least 90% of its cash flow to shareholders in the form of a regular dividend. When interest rates rise, investors demand higher dividend yields on REITs, thereby driving down their stock prices.

Mortgage Rates

The attractiveness of mortgage financing for home purchasers has important ramifications for the apartment REITs. If mortgage rates fall and credit is plentiful, buying a home becomes more attractive than renting an apartment, thus stifling demand for the company’s rental units. On the other hand, if the availability and attractiveness of mortgages declines, as did during the fallout from the subprime lending crisis, renting an apartment becomes more appealing, so occupancy rates and rental revenue per apartment increase.

From UDR's perspective as the owner of the apartments it rents out and thus the holder of the mortgages on its apartments, rising mortgage rates can have an immense negative impact on the company's profits, especially due to the nature of the business itself, however, as a REIT, rising credit costs will reduce the company's profits.^[7]

Competition

UDR competes against a wide array of other apartment rental owners and operators. In terms of market cap, UDR most closely competes with REITs like Essex Property Trust (ESS) and Camden Property Trust (CPT).

The market for multi-family housing is highly fragmented geographically within any given region. In terms of region concentration, it competes with BRE Properties (BRE) in the Western regions and Home Properties (HME) in the Mid-Atlantic and South Eastern regions. The company’s real estate portfolio is spread across four geographic regions in 10 states, and has shifted to focus its investments within 5 major metropolitan regions. ^[8].

Footnotes

1. ↑ ^{1.0 1.1} "UDR Financials" 2010
2. ↑ UDR 2008 Annual Report, pg 6
3. ↑ National Multi Housing Council- Quick Facts: Apartment Rents, 2007
4. ↑ ^{4.0 4.1}
5. ↑ The Street 3/1/11
6. ↑ UDR 2008 10-K, "Risk Factors," pg 12
7. ↑ Smarttrend "Apartment Investment & Management is Among the Companies in the Residential REITs Industry With the Highest Debt To Equity Ratio (AIV, ELS, MAA, HME, UDR)" 9/24/10
8. ↑