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Michael Francis

EQR AT A GLANCE

P/E ► -5K   EV/EBITDA ► -59.0   ROA ► 4.7% AVG ROE ► 5.5% AVG Debt to Equity ► 2.11 AVG Interest Coverage Ratio ► 1.05 AVG

 

 

 

 

 

 

Equity Residential is the second largest owner and operator of multi-family, apartment complexes in the U.S. With over 165,000 units in 25 states, the company focuses on the acquisition and operation of apartments in high growth population areas.^[1] The company's average monthly rental per unit is around $1,000, placing its offerings in the mid- to upper-market range (compared to $650 on average in the U.S.^[2]). Many of the company's properties are located in California (~15%), Florida (~14%), and Texas (~10%).^[3]

Equity Residential 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 Equity Residential 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.

Financial and Operating Metrics

Below are several metrics of operating performance for the company. 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.

Trends and Drivers

• National and Local Job Market and 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 Housing Market and New Home Construction. Factors driving the non-apartment, alternative housing market can have a substantial impact on the company. Throughout 2007, 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:^[7]

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.

• Local population growth. 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 (see National and Local Job Market and Employmentabove).

• Dependence on economies and regulations of California, Texas, and Florida. A large portion (around 40%) of the company's properties are located in either California, Texas, or Florida. As compared to, say, competitor AIV, who is widely geographically diversified, the company is exposed more heavily to risks of the local economics of these three states. The rate of job growth, property taxes, zoning requirements and regulations, and other factors within these states can have important effects on the company's bottom line.

• Continuing focus on coastal properties. EQR has been gradually selling off Midwestern properties and shifting more toward coastal properties such as New York, DC, and California. These markets are traditionally higher barrier-to-entry areas, which could help isolate the company from highly intense competition going forward. Obtaining properties and dealing with zoning regulations in these areas is usually more complicated, which makes operating in these regions more difficult for competing real estate firms.

Competition and Market Share

The company competes against a wide array of other apartment rental owner/operators. The National Multi Housing Council estimates that around 17 million apartment units exist nationwide. The median rental income per unit is around $650 per month.^[9]

The market for multi-family housing is highly fragmented geographically as well as within any given region. To the left are industry statistics for each of the major markets of publicly traded apartment REITs. The company’s real estate portfolio is highly diversified across geographic region, and operates in nearly every state. Based on data compiled by the National Multi Housing Council, the company was the largest operator of apartment units across the nation.^[10]

Furthermore, below is a table of relevant competitive data as compared to rival or comparable companies:^[11]

Footnotes

1. ↑ EQR 2006 10-K, "Business," pg 4.
2. ↑ Apartment Rental data, 2005, compiled by National Multi Housing Council
3. ↑ 2006 EQR 10-K, pg 26
4. ↑ EQR 2006 10-K, "Selected Financial Data," pg 31.
5. ↑ EQR 2004, 2005, 2006 10-K, "Business," pg 31.
6. ↑ EQR 2006 10-K, "MD&A," pg 32.
7. ↑ AIV 2006 10-K, "Risk Factors," pg 10.
8. ↑ Data from Apartment Stock data, 2006, compiled by National Multi Housing Council
9. ↑ Apartment Rental data, 2005, compiled by National Multi Housing Council
10. ↑ Apartment Stock data, 2006, compiled by National Multi Housing Council
11. ↑ All data from annual reports of companies. Market share statistics were taken as the percentage of addressable units owned by the company. "Addressable" refers to units in the companies' stated target markets