REIT Focus: Equity Residential Properties

Aug.20.14 | About: Equity Residential (EQR)

Summary

EQR is an apartment REIT than owns all or a portion of 397 apartment properties located in 12 states with 111,491 units.

EQR is one of the best managed REITs and its portfolio is primarily Class A apartments in high barrier to entry markets.

We are not recommending the purchase of the stock due to the elevated price at $66/sh., FFO multiple of 21X and low dividend yield of 3%.

One of the most overpriced assets of all asset classes, stocks, bonds and alternatives, is Class A apartments and Class A urban hi-rises. Many are trading at 3%-4% cap rates.

This REIT Focus is on Equity Residential ("EQR"), a publicly traded REIT specializing in the acquisition, development and management of high quality apartment properties in top U.S. growth markets. EQR owns directly and through investment entities all or a portion of 397 apartment properties located in 12 states and the District of Columbia, consisting of 111,491 apartment units.

Property Information

The average occupancy, monthly rental rate and rental rate increase as of Q2-2014, were 95.4%, $2,152 and 3.9%, respectively. The majority of EQR's apartment properties are located in eight core markets of Boston, Denver, New York, San Francisco, Seattle, South Florida, Southern CA and Washington D.C.

Major Events

As of June 30, 2014, EQR had 12 apartment projects in development totaling 3,871 units with a funding commitment of approximately $1 billion through September 2016.

EQR was incorporated in Maryland in 1993, is traded on the NYSE, is an S&P 500 company and is located in Chicago, IL. EQR's debt is rated BBB by Standard and Poor's and Baa1 by Moody's. EQR has 361.5 million common shares outstanding and a market capitalization of approximately $23.85 billion. EQR owns a 96.2% general partner interest in its UpReit general partnership, ERP Operating Limited Partnership.

Management

Samuel Zell, 72, is the founder of EQR and has been Chairman of the EQR's Board since March 1993. Mr. Zell is Chairman and President of Equity Group Investments, LLC and Chairman of Tribune. Mr. Zell is Chairman of the Board of real estate company Equity LifeStyle Properties, Inc., Anixter International Inc., a distributor of electrical and cable products, and Covanta Holding Corporation.

David J. Neithercut, 58, is the President and Chief Executive Officer (NYSE:CEO) and a Trustee of EQR. Mr. Neithercut assumed the CEO title on January 1, 2006 and has served as President since May of 2005. From January 2004 to May 26, 2005 Mr. Neithercut served as Executive Vice President of Corporate Strategy, leading the EQR's Transactions, Portfolio Management, Development, Condominium and Research groups. Mr. Neithercut holds a B.A. from St. Lawrence University and an M.B.A. from the Columbia University Graduate School of Business.

Mark J. Parrell, 47, is the Executive Vice President and Chief Financial Officer (NASDAQ:CFO) of EQR. Mr. Parrell was named to this position in October 2007. From August 2005 until October 2007, Mr. Parrell served as EQR's Senior Vice President and Treasurer. In this role he was responsible for capital markets, mortgage servicing and tax and treasury functions for the company. From July 1999 to July 2005, Mr. Parrell served as Vice President and First Vice President in EQR's capital markets group with responsibility for financial planning and modeling as well as $2.0 billion in preferred stock and debt issuances. Mr. Parrell is a director of Aviv REIT, Inc.

Financial Analysis and Valuation

Select financial data for EQR as of the Q2-2014 10Q, 2013 10K and supplemental information (in millions where applicable):

Financial Data  
Real Estate Assets, Gross $27,341
Total Assets $22,991
Property Debt (at weighted average interest rate of 4.5%) $11,082
Common Stockholders' Equity $10,290
Revenue $1,286
Net Income $190
Net Income Per Share $.53
Cash Flow from Operations $619
Unsecured Revolving Credit Facility ($2,500 with $35 used) $2,465
Market Capitalization $23,850
Property Debt to:  
Gross Real Estate Assets 40%
Market Capitalization 46%
Enterprise Value 32%
Dividend and Yield ($2.00/sh.) 3%
   
Valuation Methodology:  
Q2-2014 Revenue Per Above Annualized $2,572
Less: Q2-2014 Operating Expenses Annualized (excluding depreciation, amortization and interest expense and plus G&A expenses) 966
Annualized Net Operating Income 2014 $1,606
Projected Inflation Rate at 3.5% x103.5%
Projected Forward NOI for Next Year $1,662
Projected Cap Rate 5.5%
Projected Asset Value of Company $30,218
Add: Projects Under Development (at book value) 1,007
Land Held For Development (at book value) 307
Total Projected Asset Value of Company $31,532
Less: Net Operating Working Capital (163)
Noncontrolling Interests (339)
Preferred Stock (50)
Redeemable Noncontrolling Interests (440)
Total Debt Per Above (11,082)
Projected Net Asset Value of the Company $19,458
Common Shares Outstanding 375.9M (361.5M common stock shares and 14.4M in OP and LTIP units)  
Projected NAV Per Share $52
Market Price Per Share on 8/15/14 $65
Premium (Discount) to NAV 25%
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Financial Metrics

The gross real estate assets, property debt, revenues, net income (loss), funds from operations, return on invested capital and dividends per share for the years 2009 through Q2-2014 are shown in the table below:

(millions except per share amounts) 2009 2010 2011 2012 2013 Q2-2014
Gross Real Estate Assets $18,465 $19,702 $20,408 $21,008 $26,800 $27,341
Property Debt $9,392 $9,948 $9,720 $8,529 $10,766 $11,082
Revenues $1,943 $1,773 $1,525 $1,747 $2,388 $1,286
Net Income $348 $269 $880 $826 $1,826 $190
Funds From Operations $661 $682 $760 $883 $1,057 $561
Return on Invested Capital (1) 4.7% 4.9% 5.3% 6.9% 4.1% NA
Dividends Per Share $1.64 $1.47 $1.58 $1.78 $1.85 $1.00
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(1) This is the ratio of cash provided by operations divided by stockholders equity plus property debt, less cash, and measures the return the REIT is earning on its invested capital.

As shown above, our net asset value per share for EQR is $52/sh., versus a market price of $65/sh. Current average cap rates for apartment properties per our industry experience and CBRE's Cap Rate Survey are in the 4% to 8% range, depending on the location, age and quality of the property. We have used an average cap rate of 5.5% due to EQR's portfolio being primarily Class A apartment properties located in high barrier to entry markets and the superior management team.

Valuation Analysis

EQR's strengths, concerns and recommendations are as follows.

Strengths:

· First class management team.

· Diversified portfolio of 397 apartment properties in 12 states.

· Average rental rate increase from Q2-2014 over Q2-2013 of 3.9%.

· Solid occupancy of 95.4%.

· Low leverage at 32% of enterprise value.

Concerns:
 

  • Low dividend yield of 3%.
  • Elevated stock price at $65/sh. and 21 times FFO.
  • Negative working capital of $163 million


Recommendations:

EQR is an excellently managed company with a solid portfolio of apartment assets, however, we believe that the stock price is too elevated and trading at a cap rate of approximately 4.7% and are not recommending the purchase of the stock at these levels. We would be a buyer of the stock in the mid to low $50 per share.

The apartment market is the hottest sector of commercial real estate with robust demand and rental rate increases, especially in supply constrained markets like Boston, San Francisco, San Jose, New York and Seattle. Of all asset classes including stocks, bonds and alternatives, we believe that Class A apartments are the most overvalued asset with many trading a sub 4% cap rates. According to the Mortgage Bankers Association of America, there were 347,000 permits and 306,000 starts for apartment units as of May 2014 which will add additional supply to constrained markets.

A five year price chart of EQR is shown below:

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.