Andrii Yalanskyi
The trend in monthly rents puts the multifamily sector on downside watch. The most recent Zillow Asking Rents report for June showed rental rate growth continuing to cool through June. This same report highlighted a record-high number of units under construction. Upon delivery, this could cool rents even further. Names such as Equity Residential (NYSE:EQR) are trading at levels that may not reflect this downside. Perhaps it’s because they’ve shown that they’re less exposed to oversupply than one may expect. They may even be thriving at the expense of others. Taken together, I view EQR as fairly valued at current trading levels.
Equity Residential Q2 Results
EQR grew same-store net operating income (“NOI”) by 5.4% YOY. Average rental rates grew 6.4%, contributing to a 5.5% increase in total revenues. Occupancy levels did decline by 80 basis points (“bps”) YOY but remained flat on a sequential basis, despite a 1.8% increase in rental rates over the same period.
In individual markets, New York exhibited the greatest strength. Revenues were up 13.3% on rate growth and no change in occupancy levels. NOI was up an impressive 21.2%. The growth is notable, given the market’s share of total NOI. At period end, its share was 14.2%.
The Southern California market remains weak, with negative NOI contributions out of Los Angeles. But CEO, Mark Parrell, did note improving delinquency trends in the market. This improvement could be seen in the sequential performance. From Q1 to Q2, NOI grew 5.2% in the region, 10bps points better than the portfolio average. And this growth was led by revenue growth of 2.5%, which was also better than the overall portfolio.
EQR Q2FY23 Investor Supplement - Summary Of Sequential Same-Store Results
The same-store performance translated to 5.6% YOY growth in normalized funds from operations (“FFO”). Looking ahead to the remainder of the year, full-year FFO guidance was revised up by $0.02/share at the midpoint to $3.80/share.
This would represent about 8% growth from fiscal 2022. The positive revisions were due in part to increased expectations for same-store NOI growth, which is expected to grow 6.65% at the midpoint due to reduced expectations in expense growth.
EQR Q2FY23 Investor Supplement - Summary Of Full-Year Guidance
Two Takeaways From EQR’s Q2 Earnings Release
Return-To-Office Working In EQR’s Favor
Increased resident flight out of the urban districts over the past several years is well documented. What may not be getting as much attention is their return. Two significant drivers of this return are stricter in-office requirements and improved quality of life.
Consider Seattle. The market continues to be a weaker exposure area. Weighted occupancy is about 80bps below the portfolio average, and net effective pricing in the key downtown district is still below pre-pandemic levels. This is due to continued use of concessions.
But in recent months, the market has shown some promise. One neighborhood that was called out on the earnings release was the tech-heavy South Lake Union neighborhood. The pickup in activity was attributed to Amazon’s (AMZN) return-to-office mandates, which began in May.
It’s not just Seattle. In other markets, particularly on the western coast, employers have stepped up their in-office requirements. In the San Francisco Bay area, for example, 77% of EQR’s residents have said they are either hybrid or fully in office.
The in-office requirements matter because it’s beginning to create a strain on the commute. With traffic up more generally compared to the past two years, commute times into the urban areas are now longer than they have been previously. Naturally, some would like to live closer to their place of work. And among their new tenants, this was cited as a key reason for signing a new lease with EQR.
Supply Outlook Not As Concerning
Exposure to the Sunbelt region of the country has been a boom for many. EQR’s presence in these markets, however, is limited. This may have placed them at a disadvantage on the way up. But at present, it may work to their favor.
Growing rents paired with a more favorable business environment in the Sunbelt attracted a flood of new development. With significant levels of supply just beginning to be delivered to the market, the region appears at greater risk of being oversupplied.
Deliveries are also rising in EQR’s markets but to a more moderate degree. What’s more important is competitive supply, which the company defines as apartment properties within a radius of ½ mile to two miles of their properties. Here, deliveries are expected to be up but still less than pre-2019 levels.
EQR Investor Presentation - Graph Showing New Competitive Supply By Year
EQR is seeing greater deliveries in competitive supply in some markets, such as Washington DC. But they noted that the supply is being absorbed at a healthy rate. Sequentially, occupancy in the region was up 20bps, rental rates were up nearly 2%, and NOI was up a healthy 5.7%. In my view this confirms management’s assertions.
And in their strongest performing operating market, New York, EQR is seeing very little competitive new supply. This should bode well for further strength in the market.
Where they are seeing the most impact on the supply front is from their smaller and more “expansionary” markets, such as Denver, Dallas, and Austin. The NOI impact in these markets, however, is limited.
EQR could face some issues in Seattle, but I expect any weakness here to be offset by strength on the other side of the coast.
Is EQR Stock A Buy, Sell, Or Hold?
I view multifamily operators as at risk of declining rental rate growth due to rising deliveries in supply. I see Equity Residential, however, as better positioned due to their greater concentration in the urban coastal markets. A less accommodative environment from a regulatory perspective is one wedge developers must contend with. Inherent space restrictions are another.
Increased return-to-work requirements, such as from Amazon, are also creating commuting challenges for those living further away from their worksites. This is forcing many to return to the cities where EQR’s properties are located. A greater emphasis on public safety among some urban leaders is also resulting in an improved quality of life for those that do return.
Does this mean shares are a buy? I don’t believe so. While EQR is less exposed to overbuilding, competitive supply is still rising in certain markets. Shares also trade generally in-line with peer, AvalonBay Communities (AVB). AVB does command a slight premium.
Between the two, there isn’t much difference in the outlook. Expected FFO growth is comparable. In the same-store portfolio, EQR edges out AVB in overall NOI growth due to more controlled expense growth. But AVB has a slight edge in revenue growth. The two companies are otherwise quite similar.
Consensus Wall Street estimates target 8.3% upside in EQR. I believe it can get there. But I don’t believe the return would create much enthusiasm among investors, given current risk premiums. While EQR is a well-managed company with a stable outlook, I maintain a neutral view on the shares.
