Residential Equity (NYSE: EQR) is a REIT and constituent of the S&P 500 that focuses on the rental of high-quality residential properties located in dynamic cities that attract affluent long-term tenants. The company has interests in more than 300 properties comprised of approximately 80,000 apartments, with an established presence in key markets, such as Boston and New York, as well as a growing presence in growing markets, such as Denver and Atlanta.
Exposure to some of the largest cities in the United States provides EQR with a pool of large and diverse industries and businesses that attract and create high-quality jobs that are often knowledge-based. These jobs result in a significant presence of tenants who work in the higher-paying sectors of the economy and who are not too burdened with their rents. This allows EQR to consistently increase rents with little hindsight.
Another attraction of EQR properties is their proximity to entertainment venues, universities, cultural and outdoor facilities, and public transportation or highway access. These amenities are particularly appealing to younger populations, such as millennials. Additionally, this group tends to stay as tenants longer due to various societal trends, such as marriage delays and having children. children, in addition to a lower capacity for home ownership. These trends have been and will continue to be tailwinds for EQR.
EQR’s success has rewarded long-time shareholders with above-market returns, in addition to a growing dividend, which has grown at a CAGR of 6.4% from 2011 to 2022 and currently yields over 3.5 % at current price. Supported by respectable rental growth and a strong balance sheet, EQR is offering an upside of around 15%. With shares down around 25% year-to-date, the stock offers an attractive entry point for long-term minded investors.
Revenue review and other reportable events
In the most recent filing period ended March 31, 2022, EQR reported total rental revenue of +$653 million, up approximately 9% from the same period last year. but approximately +$4.5 million less than expected, mainly due to higher than expected payment delays. in Southern California.
Nonetheless, the company reported strong same-store revenue growth of 7.8% due to high occupancy and pricing power over rental rates. Additionally, same-store sales were the lowest in company history at 8.7%. These strengths contributed to a 26.7% increase in EPS and a 13.2% increase in normalized FFO per share during the quarter.
For the quarter, occupancy was 96.3%, up around 140 basis points from 2021. It was up to 96.6% on the day of publication and even higher at 96.9% in May. The upward trend reaffirms the desirability of QRE properties for a population that is increasingly homeless. Further evidence is reflected in the company’s renewal activity, which came in at 11.9% for the quarter and remained strong at record highs in April of 12.5%.
Across individual markets, New York continues to be the best performing market for EQR, with same-store revenue growth of 13.6% and occupancy of 96.9% for the quarter. The high demand translates into the renewal of 60% of their residents. Although it’s about 5% lower than renewal rates at the start of the year, the company is still able to re-let the space to new residents at even higher rates. For the remainder of the year, the market is expected to be the strongest performer among the company’s operating regions.
EQR is also benefiting from favorable return-to-work trends and increased job postings, particularly on the West Coast. The hybrid arrangements adopted by many companies require most employees to maintain some presence in the region, despite their desire to live elsewhere. Given the trade-offs, the preferences of many of these employees are rentals rather than outright purchases.
A drag on current period results was higher than expected in Southern California due to some tenants refusing to pay their rent and demand for state rental assistance funds from the square. In previous quarters, these same tenants were good payers and never had any problems. With the relief period ending at the end of March, the company does not expect any further issues to progress and intends to work with affected residents, who number approximately 300, to resolve their problems.
In addition to delinquencies, the market environment in Southern California appears favorable, with real estate prices out of reach for many residents, forcing many to rent. Additionally, the occupancy rate in Los Angeles was 97%, with growing demand from the entertainment content industry. Strong demand in the region is in turn reflected in some of the highest renewal rates in the company’s history.
Looking ahead, EQR largely stuck to its outlook for the rest of the year, which disappointed some investors given the upsides provided by two of its peers. Still, results appear on track for a strong finish, with revenue, NOI and normalized FFO trending towards the high end and expenses on track for peak performance.
As of March 31, 2022, EQR had total assets of +$20.8 billion, consisting primarily of net real estate investments of +$19.9 billion and total liabilities of +$9.3 billion, which included net mortgages of +$2.2 billion and net notes of +$5.8 billion. As a multiple of EBITDA, net debt was recently at 5.38x, a slight improvement from the 5.61x reported at the end of December.
At a weighted average maturity of 8.1 years, most of EQR’s debt is due in future periods and has the advantage of being predominantly fixed rate, which insulates the business from the current environment rate hike. The company, however, has +$1.3 billion due in 2023.
A low degree of leverage and readily available access to debt markets provide EQR with viable options to refinance debt due in 2023. With only 5% floating rate debt on the books at present, EQR would benefit hedging of refinancing at variable rates on maturity. Additionally, the company also has +$2.2 billion in readily available cash. Given the longer-term nature of their remaining debt, repayment risk is minimal at present or in the foreseeable future.
Further support of EQR’s adequate debt coverage is evidenced by their strict compliance with their existing debt covenants. The consolidated income available for debt service, for example, is 5.24x, which is higher than the amount reported at the end of December and significantly higher than the 1-1.5x requirement. The continued strength of this measure will ensure that EQR is able to quickly meet its service requirements before the debt matures.
In the current period, excluding depreciation, total expenses increased by approximately 4.4%, but revenues increased by 9.3% due to strong demand in their markets and a binding power high prices. Continued strength in rental spreads and occupancy, coupled with declining defaults, will support further revenue growth in future periods. A capable management team able to navigate an unfavorable cost environment further bolsters confidence in continued earnings growth.
Strong cash flow generation provides further support to the fundamentals of the business. In the first quarter, EQR generated +$368 million in cash flow from operations and +$171 million remained after accounting for its investing activities. For income-oriented investors, EQR provides an annual dividend of $2.50/share that is fully covered by operating cash flow and represents approximately 81% of normalized FFO. With a long history of growth, the payout has proven sustainable for income dependent investors.
EQR is a leading owner and operator of residential properties in key urban environments in the United States. Their exposure to high-income residents with jobs offering continued wage growth gives the company the power to raise rents without significant setbacks. In the current period, for example, rent as a percentage of residents’ total income was around 20%, despite double-digit growth in rents.
Rising rental losses also put the business in an excellent position to capture additional growth through 2022 and beyond. In May, the net effective rental loss was around 13.5%, compared to 11.1% in April. Although this was lower than its peers, AvalonBay Communities, Inc. (AVB) and Essex Property Trust, Inc. (ESS), the double-digit rate was still better than the company’s expectations.
Right now, EQR is trading at 20x FFO futures and near their 52-week lows. Robust demand, strong pricing power and industry resilience are a few catalysts likely to propel the stock higher in the coming months. Using a standard dividend growth model with a dividend growth rate of 4.5% and a discount rate of approximately 7.6% gives an approximate stock value of $80.
In addition to around 15% upside, an investment in EQR provides a steady stream of reliable dividend payments, which have grown at a CAGR of 6.4% since 2011 and look safe for the foreseeable future, supported by the strong company balance sheet and earning potential. For long-term oriented investors seeking rental exposure to quality urban markets, EQR is a REIT poised to deliver a sustainable rate of return on any diversified portfolio.