EQC - Rate News Not Welcome For Equity Commonwealth

Summary

• The hawkish Fed comments are unfortunately well-founded, and rates will be stubborn for a while longer.
• That makes return hurdles harder to jump, and less disciplined buyers are the ones in the market now.
• EQC is right to stay on the sidelines, but it's not good that the stock is dead capital.
• At least they are buying back stock at about 6-7% rate this year, and will probably continue to do so as they run the clock.
• Also, the stock is simply 5% below cash value. But we can allocate our own money, and don't need Sam Zell to do it for us.

Equity Commonwealth ( EQC ) is the Sam Zell real estate vehicle that has almost only cash now and is still looking for opportunities. We can't fault them for discipline, but they've been dead money besides the buybacks. Overall, we think that because of the macroeconomic climate, it's going to be a while longer before they can make a deal. Return hurdles are rising, and there are plenty of less disciplined buyers ready to lose money in real estate before EQC gets involved. While there's no urgent update, investors may want to be opportunities with EQC and move out of it if there are much more pertinent opportunities in less competitive markets.

Q4 Notes

EQC is a victim of the fact that real estate is a more competitive market, since everyone owns real estate, even households. Considering that residential markets are in the cross-hairs of EQC, this problem holds, and there are plenty of undisciplined buyers out there driving down capital return rates in these segments.

The macro conditions also present a problem. The hawkish comments by various FOMC members are well-founded . They cannot allow even moderately high inflation to linger, because it could suddenly come into consumer expectations - although for now there's no evidence of that. Rates will remain high, even though we are seeing disinflation. Risks here are a successful China recovery, which could reflate commodities and stop the downward trend. All of this has shifted the yield curve straight up, which bodes poorly for long-term financing rates and is going to affect the return profile of real estate priced at the levels of a couple of months ago. RE needs to decline, but it's slower to respond than other parts of the market.

EQC is being as efficient as you could expect about the fact that they're not investing capital. They bought back about 6-7% of their shares this year, which is a good thing, because it's tax efficient to provide payout as they wait to pounce. Still, that's just a capital return that creates no value at all for people not selling back their shares to the company and holding dead-money stock. EQC is not to blame, but the yield curve translating higher is not good for return thresholds, and they were not likely to have made a good allocation so far this year.

Bottom Line

However, we need to acknowledge that EQC is beginning to look a little cheap. It's trading below its cash value now at $23, so around 5% below cash value. Not bad as a NAV discount with no risk except opportunity risk at the moment, but the issue is that we can allocate our own money, and have been doing so very successfully in 2022, so the opportunity cost for us is actually very high since we still have new ideas. We'd venture that given the opportunities still on the market outside the real estate mandate of EQC, which is maybe just too competitive, you, investors can also find opportunities for yourselves. There is likely to be time to rotate through other investments to get your money back into EQC if you'd want to.

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