2023-11-13 13:08:06 ET
Summary
- Equity Residential is a REIT that acquires, develops, and manages residential properties all over the country.
- The company has seen high resident retention, low turnover, and decent financial performance, with a 29-year history of dividend payments.
- Although the dividend yield may be unattractive, the discount to NAV presents an opportunity right now.
Equity Residential ( EQR ), founded in 1993 and headquartered in Chicago, IL acquisitions, develops and leases multi-family residential properties all around the country.
Though the dividend yield is too low to be attractive these days, the REIT is trading at a significant discount to NAV to deserve some consideration for value investors.
I perceive the discount as unjustified as this is a profitable REIT that may be lacking a marketable growth story that other REITs can boast of, but has very low leverage and cost of debt, as well as plenty of liquidity to weather adverse conditions. Additionally, it has a geographically diversified portfolio of assets, which is what I would like to start this analysis with.
Portfolio
As of the end of the third quarter, Equity Residential had a portfolio of 305 properties, which includes indirect, as well as partial investments. The portfolio consisted of 80,683 apartments and is spread across 10 states and the District of Columbia.
What mostly caught my eye is that the REIT's diversification reflects a balance between the East and West Coast markets; something that we should take into account in regard to the assessment of risk.
Performance
When it comes to Equity Residential's occupancy, the rate by the end of the 3rd quarter was 95.9%, lower than the rate of 96.5% for the same period in 2022.
However, it is encouraging that the lease renewal rate was at 54% for the third quarter; within the context of the residential leasing market, I find this to be sufficiently high. Moreso, resident turnover was reported at 34.3% for the 9 months ended September 30; one of the lowest levels in Equity Residential's history.
What doesn't inspire much confidence is the long-term operating performance of the REIT:
As you can see, growth has been slow. But more importantly, it lacks a definite trend and, therefore, some degree of predictability. That said, the more short-term results indicate some growth.
On an annualized basis, rental revenue for the third quarter represented an 11.81% increase from the average annual figure over the last 3 fiscal years. A higher increase is reflected in the annualized same-store cash NOI when compared to the 3-year average. Based on the same approach, AFFO indicates a 16.78% growth.
Leverage
When it comes to the use of leverage, the REIT has been operating at conservative levels over a long period. First, its ~38% debt-to-assets ratio seems to be the result of a continuous downtrend over the last decade. But more impressively its debt-to-EBITDA sits at 4x, a very low level in the last 5 years. Coupled with an interest coverage of 3.7x, liquidity appears to be as strong as the capital structure.
Additionally, it carries its debt at a 3.67% weighted average interest rate and based on the last 10Q report, it has no significant maturity until June 2025; enough far into the future to not represent neither an immediate nor a highly likely future higher cost of debt.
Dividend & Valuation
Currently, Equity Residential pays a quarterly dividend of $0.66 per share, which suggests a 4.84% forward yield. I believe that this is fairly safe because the company has paid a dividend for 29 years, has been steadily increasing it in the last 5 years, and the payout ratio is 72.04% based on AFFO.
Regardless, the yield doesn't represent good value here. The FFO multiple agrees with this statement as it's fairly close to the average one of the closest competitors:
Stock | P/FFO |
EQR | 14.42 |
AVB | 15.88 |
ESS | 14.01 |
MAA | 13.38 |
UDR | 13.20 |
Average | 14.18 |
However, I find that the implied cap rate of 6.61% which EQR is trading at is a lot higher than the rate at which its properties would likely be sold today. In my opinion, a more appropriate cap rate would be around 5%, which would suggest NAV at $78.51 per share and a current discount of 43.95%.
And for what it's worth ~$80 is not unfamiliar territory for the stock:
Risks
EQR checks the main boxes of what I'm looking for; a high discount to NAV with a decent yield. The undervaluation is the main dish for me. However, I understand that for many investors who are interested in REITs, the dividend yield is. If you're one of them, EQR doesn't have much to offer.
From a safety viewpoint, the REIT has low leverage and plenty of liquidity. But since dividend investors are better off with long-term positions, EQR is a risky one to hold for a long period of time. Profits appear unpredictable and the same thing is reflected in the historical stock price. Volatility can shake an investor's conviction; especially if their primary goal is to enjoy low but predictable dividend returns. To such an end, EQR as an equity is unfit and represents a risk.
To those who are more like me and mainly appreciate the NAV discount, I want to highlight a different risk. As I said, the NAV I mentioned above is what I estimated based on a 5% cap rate. But calculating NAV is not an exact science and such a figure should be approached with caution; especially if you feel that this is the heart of valuation and place the most weight on it (like I do). Though a 5% cap rate may be appropriate today, we don't know if it will be tomorrow. And that represents a risk.
As a side note, I see a lot of average cap rates reported in the mid-4% level for residential properties across the country. So, I think that 5% is a conservative assumption. Additionally, the suggested discount is so large that I find it very unlikely that someone wouldn't be buying below NAV at the current price.
Verdict
In conclusion, I rate EQR as a BUY. The yield may not be much these days, but I believe you would be buying a diversified portfolio of residential assets at a significant discount managed by a company that uses very low leverage and has sufficient liquidity.
The history of the stock price also provides an attractive picture for me. Though the REIT is obviously not a long-term investment opportunity, it has reached and surpassed the NAV before. It's one of those long-term trading opportunities instead.
What's your take? Do you own EQR shares or intend to? Also, let me know if this article was useful. Feedback means a lot to me. Thank you for reading and I'll see you below.
For further details see:
Equity Residential: Low Yield, But Large Discount To NAV