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Morningstar | Equity Residential Fundamentals Disappoint in 4Q, but 2019 Outlook Appears Reasonable

Lower top-line growth led to Equity Residential's fourth-quarter bottom-line result missing our expectations. However, our 2019 bottom-line estimate is within management's guidance range, so we won't change our $66 fair value estimate for the no-moat-rated company. Fourth-quarter same-store occupancy remained flat sequentially at 96.2% and same-store rate growth was 2.5% year over year. As a result, same-store revenue growth was up 2.6%, below our 3.0% estimate. However, payroll and repair expenses came in above 8%, driving expense growth up 4.2% for the quarter. Therefore, net operating income grew only 1.9% for the quarter, below our estimate of 2.4%. Equity Residential's West Coast markets continue to be the top performers, with NOI growth highest in San Francisco (5.8%) and Southern California (3.4%), while New York (down 2.6%) and Washington, D.C. (0.2%) continue to lag. The lower revenue and higher expenses led to normalized funds from operations of $0.84 per share, $0.03 off our estimate.

Equity Residential's same-store guidance for 2019 came in slightly below our expectations, but external growth guidance balances out the bottom line. Our estimate of 3.0% same-store revenue growth is near the top end of the guidance range of 2.2%-3.2%. Our expense estimate is slightly below the low end of the guidance range of 3.5%-4.5%, which leads our NOI estimate of 3.3% growth to be above the high end of management's guidance range of 1.5%-3.0%. Management plans more acquisitions and dispositions than we anticipated for the year, but the net balance is neutral and higher than our assumption that it would be a net seller for the year, and the dilution spread is expected to be tighter. As a result, normalized FFO is projected to be $3.34-$3.44, so our $3.41 estimate fits comfortably in the new guidance range. While we would hope to see more internal growth in 2019, we think management has achievable goals set for the year.

Supply continues to be a major issue facing the apartment sector in 2019. Equity Residential expects supply growth to be lower in Boston, New York, and Orange County this year compared with last year. New York supply will actually drop nearly 50%, driving management's revenue growth guidance of 180 basis points for the year, 100 basis points higher than what it achieved in 2018. However, the rest of Equity Residential's markets will see supply that is flat or even up in 2019. 2019 now looks to be the new peak year for supply as a number of projects slated to finish at the end of 2018 slipped into 2019, pushing supply growth back a year. While construction costs are rising faster than rents, the pressure isn't great enough for developers to shut off their pipelines and abandon projects underway. Management believes that 2020 will see lower supply growth than 2019, but its visibility that far out is limited at this point, and the past several years have all looked like the peak supply year at their start. We believe that 2019 will be a peak year for supply, but unless there is a sharp increase in construction costs or a recession lowers rent growth prospects enough to reduce supply, then the next several years won't look materially different than 2019.