EUR 850.00 For Business Accounts Only

Morningstar | West Coast Strength and Accretive Acquisitions Lead to Beat for Equity Residential in 3Q

Equity Residential's third quarter was better than we expected, though we don't anticipate any material changes to our fair value estimate for the no-moat-rated company. Occupancy remained flat at 96.1% and same-store rate growth was 2.1%, with continued strength coming from Southern California (3.6% growth) and San Francisco (3.2%) while New York (0.4%) and Washington, D.C. (0.8%) continue to lag. As a result, same-store revenue growth was 2.3%, above our 1.4% estimate for the quarter. However, expenses also came in higher than we anticipated, growing 3.7% year over year due to high growth in maintenance costs, insurance, real estate taxes, and labor costs. The combination lead to net operating income growth of only 1.7% for the quarter, though still above our estimate of 0.9% growth. On the strength of the quarter, Equity Residential estimates 2018 NOI growth of 1.7%, near the high end of its prior guidance range of 1.0%-1.8% and slightly above our estimate of 1.5% for 2018.

Equity Residential reported normalized funds from operations of $0.83 for the third quarter, a penny over our estimate due to the higher-than-anticipated internal growth. It also narrowed 2018 normalized FFO guidance to a range of $3.25-$3.27 from $3.22-$3.28. The new guidance range is above our estimate of $3.24 for the year, though we attribute the difference to timing of external growth. The company had guided to $700 million of both acquisitions and dispositions for the year, so we spread out the remaining balance equally over the back half of 2018. Equity Residential executed $507.3 million of acquisitions and $416.1 million of dispositions at a positive cap rate spread, so the accretive external activity earlier than we anticipated explains the higher 2018 FFO guidance but doesn't affect our long-term outlook for the company.

The transactions that Equity Residential completed in the third quarter look like a promising shift of assets that we hope the company can continue to achieve in the future. We have generally assumed that the company sells lower-quality assets in low-growth markets at cap rates higher than transactions in high-growth markets, which tend to see higher prices due to increased competition. However, the 506-unit apartment building in New York City that Equity Residential sold in the third quarter was sold at a 3.9% disposition yield, lower than the 4.4% acquisition cap rate paid for the three properties in Denver and Boston that were acquired in the third quarter. While we believe that New York City should continue to command a sub-5% cap rate as it has many demand drivers that should persist for at least the next decade, the near-term growth of the city will be limited as it continues to face high supply. Being able to exit this market at a sub-4% cap rate is a great deal. Meanwhile, Denver is a high-growth market with a significant inflow of residents attracted to the job growth in the city, and Boston has maintained higher rent growth than other East Coast markets, so paying a 4.4% cap rate seems a little expensive but justified, considering the expected growth, and is immediately accretive, given the spread over the disposition yield used to finance these transactions. If the company can continue to execute these types of deals, it can continue to create shareholder value through external growth opportunities.