Equity Residential (EQR) Earnings Call Transcript & Summary

Good morning, everyone. For those of you who don't know me, I'm Josh Dennerlein, Bank of America's Senior Analyst covering the residential REITs. I'm joined by my colleague, Jeff Spector, who is the Head of the Bank of America's REIT team. We're extraordinarily pleased to have with us Equity Residential's President and CEO, Mark Parrell. [Operator Instructions] With that, I'd like to turn it over to Mark for some brief introductory remarks.

Yes. Good morning, everyone. I'm Mark Parrell. I'm the CEO of Equity Residential. And just by means of introduction to the company, we're a $38 billion S&P 500 Apartment REIT. Our strategy is to own apartments in places where affluent renters want to live, work and play. That predominantly was the coastal markets of Boston, New York, Washington DC, metro areas, the Bay Area, Southern California and Seattle. In the last few years, we've expanded our presence as our affluent renter base has moved to places like Denver, Dallas, Austin and Atlanta. So we're expanding into those markets as well. We do have a portfolio that's tilted more urban than suburban, so we did feel the COVID pandemic quite acutely. And for us, 2020 was more about operational intensity and just getting through that process. At the beginning of this year, we said on our earnings call that 2021 will be a year of recovery and that is 100% true. Net effective pricing, and I want to just define that, that's our current spot rents, and that includes the impact of concessions, is up 30% since January 1, so an extraordinary improvement. Demand is very high. We're very well occupied today at 96.9%. And as you saw on the press release we put out yesterday afternoon, our same-store revenue growth is on track to meet or slightly exceed the guidance we put out back at the end of July. So we see 2022 as a year of acceleration. So if 2020 was the tough year, '21 you're getting yourself recovered, '22 is going to be a year of acceleration for us we think. And we believe the company is going to post the best numbers in its history in terms of same-store revenue growth. In fairness, that has to be thought of in the context of the prior 2 years, which were very difficult, but we still feel like this recovery has gone exceedingly well and we're very well positioned going into next year. So to give you context on that, our loss to lease, and that's another term I'll define, which is that if you take our current rent roll and you just imagine there is no inter-period growth and you just rolled it through the next 12 months, so every lease that was below market would go up to market and occupancy would stay constant, that increase would be 16%, so quite significant. It will go down a little because we're a seasonal business. So towards the end of the year, rents tend to go down, occupancy tends to go down and we're likely to see some measure of that this year as well, but we'll still go into next year very well positioned. So switching from operations to capital allocation, I said in the introduction, we've been very active in trading assets. The market is extremely competitive. The private equity firms, the private buyers of real estate are very active in our space. They see apartments as a great place to invest capital and we're seeing the benefit of that when we sell assets. So our capital allocation activity currently is really much more about a trade. So we're selling California assets, usually older properties, regulatory challenges, property-specific challenges. Usually, they're 25 years old or so, and we're buying properties in markets like Denver, Austin, Atlanta and Dallas. We're also planning to sell in New York and Washington, D.C. The New York market is rapidly improving. In fact probably has the highest upward trajectory right now. So we think that the investment market will follow, and there'll be an opportunity for us to lighten the load a little bit in New York as well. So we expect this to create a company with better long-term cash flow growth prospects and less volatility. And we're also doing a bit more development than usual. We announced a joint venture with Toll Brothers, the well-respected homebuilder. They have a terrific operation and very well built out in suburban locations and in some of the newer markets for us. So we don't have development teams in places like Dallas and Atlanta, where we've moved recently. To acquire those teams, it would take years of just finding the right people, finding the right opportunities. By partnering with Toll, they find those opportunities. We're 75% of the capital, and we have the ability to acquire the asset at the end. We're really accelerating our transformation. So again, a lot of activity at the company with the goal, again, of creating a company that's probably in 11 or 12 markets, has very good balance and is a little less volatile and is maybe 60% urban, 40% suburban. We're probably more like 70%, 75% urban right now in the total portfolio. I'll note just a few things on the ESG front, and then I'll turn it back over to Josh for questions, but we're a leader in ESG area. We're going to publish our 8th annual ESG report in a few weeks. We focus on each of those 3 elements. We are the North American development leader according to GRESB this year in that area. And we also have significant activities, both in the social area, in terms of diversity and inclusion initiatives and the like, and I'm happy to talk about those. And on governance, we continue to get very good scores and excellency on pay scores and things of that nature. So we consider ourselves a very well-run organization and very well governed. So I look forward to your questions in those areas, and I'm ready to roll when you are, Josh.

Yes, appreciate that intro, Mark. Fantastic. Maybe -- I mean, I like to kick start these Q&A sessions with a question I ask everyone and just kind of what is your view one of the top reason investors should buy your stock today?

Sure. So I'd start with the quality of the portfolio. So we have a younger portfolio in these newer markets than our competitors. So one of the questions we get is our portfolio will resemble some of our competitors. I don't think that's really true because we're going to have much younger assets in places like Dallas and Atlanta. So I think the quality of the assets attracts a better quality resident, which is our second advantage. And it also means we're going to spend a lot less on CapEx. So a lot, again, of private and public competitors of ours we'll say they're getting pretty good revenue growth, but we spend about 7% or 8% of our revenue on capital of all sorts. A lot of our competitors spend double that. So I think there is something going on there in terms of cash flow diversion to capital that needs to be considered by investors. And again, our second advantage, I'd say, Josh, is just for renter demographic. Our average renter makes $150,000 a year, is in the technology field, is in the legal field, is in the finance field, very well employed. We had very little delinquency in the portfolio through the whole COVID process. I think what that's going to allow us to do in this affluent renter base is raise rents more quickly because I think people are well positioned. They're paying us about 19% of their income on average in rent. So there's a lot of room there to raise rent. I think they've gotten good pay increases. All this wage inflation is positive from that perspective for us as well. So I think you're going to see that quality portfolio. We had also always been concerned, and I think there will be an acceleration here that what would happen in the service sector in terms of automation would be the same thing that happened in the manufacturing sector. So in the manufacturing sector, a huge downstroke in employment over 3 decades as people automate it and offshore. And I think all this technology we learned to use during COVID will have the same effect in the service sector over the next half decade or so. And I guess, I would say I'd rather be housing automating than the folks that may have fewer job prospects as a result of the automating. And finally, and this is really important. The upstroke, the power of the recovery in our company is going to be extraordinary, I think. Again, assuming conditions remain supportive, I think the pandemic, if it can remain more about masks than about closing down cities, I think you're going to see an acceleration that's really very strong in our company and the business overall, but particularly in guys like us that owned a lot of New York and San Francisco, where there's a lot more recovery to be had. And all our markets, except San Francisco, are already at or above rents from peak periods in '19. So we'll recover back. So as those leases roll at the end of this year and into 2021, you'll see that run through our numbers. Concessions are really low in the company, around 2%. So as those roll off, we are a straight-line concession shop. So as those accounting charges roll off, you'll see that benefit as well. So again, quality of portfolio, quality of the renter and just the accelerated, I think, revenue growth you're going to see in the next 2 years.

Yes. No, interesting that you started off kind of your opening remarks with 2022 as a year of acceleration. And I think if I heard you correctly, you said you expect to kind of post the best numbers in history. So...

Yes, I think so, but I want to just -- in fairness, again, we put up the worse numbers in our history the last year. So we're going to recover all that. But what's exciting us, Josh, is I think we're going right past it. I think we're on that V recovery, and we're going to sort of keep going because demand is so amazing right now. When you see our occupancy numbers that we feel like we've got a lot of opportunity to just sort of keep going in terms of revenue growth.

Josh, if I can...

Yes, please, Jeff.

No, I just wanted to ask just to clarify, Mark, are we saying that the Sun Belt markets have just continued to see strength? Are you saying that the urban coastal markets -- again, I know it's easier comps, but urban coastal should outperform Sun Belt next year?

That seems likely to me. Again, you always have to be fair about your comp period, and you referenced that correctly. I think we have a relatively easy comp. And as a result of that, we'll do very well. But I also think you'll see very good growth in places like Los Angeles, San Diego, Orange County, Jeff, where our portfolio wasn't hurt much, where a lot of those markets resemble the Suncoast -- Sunbelt markets, pardon me, and those will show good numbers, too. So I think all of urban business is going to have a great 2022. I would expect us to be at the higher end of the range of outcomes.

And then, Josh, if I could just ask 1 more question, I'll turn it back to you. I guess, Mark, the strategy to reenter Atlanta, we're comfortable with the market focus, the reentering, again, Atlanta. You're entering Dallas and Austin, but we are -- we do continue to receive some pushbacks. So for those investors on the call that are still stuck with the fact that Equity Residential sold out of some of these markets, you're reentering at an expensive time. How are you trying to convince people that, again, this is the right strategy for the next 5 or 10 years?

Sure. Great question. So I shared that skepticism, Jeff, because the Atlanta and Dallas that I knew and loved back in the middle of my career, 15 years ago, [ wasn't ] Atlanta and the Dallas we didn't want to own in. It was an area where there weren't that many high-quality jobs and where single-family housing is relatively inexpensive. And you had to put a lot of capital in your properties, which again is, I think, what a lot of our competitors do to remain performing and they are further out suburban assets in these markets. But what's changed is pretty significant in those markets. There's been a shift to a lot of high-quality jobs, whether it's Microsoft's campus in Central Atlanta, whether it's all the State Farm operations, Toyota and the like, that have moved to places like Dallas. And of course, the story in Austin is really compelling. So you have a lot of high-quality jobs, a lot of high-quality renters and single-family housing prices have really increased. In Austin, all across the market, in places like Dallas and Atlanta, you have to be careful where you buy because there is cheap housing still in Atlanta. You just have to drive to it. In some of our neighborhoods we're buying in, we feel like housing prices are $600,000, $700,000. So this big increase in single-family housing costs, combined with this move of renters, along with the benefit of this political risk being a little lower in these other markets. That to us and that to our Board, really changed the dynamic and made these markets different than they were 15 years ago when we left and made it compelling to go in. We're going to continue to have a lot of exposure in our coastal markets. They will predominate the portfolio, but having a little bit more balance in the portfolio, mitigating a little political and resiliency risk, that seems thoughtful to us and following these affluent renters. We're not changing our strategy. We continue to follow high-quality properties, high-quality renters. We're just following on the new geographies and those geographies have a better dynamic, I think, on supply and demand than they did 15 years ago. And when you talk about the expensive, I just want to be clear, expensive is a relative term. We're selling things where considerably -- 25-year-old properties in California, you're going to see some stuff in D.C., hopefully, in New York. These are older assets. They have a lot of renovation needs. We don't think those [indiscernible] in a submarket where we have a lot of exposure already. But we don't particularly like the regulatory climate in that particular town. We're selling out of those assets at higher prices than we ever imagined. Cap rates around 3.3% on an honest forward 12-month basis, and we're buying 3.5% in these other markets. 3.5% is a really low cap rate for Atlanta, for sure and for Dallas. But I'd tell you, you're buying a better IRR, we think, in the long run. And you're not selling your best assets, EQR rates in California. You're selling the assets you probably want to sell anyway. So doing a non-dilutive trade to a better IRR makes plenty of sense to us.

Josh, maybe that ties into 1 of the questions we received from our audience, how are you thinking about the price you'll pay for a new asset relative to the current replacement cost?

So great question. So right now, we are paying and we are seeing in the market, 5% to 10% premiums to spot replacement cost to buy the assets we're buying. Now, that's not that unusual and paying some premium is okay because building it ourselves has certain risks associated with it. As those premiums get more significant, you have to be more careful. And so, there are deals that we've not pursued because the premium has been too significant relative to what we think spot replacement cost is.

Josh?

Yes. Might as well -- there was another audience, another question. You mentioned net effective rents are up, I think, 30% from January 1. Could you remind us what they are versus maybe 4Q '19 in your portfolio?

4Q '19, okay. [indiscernible].

We can always follow up. So...

And I want to define 2019. So this is the high watermark. Remember, we're a seasonal business. Highest rents in a normal year like 2019 are in July and August, right? So at that point, our rents comparatively to now, we are 4% above that high watermark. Our rents will likely slightly decline for the balance of the year due to seasonality. But again, with the occupancy we have above or at where it was in 2019, and big outliers are Los Angeles is considerably higher, Orange County and San Diego.

Okay. And how are you thinking about the timing and maybe pace of that recovery in San Francisco. It seems to be the 1 [ wild market ] you're focusing on.

I was out there in June with our Chief Operating Officer, and I did think the quality of life improvements were real. Many of us who have been out there in 2019 and maybe felt less comfortable than we usually had in that wonderful city. And I think that got a little bit better. But it didn't have nearly the activation of the East Coast cities or Chicago. I think the reopening in California just happened later. And as a result, San Francisco was just behind. And with Delta -- the Delta variant coming and the delays in going back to the office, and this comment applies to Seattle, too. So when Amazon set in Seattle, they're not coming back, that sort of stopped the progress in Downtown Seattle. Things didn't turn into a swoon, but that's sort of Michael Manelis, our COO, called it second wave of demand. That just didn't happen. All those people we thought were coming at Labor Day, they just stayed wherever they were. We had good demand, but not that sort of over-the-top where we could blast through 2019 prices like we had in every market. So I think San Francisco is just a little behind, and I think it will get that wave of demand in the first quarter, assuming things really do reopen and employers call employees back and folks get back into their markets. And I think you'll see something akin to what you saw in New York, which is rapid improvements in occupancy and pricing.

Is that the key thing to watch is when these big employers say, okay, come back to the office in San Francisco and come back to office in Seattle and then -- and things start to really improve? Is there something else we should look at?

Yes, what a great question. I mean, New York, there is -- and I hate saying this to New Yorkers because you all think this way already, but there is something special about New York, and New York started to get better before the employers called people back. There is something that draws people to New York City, and we started to recover, Josh, even before widespread increases. Plus, there was a lot of talk that -- all the finance companies, all the banks said, "Hey, listen, we're coming back, almost all." And so as a result of that, in New York, the employers were relevant, but people were in a hurry to get back. And they liked the discounts and they were back in the market and prices are [Technical Difficulty] happened fast. In Seattle and San Francisco, it seems to be just a little bit slower. And I think it is a little bit of the employers holding back a bit. So it doesn't mean -- again, we're 95.8% occupied in San Francisco in that General Bay Area. So it's not like there's a problem. It's just that additional acceleration that we see everywhere else hasn't occurred yet. So my guess is when you see the name brands, the Amazons in Seattle, Facebook and the like in the Bay Area, call employees back, people will start to see and hear that message, and they'll start to react to that. So I think the employers lead the conversation, but I will say in New York, people wanted to be back enough that they went ahead of the required returns.

Lot of A types in New York. So they're going to come back early. Mark, maybe it would be great if we could explore the Toll Brothers partnership more. How that came together, the nature of your partnership, the relationship for EQR?

Sure. So Doug Yearley and the team at Toll and EQR have known each other a long time. We built the tower at 28th and Park Avenue South in New York together. So that was a joint development deal. And what really came to pass is we are, I think, perfectly complementary in our goals. EQR would like to put more assets on our balance sheet, particularly in these expansion markets, and we like newer assets that are well-located that appeal to our clientele. Doug wants to build and Toll wants to build those assets, but they don't want to host with them and go in with them on the land. So for them, they have better capital efficiency. For us, we're involved at the beginning. We can wave them away from things we don't like. We can encourage them the submarkets we want to be in. We can impact the design, whereas private equity and others, they're just money. We're money and we're advice, and we're reliable. I mean, they can lean on our balance sheet. On our end, you take significant counterparty risk in a joint venture. And I think that's greatly mitigated with Toll. So I think, again, they are developers, and we'll be aware of our differing interests. But on the other side, they build quality product and single-family and in apartments, and we bought their stuff before so we know it well. So it sort of was this confluence of things, Josh, I'd say, where they really wanted balance sheet efficiency. We wanted to add assets to our balance sheet. They wanted a more skilled and confident partner in terms of taking development risk with them, and we wanted more scale and not have to one-off all these development deals. So we started conversations. We have master agreements and we have a process where in the markets that are designated, which are Boston, Atlanta, the Texas markets of Austin and Dallas-Fort Worth, Denver and Seattle. And then for Southern California, it's just San Diego and Orange County. In those places, they show us deals first, and we have sort of an exclusive in that area. We can go ahead and do business away from them, but our expectation is they will be the predominant development channel for us in those markets. And we're 75% of the capital. They're 25%. They go out and get the bank loan. They provide all the guarantees. We go through the process and after stabilization, we have the ability to acquire the asset. We do need to acquire it at a market price. We don't have some discount process, but it is set up with the understanding that we would acquire the asset. And my expectation is we'll buy the asset 9 out of 10 times. And we've had similar ventures like this with a couple of the big national developers in the past. And they've generally worked very well for us. So we're really excited about it, and we're seeing a ton of scale. I got an e-mail this morning with a list of projects that -- it's pretty long, it's 13 pages long. I like lists like that. And I'm sure a lot of that will fall through. But those guys know what they're doing, we know what we're doing and I think it's going to have a really positive change to the company.

Mark, you said -- go for it, Josh.

No, no, please, Jeff.

I was just going to say that, Mark, you said earlier, the Toll Brothers partnership accelerates the transformation of the company into these markets. So the next logical question is acquisitions, larger scale acquisitions. Are there opportunities for EQR? How should we think about acquisitions, again, wanting to grow quickly versus, let's say, locations like the Atlanta asset you announced, I think, it was yesterday. Great location. But again, these are singles. How should we think about that?

If you hit enough singles, Jeff, it ends up being a lot of runs. And we're a volume shop. We're very good at this. The people that we have that run the acquisition team, Alec Brackenridge, who's our Chief Investment Officer. He bought our portfolio in Atlanta. He has 25 years of experience. So we hit the ground running in Atlanta and in Dallas. One of our lead acquisition officers still lives in Denver, did the entire time. So what I would tell you is, I would expect development to be $800 million $1.2 billion a year of assets once it gets going. So these are assets added to the portfolio. And I'd expect acquisitions to be more like $2 billion. Because we can acquire much more quickly than we can develop. Development just takes time. So it will take a couple of years to get up to that development level. But I think you'll see us hit a whole bunch of singles. I mean, right now, we are buying and selling $500 million each. So all the answers I am giving you though [ suppose ] a pretty open transaction market. So again, right now, the market feels great, but there will be bumps. In terms of M&A/portfolios, we're very open to portfolio acquisitions. There's a few we're looking at now. Those are harder to do. Sometimes our OP units are helpful. The operating partnership units create a tax benefit to buyers. So sometimes those are helpful. M&A is complicated. You have to have a willing partner. You have to pay generally a pretty big premium. You got a lot of transaction costs. So again, we're open to all sorts of suggestions to accelerate this process. But our presumption is we'll move along with development. We'll move along with acquisitions and on a $39 billion asset base, if we're doing $3 billion a year, we can make pretty significant progress over the course of several years.

And then just 1 follow-up question that we receive, again, for those that might be newer to EQR and apartments, you're -- again, I think it's clear you're selling older assets, let's say, you mentioned in California, New York, but you have mentioned regulations a few times, cities that might be more difficult to, let's say, operate in with rent. So how does an investor think about those comments? Because as you said, you're staying in New York, you're staying in California, you're growing elsewhere, but at the same time, I guess, is it just there are select markets that you feel over the next 5 or 10 years or just currently are more difficult, and then it's really the age of the asset?

There is no -- there are no risk-free multifamily markets. Every market has risks, and they're just different. So in New York, we have the largest base by almost a multiple of 2 of affluent renters. Renters making $100,000 a year or more. People in New York will rent their entire working lives. That's a terrific powerful renter base. Our average incomes in New York are $250,000 odd per unit. So very high rents and very high incomes. It's hard -- very hard to buy a home in the New York metro area. Those are all big advantages. I think supply in New York is going to be profoundly low for the next several years. I think that's going to be greatly to our benefit as well. And on the offset, you've got these regulatory issues where, again, I think the incoming mayor, assuming he wins the election in early November, Eric Adams. He certainly is a more progressive individual, but he also has worked with real estate interest and understands the business. And I think as the right frame of mind, we hope the same will be true for the governor. So it's that sort of constant conversation, Jeff. So if we thought a market was so negative, we would sell out of it. New York has counterbalancing benefits, and I'm just using it as an advantage here as an example. California, Prop 13, which I think most people are probably familiar with, does restrict property tax increases on apartment buildings as well as single-family homes. And so, our expense growth and our margins, expense growth is very low, our margins are very high in California. And you think about San Francisco, it still is the technology engine and driver. We believe in that. And all the content we're consuming, all of us, every night, sitting around on Netflix, that's coming out of places in Los Angeles and in Southern California, by and large, or at least is impacting the economy in that area. So I think having a good presence in California gives you a lot of exposure to all those industries, high housing costs, tough to build. So there's big advantages. And against that, you weigh regulatory risk. The Sunbelt markets when you look at it, and this is the risk we're buying into, they can get very oversupplied. You have to be very careful about supply in the Sunbelt markets. And the supply can react very quickly. And so, we're trying to be thoughtful. So thinking of Sunbelt markets, you're buying growth and a little less regulatory risk, but you're accepting supply risk and you're accepting this risk that maybe all this movement to the Sunbelt doesn't occur -- doesn't continue to occur forever. So by building this balanced portfolio of 11 or 12 markets where our kind of renter wants to live, I think we'll get the best of both.

I mean, that's a good segue into a supply question. How -- what are you kind of seeing for supply across your markets?

So we are trying to be a little bit more precise when we think about supply. Our research has indicated that supply within a couple of miles of our properties is much more impactful than supply in the general market. So when we think about a radius of 2 or 3 miles from our properties, we see supply declining, especially in New York, but in most of our existing coastal markets after 2022, there's just a little bit of a drop. There's been some big permitting numbers, not all permitting numbers, permits lead to construction. But I think there will be significant levels of construction in some of the Sunbelt markets. So I would tell you -- I think supply, there's a very good picture and a very good dialogue about the benefits of declining supply in '23. I think what the investors are going to see is strong recovery numbers from us in '22. In '23, if the economy continues to do okay, we'll continue to have good momentum and we'll benefit from what's likely to be less supply in '23. It's hard after that to really predict, but I would say there will be supply certainly in the Sunbelt markets. The coastals may get a little bit of a break, and that will be -- there'll be some balance there.

And early on, you mentioned your portfolios, I think -- I think you said it was like 75% urban or 70% urban at this point. How are you thinking about kind of that suburban/urban mix over the next, call it, 5 years?

Sure. So some cities feel really good in the urban center and some cities have terrific suburban locations as well, and some don't. So Seattle is an example of where Bellevue and Redmond, where we already have a fair bit of exposure and maybe going up towards Everett. Those are places we probably like to add exposure. We have a fair bit Downtown and in South Lake Union. So lightening the load a little bit in the center city of Seattle and adding to the exposures in the North and East suburbs, probably a good idea. You may not see our allocation of capital to that market change a lot, but you may see the balance in that market change. The other 2 markets where that's likely is New York where, again, you have some really good suburban locations. We're starting construction of a project in Westchester County literally right now. So there's [ a little ] suburban locations we like in New York, and we have 28 towers between Manhattan and Brooklyn and maybe having a few less in those 2 boroughs would be a good thing. So I think in those 2 places, maybe Boston, we'll lighten the load a little bit in the center city where we have a concentration, just to have it in the suburbs. That gives you a little help on political risk, but it also just lets you follow your affluent renter who is interested both in urban and these dense suburban locations.

Great. Mark, we're about -- we're down to about a minute. We've been asking every company 3 rapid-fire questions. We're hoping to get your responses. We'll jump right in. First one is, which of the following is the greatest challenge facing U.S. public REIT today, Fed action and high -- A, Fed action and higher rates; B, supply chain issues, which include labor and logistics; or C, flows to non-traded REITS?

I guess the Fed.

Second question, over the next 5 years, which markets will outperform, urban coastal or Sunbelt?

I love that question. It puts me right in the middle of a dilemma, doesn't it?

[indiscernible] it's easy.

Yes, yes, you don't make it easy. I'm not going to go right to multi -- I'm going to say that next year, the urban coastals will do better. And then over time, those 2 will converge when you get into '23 and both have pretty good numbers.

Excellent. And then final question, for your company's office plans post pandemic, will you: one, have changed from pre pandemic; 2, leave it up to individual teams within the organization; 3, offer hybrid; or 4, go remote?

More of a hybrid, so I guess, that's C.

Excellent. Awesome, Mark. That concludes our panel. Thank you and good luck for the rest of the conference.

Yes, Thank you, both. Thank you, all.

Thank you, Mark.