Equity Residential (EQR) Earnings Call Transcript & Summary

Good morning, everyone. Thank you for joining us today. Appreciate you all taking the time out of your schedules. I know it's a crazy day for everyone, but we've got great conversation ahead for the next 30 minutes. My name is Chandni Luthra. I'm a senior REIT analyst here at Goldman Sachs. So with me up here on the stage, I have the privilege of moderating a conversation with Equity Residential. Equity, as many of you in the room already know, is one of the biggest, highest quality portfolios of apartments and one of the most robust balance sheets in the space. With me on the stage to my left is Mark Parrell, the President and CEO. On his left is Michael Manelis, the COO. And to my right is Bob Garechana, the CFO of Equity Residential. We will have the opportunity to learn a lot from these guys here today. I encourage you all to please participate. There are mics in the room. You'll have time towards the end of this presentation. But before we dig into some questions, I'll hand over to Mark for some opening remarks.

First off, I thank all of you for joining us today. And I'd like to thank Chandni and the team for moderating the panel. So just to talk for a minute, we're having just a terrific leasing season. Michael is going to speak to that in a moment, give you a little detail on that. I just want to talk a little bit about our customer because that's the sort of foundational fact of our business. So our average resident is generally employed in a technology, financial or medical field. They make about $166,000 a year. They pay us about 19% of their income in rent. And by our calculations, they got about a 12% increase in their compensation quarter-over-quarter, first quarter '22 over '21. So it's a very healthy customer that we have, one that we think will be resilient in the face of whatever inflation or slowdown occurs. So again, we feel terrific about our business. And I'm going to hand it over to Michael to give you some operating details. And I'm sure we'll talk capital allocation and all kinds of other wonderful topics.

Okay. Thanks, Mark. So I guess I would characterize the last 60 days for us as a supercharged spring leasing season. The portfolio today sits just under 97% occupied. We continue to renew just under 60% of our residents with achieved renewal increases of around just over 10%. We have quoted increases out for the next 90 days, and we have a high degree of confidence that we'll continue to maintain that achieved renewal rate above 10%. Our pricing trend, which is the rents in the marketplace, has grown 10% since the beginning of January. In a typical year, this rent would grow about 4% to 5%. So that kind of describes just the acceleration and rate growth that we've seen across the markets. The pricing power that we have in the portfolio right now has produced a new lease change of 19.9% for the month of May, that is, if somebody moved out, a new resident moves in, what is the increase that we achieved on that lease-over-lease rate. And the loss to lease in the portfolio is now at 13.5%. This was at 11.1% in the beginning of April, and this number will trend as rents continue to rise. That loss to lease will also continue to grow, but it will moderate with normal seasonal moderation as rents decline into the fourth quarter. As a company, we remain extremely active around innovation and operating efficiencies that are focused on creating the operating efficiencies not only with staffing but also creating a seamless customer experience. We are still in the early innings of all of the staff efficiencies in the portfolio. We've been centralizing a lot of the tasks on site, and we have been adding technology to just fully completely automate and reduce the dependency on labor. So artificial intelligence in the leasing side of the business, robotic vacuum cleaners, remote video camera monitoring for security are all great examples of how the company is leveraging technology to just reduce the dependency on labor, whether that be internal labor or external. On the expense side of the house, we continue to feel pressure on utilities and wage pressure, again, both internal wage pressure as well as every contractor we're doing business with. The good news is that low expected real estate tax growth and all of the benefits from the operating efficiencies that we've delivered on are really kind of mitigating those pressures out, and we still have a pretty good degree of confidence in our overall kind of expense range for the portfolio. Right now, I will tell you, rather than go around every single market, I normally kind of would hit the high points for each market, I would tell you I'd sound like a broken record. Every market has exceeded our expectations. We are well occupied across all of the markets, demonstrating above-average pricing power, good retention, good rate growth. I'm going to call out a couple of markets, one being New York where we all sit today. Every single submarket in this New York Metro Area is performing above expectations. Super strong demand at the front door, exceptional kind of rate growth in the last 60 days, strong retention. And we really haven't seen kind of any signs of softening on that front as we work our way through the summer leasing season. The other 2 submarkets I will call out specifically are on the West Coast, which is the City of Seattle and then Downtown San Francisco. Both of these markets, submarkets, were areas that kind of lag the recovery of our other submarkets across the portfolio last year. Both of them are demonstrating kind of this path to recovery. You stand back and you just look at the last 4 to 5 weeks in Seattle, you've seen concession use amongst the stabilized assets start to abate. You've got strong demand. You got a little bit of pricing power and you've got recovery of the occupancy, which is what we needed to see in the Downtown City of Seattle. If I contrast that to San Francisco, you have strong occupancy right now in Downtown San Francisco. You're just in this mode where you're pressure-testing your ability to recover the rate. But both of these submarkets that have lagged kind of the others around the country are demonstrating this path to recovery, which gives us a lot of confidence and kind of the ability to kind of demonstrate above-average growth in the back half of the year. So sitting here today, I would tell you that our dashboards are all bright green, and we are going to continue to push rate on both new lease and renewal while maintaining strong occupancy in the portfolio.

Great. Thank you all for that state of the union. So let's dig into operations a little bit. You obviously had a very strong start to the year, but the reality of the tougher macro environment all around us cannot be ignored at this point. So help us understand how we should really think about the business in the event of a potential recession. Are there any precedents that you can share with us based on your experience and based on your experience in this business?

Sure. So first, I mean, we'll start by saying, as Michael just described, we don't see any cracks in that demand picture. So it feels really good to us now. But what you should understand about the apartment business is we're not a leading indicator of a recession or slowdown or a lagging indicator of that. So all of this is unsurprising, and the business being so vibrant is exactly what we hoped would occur. I would say, though, that our resident, and I started with that comment being as well employed as they are, even if there are fewer tech jobs, if you do see that so-called second derivative decline, there are so many outstanding positions already. I mean our company alone has a couple of dozen jobs we're looking for, and these people are in very high demand. So some of the froth comes out of companies that really don't have earnings and really can't be sustainable in a new, more risk-focused capital markets environment. I think we're still going to do a pretty good business with tech employees which are not, by all means, all of our residents, but they're a fair number. When you think about where our markets are, I feel really good about their employability. I think you look at the unemployment rate for the college educated. So Chandni, when we look at that, we feel like we've got folks that are eminently employable, that have weathered the storm during the pandemic and have the skill sets to compete in this economy. And if they lose one job, they'll get another, and they may move from the very edge of the new economy into a middle of the new economy type job. But I feel really good about that. And I do think a little bit of chaos is helpful to a company as well capitalized as Equity Residential. When everyone can get capital, it's harder for us to compete for acquisitions and development. So we've typically shined in periods like this. So again, this is really early. It's going to take some months for the capital market to understand what sort of happened and what prices should do. But I feel great about the growth in the near term, and I really do like the resilience of our customer.

So it's interesting in your prepared remarks or just now, you talked about West Coast. So let's dig into that because that's what's making headlines every single day here, right? What are you seeing there? I mean we've seen hiring freeze announcements. We've seen some layoff announcements from several tech companies in the last few months. How do you think about the impact to your business? And how should we think about contagion to other markets given a lot of these West Coast-based tenants move to other pockets? I mean, you are also following those tenants, right? So how do you think about contagion, and I might have a follow-up to that.

Yes. So I think I would start, just going back to the prepared remarks, around the City of Seattle and Downtown San Francisco. Despite the headlines that you read, we still see improving demand, strength at that front door. So I think some of what Mark just described is there are more tech positions posted in all of these markets than there are employees. So some of the hiring freezes, some of the announcements around layoffs really have not impacted anything on the demand front. We haven't seen any signs of cracks. The one area that we will watch is, while we have less direct competitive new supply in our portfolio today and we expect the same thing to hold true into 2023, which is just looking at the proximity of new supply against our portfolio, we're watching this new supply week in, week out, and what are they doing with concessions. It's a great leading indicator for our industry on velocity and their ability to close leases. So if you will see changes in how they're offering those concessions, not just a 1-week or a 2-week but like a sustained change over like 3 or 4 weeks, that's an indicator that the velocity in that market is slowing, and it would cause you to kind of shift and maybe open up your negotiations, preserve your occupancy a little bit different. In terms of contagion, I think any of the markets you've got to watch for these signs. I don't think you're going to see this start in like West Coast and then move its way through the country. I think you're going to be watching for isolated pockets where you could see a slowness of jobs. But today, just looking at the volume of job postings that are out there, I don't see this hitting us in 2022. I think, if anything, this would be a late '23 and into '24 where you'd start to feel a little bit of this demand slowing.

That's very interesting. So you've talked about 13%-plus loss to lease and how that's risen by over 200 bps since the start of the year. As we think about 2023, do you think we can get all the way there if we, say, get into a recessionary environment at this point? I mean how do you expect that loss-to-lease number? Can it be bridged all the way there if the macro environment gets tougher across the board?

Yes. So again, I think loss to lease is a point-in-time calculation of just snapshotting rents today against every single unit that you have and what you can achieve if you mark everybody to market at one time. That number will most likely grow as rents continue to grow through this peak leasing season. Whether they peak at the end of July, August, September, I think that we don't know yet when rents will peak, and then they'll begin to moderate. So as you think about any kind of shock to the system from macroeconomics, that will impact the degree of that moderation that you have. If there's a huge shock to the system, you could expect a continued moderation of that loss to lease. But sitting here today, this portfolio has never been positioned this way. 13.5% loss to lease is unprecedented, which gives you a lot of confidence in not only your ability to mark leases to market for the back half of this year but really to start off 2023 in a position like we have not been positioned before. So I think despite the economic kind of headwinds that we have out there, I think we are still going to see kind of a beginning, a starting point that is stronger than above average norms.

Yes. I'll just elaborate on that a little bit. Usually, we would go into the new year with a 1%, plus or minus, loss to lease, that sort of earn-in, I sometimes call it. There's no way that number is not going to be a lot higher than that. There's just a lot of markets that, for regulatory reasons, we couldn't raise rent up to what current market levels are. So even if places like San Diego moderate or L.A. County moderate or New York moderate a little, we're so far behind in those places that you got gas in the tank for '23. So the position in '22 is very good and the opening position for '23, while we're not giving guidance, the positioning is excellent. And then we'll just have to see what the economy holds at that point.

Switching gears to some demographic trends. So if you think about the last 10 years in apartments, this was sort of a big tailwind period with millennials delaying home purchases and just having other situations, with debt, et cetera, as we think about the next cohort, the Gen Z cohort, that, as a population, cohort is about 10% smaller than millennials. So how should we think about the next 10 years for apartments?

Yes. Great question. When we talk about demographics, we still feel very good about that. So we have about 4 million in this country, about 4.3 million people turning 18 every year for the rest of the decade, so it's a very significant number. But what Chandni's really referring to is on the other end, when you start to get close to 40 years old, traditionally, you'd buy a home, you do those sort of life-change events, and that might mean you leave our renter population. Well, there have been big changes in the way we all work and live, and it's not just related to the pandemic: people marrying later; people having student loan and other issues, which means they have good income statements but not great balance sheets; they're not having children, they are having fewer children. So about 45% of our units are occupied by a single individual. So we feel like our little niche is going to continue to see very good demand both from these Gen Zers. And I got a couple of those at home myself and desperately want them to launch into the apartment market, hopefully not on my nickel, but hopefully launching in the apartment market. And then on the other end, I think we're going to retain more of these millennials. I do think they're going to stay with us longer than they would have. We see that already. What percent of our residents are leaving to buy homes right now, Michael?

So we typically run anywhere between 12% and 13%. And I haven't snapshot at this in the last month, but my guess is it's going down.

So with single-family so expensive and rates going up, that's just another positive. So I like our demographic positioning. I think the millennials aren't going to come off the conveyor belt as quickly as they normally would, and I think a number of new Gen Zers, you got a lot of people bundled up with their parents. We'll see. There's already been some unbundling of that, but I am hesitant to suggest that most of those people are going to unbundle. It seems that there's been a shift where there are considerably more people in their early 30s and 20s that are living with mom and dad still. And I'm not sure I know the reason for that. But some of those folks, I think, will unbundle, but it probably won't go all the way back to what we would have expected in the '90s and 2000s.

Very interesting. Let's switch gears to acquisition environment. So you and your peers all across the last couple of months have talked about seeing a pause in transaction activity and how that frothiness in the market has dissipated. Give us an update there. What are you seeing on the ground at this point? And given that the leverage buyer has pulled back, do you think core capital could be next? How should we think about your ability to meet your acquisition target this year?

Great question. So when capital markets dislocate, when rates go up like this -- and we've seen this. Everyone at this table has been with the company 15 years or more, so we've been through this numerous times. In fact, our Chief Investment Officer started at the company the day the company went public in 1993. And so what he would tell you is, when you have this sort of big change, you have a big bid-ask spread. And that's exactly what we're seeing. Sellers want last month's price, buyers want next month's price and there's a bit of a standoff on that. And that will go on for a little while. So we're seeing there's still a lot of conversation, but brokers can't make deals get to come together. People are just trying to figure out what they're going to do here. Our sense is that properties that are more appealing to a leverage buyer -- so think about a renovation play. You put a lot of debt on that asset. You fix it up and hopefully increase rents, maybe sell it to someone like us or another more institutional owner, that trade's a tough trade. Selling a property that needs a renovation now, that's going to be a bigger discount. I don't know what that number is. Let's pretend it's a high single-digit discount from top values earlier this year. If you're selling an asset like in New York that Michael is running where you really see those rents going up and you really feel that momentum, you're probably a lot smaller on your discount because you can feel, as someone underwriting that, you can see and feel that momentum and you're not willing to take as much risk. So the important concept to keep in mind is negative leverage. Negative leverage in apartments generally leads to prices going down. So negative leverage for us means Fannie Mae, Freddie Mac and others loaning to people like Bob, what, 4.25%, 4.5% or more, 4.60%, is that about it?

Yes. Probably 4.5% or more at this point.

So 4.5% money doesn't support 3.5% cap rates, so something is going to give, and I think those 2 will sort of meet in the middle. So I'd expect values to be a little lower. I think the strength that apartments have shown in recovering so quickly from the pandemic, I think the financeability with the GSEs, the growth picture, all of those mean that I think that core money is going to keep coming I think it's just going to be looking for a modest discount from where it is. But I do think some of the renovation plays, some of the plays where you're buying on the [ comm ] and expecting a lot of growth that you couldn't see in the rent roll, I think those will be a little more challenged.

What about the ability for you to meet your acquisition targets?

Right, so our guidance right now is $2 billion buys, $2 billion sells with minimal dilution. To date, we've bought about 1 asset for $110-odd million, and we've sold one here in the city for a little over $200 million. I expect we'll sell a little more here in New York. But I would be surprised if we could get to $2 billion. I mean we will formally discuss guidance in July. But I think what we've shown is the usual thing you'd expect from Equity Residential, which is discipline. I mean we told you our guidance, but it's not anything except what Bob has in his numbers for purposes of FFO calculations. If we find a lot to buy, we'll hit it hard. If we don't, we're happy to revise the number down. So I think right now, the market being a little dislocated, volume being lower, probably is going to lead to acquisitions and dispositions being somewhat lower. And you should expect us to mostly match. Like whatever we sell, we'll buy, and we'll mostly match fund those 2 things.

Very interesting. Let's switch gears to what's been sort of topic du jour for multifamily: bad debt. So what's going on there? Give us an update on what's happening on the ground, what's your policy at the moment and what you're seeing in Southern California.

Yes. So we updated, in our prepared remarks for NAREIT, our outlook on bad debt and kind of what we've seen so far in April and May. And just to inform the audience, bad debt, given our relatively affluent or highly affluent resident base, hasn't been a particularly material issue but for concentrations in Southern California, and it can move the numbers and create volatility. So in May and April, we've actually seen improvement in bad debt, and that comes in 2 forms: one, just increased volume of government rental relief payments that we've received that was expected; but also, and probably more importantly, improved actual resident payment behavior. So we are seeing better payment behavior from the residents, particularly again in that Southern California area. And we attribute that largely to the regulatory environment that exists right now for April and May. Because the government rental relief is not available to the residents and because there are other traditional tools associated with demand notices, credit reporting and other things, we are seeing residents pay more. We're cautiously optimistic that we will continue to see that behavior in the back end of the year, and we've assumed that while bad debt will be elevated relative to pre-pandemic levels, that we will continue to see that behavior. But we're cautious because you can see volatility and changes in rental payment behavior really driven by the regulatory environment for the back half.

If anybody has a question in the audience, please feel free to raise your hand. I'll take the next one. So your expense guide for the year is some of the lowest across multifamily, even in this inflationary environment, which is quite remarkable. So give us an update on what you're doing, especially with your customer experience initiative. And then how should we think about cost savings for 2022 and then on a run rate basis?

Yes. So I'll start, and then maybe Michael can also add if I miss anything. So our guide is low relative to the rest of the sector. And I think it's a positive reflection of 2 things, which is both rental or real estate tax increases being modest but also, to your point, Chandni, the excellent performance in the operating initiatives that we're seeing. Our goal is to run this portfolio from an expense growth standpoint that is sub-inflationary. And the way that we achieve that is by innovation and by reducing our exposure, as Michael mentioned, to the primary drivers of inflationary pressures today, which is labor. And the way that we do that is through the combination of centralization, process improvement and then implementation of technology. We have some excellent examples that you've already seen manifest themselves as we've garnered kind of $15-plus million already in NOI improvement, much of which was through the expense side by layering in AI on top of the leasing experience. And the areas like that where we can do like Stealth, which is a video component for security, in other areas where we can really not just subcontract out or contract out to other areas where there's labor pressure still but use technology to reduce the exposure to that pressure and also, at the same time, create a much better customer experience. Our customer is interested in interacting from a technological and electronic standpoint, right? This is how you're meeting both the customer where they're at and reducing the expense piece. That said, there are areas in the line items that Michael mentioned as well that you can't alleviate that pressure, and utilities is probably the one that's front of mind today where it is challenging just given the raw commodity price to offset. But we'll do our best in the other categories to maintain our 2.5% to 3.5% guidance and that sub-inflationary viewpoint on expense growth going forward leading to great margin expansion.

Anybody in the room has a question?

Are you planning to expand in more markets or cities?

Sure. I'll repeat the question. Are we planning to expand in more markets or cities? So we talked about our initial markets being here in New York, Boston, Washington, D.C., Seattle, Southern California and the Bay Area, and we've added Denver, Austin, Dallas and Atlanta. And all those markets share the same characteristic, they have a lot of our affluent renters, people that are making good incomes. Here in New York, our average renter makes $250,000, $260,000, certainly lower in Atlanta than that, but the cost of living is lower and it all sort of makes sense. So when you think about adding more markets, I think it's possible, and they would be markets that have similar characteristics to the ones we've added: affluent renters; pretty high single-family housing costs; we've got to feel really good about supply, there's certainly going to be more supply in Texas than there is in New York, but you really like the demand offsetting that; and then places where you like the political and resiliency risk, and we've got a significant amount of political risk here in New York already, so to go to a market that had significant political risk seems unnecessary to us. We'd like to create more balance. The goal of the whole thing is follow this higher-end renter. As they circulate more, they used to be mostly in these coastal areas, now they're a little more spread out in the country, and also just have cash flow growth that we're producing for all of you that's just more stable and reliable. Six markets means we're 15%, 20% allocated in each market. So I think you'll just see us lower our allocations, be a little more balanced. If there's an issue in a market, we can just keep plowing through, keep raising the dividend, keep growing cash flow. So that's the vision of that. So I'd expect a market or 2 more, but probably not like 10 more or 5 more. I don't think that's needed.

Mark, you briefly talked about something that's definitely been top of mind for investors lately, and that's rent control and regulation. I mean we have regulation in New York. That's no surprise to anyone. But the dialogue definitely has gone up in some of these expansionary markets that you talked about, Florida, Austin, Dallas. We've seen rent control margins, et cetera, et cetera. So are you concerned that there is increasing risk? And what's worrying you from a regulatory standpoint?

So there's probably 3 pieces we think about. We think about rent control, which feels it's obviously a very significant risk. We think about quality of life. Those are very big concerns here in New York and really all across the country. And then the fiscal stability of the city, can they invest in infrastructure? Our residents in a place like Boston, New York, Washington, D.C., they depend on the mass transit system. It's really important that the city be able to invest in that. So I'd start with rent control. I think we're doing a pretty good job as an industry with the leadership of National Multi Housing Council, which is our trade group, as well as people like REBNY here in New York and others, to just really get that message to policymakers and individuals. I think people understand rent control does not produce 1 unit of affordable housing. New York's had rent control since World War II. It's a very high, hot cost market. It has not at all alleviated the problem. So we think that conversation is well heard. We're pushing ideas like less rezoning regulation, and you see California do that. California has done that recently. It's helped institutes more supply the so-called auxiliary dwelling units. So putting a unit in your backyard with less regulation. Those kind of things have been working out really well. Public-private partnerships, like the reauthorization of the 421a program in New York is something we're pushing for. So we recognize there's a problem. EQR, in fact, has invested $5 million in a fund that preserves affordable housing and about 2,500 of our 80,000 units are affordable. So again, we're leaning in on rent control. I do think it's an anxiety throughout the country. I do think that the need to continue to build housing, there's a really significant gap in the amount of both owned housing and rental housing that was underproduced the last 12 years, and we need to catch up. And I think you're going to see that as the supply chain evens out. The fiscal thing, I think is a risk we don't talk enough about with you because the federal government's big pile of money from all the COVID relief bills has left a lot of local jurisdictions in a pretty good spot. But places like New York need to continue to be diligent about reinvesting in infrastructure and making sure that these places are livable. Public safety, I think there's a very important recall election today in San Francisco. I think just the focus on both justice and safety that the industry is pushing is the right balance. So I think regulation is a big issue everywhere. It just depends which of those 3 flavors are at the top.

And if I can squeeze one last one, where are you in your ESG efforts? Where do you think apartments are in the ESG life cycle?

Yes. I think we're still pretty new to it as an industry. EQR has been posting a report for 8 years. I think we were the first ones to do it. So we've been doing it for a while. And I remember we took out all our incandescent light bulbs. We have 300 buildings, that could take a while. But that was real savings, putting in LEDs and doing that. And now 1/3 of our buildings have either on-site power generation or clean power generation out of 300 buildings. So we're making progress. Science-based target is 30% reduction in greenhouse gas by 2030. So I think the industry is being more rigorous. But we need to invest in these engineering solutions. How do you heat in New York with less gas, less oil? How do you do that? Because a lot of these solutions are engineering problems. They're not just good intentions. And so we've invested, and a lot of our competitors have, in a variety of these funds that are trying to create different solutions here, create windows that are more energy efficient, things like that. So we're excited about it, but there's a lot of work to do.

We're out of time. Mark, Michael, Bob, thank you so much. Thank you, everybody, for joining us. Please, thank you.

Thank you.