Equity Residential (EQR) Earnings Call Transcript & Summary

Good afternoon. I'm Mark Parrell. I'm the CEO of Equity Residential. Thank you all for taking time with us today. I want to introduce my colleagues here with me today, Michael Manelis, our Chief Operating Officer; Alec Brackenridge, our Chief Investment Officer; Bob Garechana, our Chief Financial Officer; and we have Martin McKenna in the audience who runs Investor and Public Relations. Before we start talking about the business, which is in really good shape at this point, I want to just thank a lot of the people in this room and the people that are listening in for the nice notes they sent me and other members of the team upon the passing of our Chairman, Sam Zell, a couple of weeks ago, very kind. The most interesting thing about those notes, were the many people who shared stories about Sam's positive impact on their lives. How at time they had seen him present or something they had read or maybe personal interaction they had with him, changed the course of their career or even their personal life in a positive way. So as -- there's a very nice video the family has put out on Sam Zell legacy video site, very nice. Within that Sam talks about, let's all have a positive impact in our life and he certainly did that. So again, I thank many of you for that. We're lucky to have spent that time with Sam and he's -- we are his legacy. 0We and the other companies and the folks he trained over many years. So moving on here to the business at large, we raised our guidance last week. We put out a new presentation, so I want to refer to that. So if you don't already have our presentation out with you, we're going to ask you to grab that. It's at equityapartments.com and in the investor -- in the Presentations section under Investors. So what I'd say right now is, the business feels very good. We raised our guidance last week. We raised the dividend a couple of months ago. We're a simple business, supply and demand and demand feels very good. And in a moment, Michael Manelis is going to speak to you about that. We don't feel pressure about job loss in our portfolio. So if our residents are losing jobs, they're quickly gainfully employed. I remind you about our demographic. So generally folks in early 20s, 30s, early 40s, our average rental household income is about $174,000 and they pay us about 20% of their income in rent. So they're not rent stressed. So they're good inflation hedges. They can handle the cost that we all see kind of coming through the system. And supply matters a lot and that's a real distinguishing positive for our company. So there's a lot less supply in the markets in which we do business generally. So that's here in the New York area, Boston, Washington, D.C., Southern Cal, Northern Cal and Seattle. So those 6 markets are 95% of the company. And we do have a nice beachhead in 4 of the Sun Belt markets in Denver -- so Austin, Dallas, Atlanta and Denver. And those markets, those Sunbelt markets are seeing very significant levels of new supply. And in fact, this is the first year or the very beginning of the first year of a lot of supply. They have the same amount next year. So those markets do have good job growth but they're going to feel it on the supply side and we won't. And so I think that will drive some differential outperformance for us. So I'm going to turn it over to Michael Manelis. He's going to give you a few bits about the operating business in detail. And then I'll ask Bob Garechana, the CFO, to say a few words about margins. And then Alec Brackenridge, we have some materials in the presentation on San Francisco and Seattle, very topical markets, a lot of concern around those markets. And we address those straight away and Alec will go through that with you. So Michael?

Yes. So thanks, Mark. So overall, I would say the operating fundamentals remain healthy. We are seeing the very typical sequential build in both lease, like the application volume as well as kind of the pricing or the rent volume occurring week after week. A very solid spring leasing season. We're now entering in kind of the summer peak leasing season but we just finished up what we would say is a very solid spring. The portfolio is 96% occupied. Our loss to lease is now 5% as compared to where it was at the beginning of the year, which was 1.5%. And our blended -- our May blended rate growth is now at 4.6%. Our foot traffic, which is a great proxy for demand, is up 3% year-over-year. And our application counts, as I mentioned before, continued to grow sequentially week after week. And heading into the summer, that's just a great position for us to be in. We continue to renew just over 55% of our residents. We have renewal offers out for the next 3 months into the marketplace and we expect to achieve about a 6% increase from those renewal offers. Our pricing trend, which is like the net effective prices for our units from the beginning of the year to today is now up 6%. In a normal year, rent seasonality would tell you, you should expect rents to be up about 5% to 6%. At the beginning of the year when we created our guidance, we said we were going to be a little bit more conservative and kind of build the models off of the lower end of a typical year. So the fact that we're up at 6% compared to the 5% that we originally modeled is part of the driver to the fact that we're exceeding our expectations from a pricing power perspective. The East Coast is clearly outperforming the West Coast right now. Overall, suburban is outperforming the urban markets, although it does matter a little bit by which market you're in. And I'm going to take a minute and I'm just going to go around the horn real quick and give you some bullets for each market that we're operating in. So Boston right now, the urban portfolio is outperforming the suburban portfolio. The overall market occupancy is at 97%. We continue to see strong demand and good pricing power into the summer here. New York, the market that we're in right now, continues to exceed our expectations. Performance remained really strong throughout the spring. The market occupancy is above 97%. And literally, regardless of the submarket, I would tell you we see strong demand and good pricing power and very stable occupancy. The D.C. market right now is also trending ahead of our expectations. This is a market that historically has delivered about 10,000 to 12,000 units a year. This year, we said we expected more supply pressure because the deliveries were going to be at about 14,000 units. So we modeled the year with very, very limited pricing power. Sitting here today, the first week of June, we're actually ahead of where we thought. But we are realistic, just given kind of the back half volume that's coming at us. So we don't expect that pricing power to continue through the year in that market. Heading west in a minute, Alec is going to speak to some of the long-term drivers for both Seattle and San Francisco. But if I just start with Seattle right now, our operating fundamentals remain below our expectations. This is primarily due to less pricing power than we expected in the downtown areas. But I'll tell you the last 30 days or the last 5 weeks, we are starting to see some signs of improvement in the market. The overall occupancies has improved about 50 basis points in Seattle. We're now running at about 95.5%. And pricing power I guess I would say is running a little bit better than what we felt 5, 6 weeks ago and that's predominantly because of the concession use that we had in the downtown is starting to recede a little bit. Today, we're running about 30% of our applications are receiving about a month. If you asked me this about 6 weeks ago, I would have told you about 60% of those applications downtown. So we are seeing a little bit of ability to pull back on that concession. And we'll just see kind of what happens with the pricing power through the summer. The city feels better, right? Amazon did their return to office on May 1. We were watching to see if we saw in-migration from other states occur. We have not seen that yet. We did not really see a surge in demand but the application volume is starting to build sequentially week after week. But it is what you would expect it to do for this time of the year. So I think it is kind of a wait-and-see moment. What we do know is traffic is really bad in Seattle. We can hear it from our own employees. So it sounds like what's happened is the folks that are out in the further suburbs are just taking the time to commute in. And we'll see if Amazon holds the line and doesn't acquiesce on return to office. My guess is, some of those individuals will acquiesce and start moving in a little bit closer to work. If I head down to San Francisco, similar story to Seattle, except that this market overall is kind of performing in line with our expectations. We entered the year, we did not expect much growth out of San Francisco. May is starting to show some early signs of improvement but very much in line with what we would say are very typical demand and rent seasonality patterns. Similar to Seattle, the concessions are concentrated in downtown San Francisco. We were running 60%, 70% of applications over a month ago, just over a month. Today, we're at like 25%, 30% of applications right around a month. So very similar story of being able to pull back some of that concession use. It does matter what submarket you're talking about in San Francisco because the South Bay demonstrating a lot of strength, good demand, good pricing power. Peninsula is stable. Downtown, like I said, it's improving, but it still has a ways to go to kind of really kind of get back to where we were pre-pandemic level pricing. Today, the overall market is about 5% off of where we were back from March of 2020. If I move south to Southern California and just tell you that the demand overall remains strong. The occupancies are definitely feeling some pressure from the eviction moratoriums that have expired. So what we saw which drove a little bit of the guidance raise, and Bob can maybe speak to this in a second, we had improvement in our bad debt net, which is basically a function of seeing more of our highly delinquent residents move out earlier in the year than what we thought. As the eviction moratoriums expire, we've been communicating with those residents and we're seeing more of them just decide to turn the keys in and move out. So we're seeing about 100, 150 basis points dilution to occupancy. But again, overall, we're going to view that as a positive because we will ultimately be able to fill those units with residents that pay their rent. And with that, I will turn the call over to Bob.

Yes. Thanks, Michael. So before we get to the capital allocation discussion and discussion about San Francisco and Seattle, I wanted to highlight one of the core financial strengths for EQR. And this is on Page 29 of the presentation that was posted that Mark referenced to. And that's our overall superior cash flow margin generation. So this is EQR's ability to take every dollar that we earn on the top line and translate that into cash flow horsepower that can then be dividended or distributed out to the shareholder. And what you'll see in that slide is that relative to our peer group in multifamily and relative to other residential players in the space, we are able to generate more dollars or cents per dollar than others. So on average, we can get for every dollar of revenue that we're earning, we translate into about $0.45 to the bottom line from a cash flow standpoint. And this is on all kind of expenditures, whether it's same-store expenses, overhead expenses, interest expense, CapEx, et cetera. We think that's one of the big drivers of our business and of our superior value creation over time. We also think that, that's going to be the generation for future cash flow growth that we look at going forward. And when you couple that with innovation and other initiatives we have, we look to continue to expand that already superior position that we have. So if you think, margins are commonly discussed in our space, I think that's the margin that is most important and one of the highly correlated strengths for EQR.

Thanks, Bob. So we think one of the opportunities within our portfolio is the recovery of San Francisco and Seattle. Cities need to be constantly reinventing themselves and in my lifetime, I've seen that several times in New York, most recently coming out of the pandemic. And since the pandemic started, rents are actually 19% higher than before the pandemic in New York. In contrast, in San Francisco and Seattle, they're 4% to 5% lower. And we don't think that's a permanent condition. We think these cities have these tremendous economic drivers that will help them get back to where they used to be in a reasonable amount of time. And at the same time, we need the cities to be cleaner, safer and frankly, just nicer place to be. They don't have to be perfect. They just have to be nicer places for people to spend time. And we've seen that in New York, which has been part of the recovery. So the good news for both of those cities is they have strong economic drivers. In San Francisco, it's all about the tech. It's still a massive tech -- hub for technology, 30% of venture capital money is allocated towards San Francisco. There's tremendous intellectual capital coming out of Stanford and Berkeley and that's not going anywhere. And AI is really coming from San Francisco. On Page 39, we show that evolution has -- starting in San Francisco. We don't know where it's going to end up. But we know that the community effects, the networking effects are vibrant still. And as they have helped in other cycles in San Francisco, we see that helping drive economic growth there. At the same time, the city has to get better and safer, as I said. The mayor has changed her tune. We need better public policy. There's a new district attorney. That's definitely going to be helpful. And we start -- you hear some -- a lot of negative headlines but IKEA opened a store there. SAP has just taken down some office space. We've been there, personally all of us fairly recently and it's better. It's not great but it's a lot better and we think it's going to continue to improve. And in Seattle, it's a little bit of a different story. And on Page 44, we lay out the different employers that are headquartered there. And the story there is kind of a cool diversity. And if you can look at that chart, you can see that there are a wide range of employers who are headquartered that goes well beyond Microsoft and Amazon and Starbucks but to a whole array of companies that really see the benefit of being in a city that historically has done -- shown tremendous growth. And we expect that to continue as well. One of the things that's happened in Seattle is that they had an elevated highway similar to Boston that has been taken down. And that highway cut off downtown from the waterfront. It's just now come down. Now they're building parks and we are the beneficiary of what's going to be a much more pleasant environment for our residents. We own properties all around what was the elevated highway. One of our properties called Harbor Steps has about 700 units, 30,000 square feet of retail. The steps literally cascade down towards the waterfront. The retail got really beaten up during the pandemic but we're starting -- we've since then recovered. So we've leased all that space back up and had some great uses, one restaurant literally opened last night, as a matter of fact. And we're really excited about that, and it's a sign that the city is reemerging. Tourism is back. The cruise ships tend to harbor there and we're seeing that activity. So a lot of good news. We certainly need more on the political front there as well. There's a new mayor there. Seattle was infamous for literally losing control of a police precinct in Capitol Hill during the pandemic. They've reversed course and are now actually hiring more police. So we just see the combination of a better, safer, cleaner streets, plus these economic engines continuing to drive both of these cities to recover back to where they used to be.

All right. Thank you, Alec. So -- we want to ask for questions from the audience. If you got a question, just speak up and we'll do our best. It's a large group, they don't look shy. Well, while you're thinking, oh, please.

[indiscernible]

So the question was, what are we seeing on the expense side? Specifically, there was mention of real estate taxes and as well as insurance. Maybe I'll start with the top-level expense guidance, which is unchanged. So at the midpoint, we're seeing 4.5% expense growth. On real estate taxes, specifically, we are the beneficiary of having 40% of our portfolio in California. So we have the Prop 13 benefit of low expense growth on that side. And in most of our established markets, so this would be in areas like New York, Seattle and other areas, we're seeing relatively modest real estate tax growth. So we're seeing growth that is typically in the low to mid-single digits. Where we have a smaller presence in the Sun Belt, that's where we're seeing the pressure. That is an unexpected pressure. We underwrote it as such but that's where we're seeing things that are more double digit, et cetera. So we would expect that real estate tax growth will remain relatively modest in 2023 and help anchor the bottom end. I think you also asked specifically about insurance, which I might pass to Mark, who will talk a little bit about our renewal and how that went.

Yes, just a comment. The insurance market is tough. We've all heard about that, both in our personal life and certainly business insurance. So as we disclosed on the call, our insurance renews in March. So in March of this year we renewed, our property premium was up about 20%. And we thought actually that was a pretty good outcome. There were many folks that have exposure to the Sun Belt, think Florida. Think Florida, Coastal Texas, Louisiana, parts of North Carolina that have significant windstorm hurricane risk, that market is very, very challenging. Reinsurers are -- flood that market, primary insurers have taken big losses. So we saw increases there more like 60% to 100%. So I think it's going to focus the real estate industry and investors on resilience concerns. And even if you do have good growth like in Florida, you do need to be cognizant of that insurance risk. And possibly the future may hold even more challenging insurance market. And if you can't get insurance it will be hard to finance and it will be hard to sell in a market.

I know that you talked about in no small part because of political headwinds. But how long do you think it's going to take for us to see repurposing of New York city office buildings into residential?

Yes. The question was how long do we think it will take until you see the repurposing of office buildings into residential. And the answer is a long time. I mean it's hard. I mean it's very difficult. A lot of the buildings that were easier to do have already been done. Many of the properties downtown that were done decades ago now, benefited from a tax abatement called the 421(g). There's no such program right now. And it's just really expensive. You need the right floor plate, you need the right layout, you need -- you need the right location. And not all the buildings have that and it's just really expensive to make anything underwrite in terms of building apartments, right? That's why you see almost no supply in Manhattan. So there needs to be a public policy initiative to help promote it. Absent that, I think it's going to be a very long time.

What is that like, let's say that intervention ones, is that like 5 years away, 10 years away [indiscernible]?

Yes, we wanted that. We want vibrant streets. We support that. How long it takes depends a lot, honestly, on the program and how viable it is, some buildings may need to be knocked down. That's part of the challenge. They just may not work. There have been different studies done. I don't remember the one specifically for New York. But I do know that a engineer did a study of Boston. And within Boston only 15% of the older office buildings were even suitable for it. So it's not -- it's part of an answer but it's not the answer that's going to solve all the housing challenges. I don't think.

Just speaking about, for example, LaSalle Street in Chicago, which would be equivalent to a midtown though, of course, much smaller. And that's all office buildings, all -- almost all Class B, less desirable office buildings. So there's a lot of discussion about repurposing those buildings. But again, they are one block by one block footprints. And there's no elementary school nearby. There's no primary grocery store nearby. So I think these areas all need to be reimagined. And I do think the pattern is downtown New York. I think after 9/11, I mean, it's very livable down there. So I think -- but that was a huge infusion of state and federal cash, a lot of focus. So we hope there is more vibrancy. It'd be nice for areas to have mixed neighborhoods of both office, retail and residential. So that's a great goal. Our thought is just, you just need to be thoughtful. It's going to take a while. These cities do reinvent themselves constantly but more of these buildings probably need to be knocked down than just simply like a little bit of plumbing done to it. I mean it's a big deal. Please.

[indiscernible] excuse me, if you touched upon this. I was a little late coming in, Fannie and Freddie financing. I mean any change in status post the SVB?

Yes. So the question was availability of GSE financing, so Fannie and Freddie. And the answer is no real change. They have been very active in the markets. Their volume is down, solely because the transaction activity in the market. So they're often refinancing existing loans or they're financing new acquisitions and dispositions. Acquisitions just aren't happening in the market that much, so their volumes are down but their presence and availability remains the same. In fact, anecdotally, we actually, I think the day -- the Monday after SVB went into -- or failed, we actually talked to market makers and they were bidding on existing assets right then and there. And so they remain very much available to the multifamily space, not really a lot of change overall, other than the change in rate due to the higher treasury rate.

Can you give us an idea of [indiscernible]

So we are predominantly -- we, EQR are predominantly an unsecured financier. So when we finance ourselves, we finance ourselves in the corporate bond market. So we have an A- /A3 rated credit from the corporate level. So the vast majority of our, call it, a little north of $7 billion of debt, is in the unsecured bond market, which is also readily available. So we don't do a ton of direct financing with the GSEs, et cetera. We do have -- and our relationship with the bank market is predominantly -- we have a revolving credit facility. It's $2.5 billion in size. It's kind of our short-term liquidity provider that acts as a backstop to our commercial paper. So we mostly fund ourselves like a regular corporate. Although in the private space, the GSEs play a much bigger role because they're doing secured financing.

What's your take or how do you see the New York market evolving? Public polices that you talked a lot [indiscernible].

We're a big owner in New York and we're long term on New York for sure. And it's been a good market for us over a long time. Local Law 97 specifically relates to how you're going to decrease to begin with your carbon emissions and ultimately, electrify buildings. And we've done the analysis on how we comply up to 2025, for sure, no problem. 2030 was, 2 or 3 buildings had some issues that we think we can get through. The bigger challenge though and this is true in all states and in any jurisdiction that's trying to electrify, is whether or not the grid can take it and whether or not the technology is sufficient enough to give enough heat and hot water in a reasonably efficient manner to do that. So there are a lot of technical challenges still ahead and it does also integrate a lot with the grid. So it's a journey we're all going on. The Economist had an article this week that France and Germany are actually talking about slowing down. They've been moving very quickly to electrify and they've realized that the grid isn't ready and they don't have enough power for it.

Can you talk a little more broadly about the political environment and possible rent regulations and emission regulations in the [indiscernible] cities that you tend to be?

Sure. So the question was about, I'll say, broadly, regulatory and political risk. And we do call it both of those things. I mean, we're concerned both with rent control, which is just bad policy. I mean you want to encourage more housing to be produced. You don't make price controls exist. So there's really no economic person we know that thinks it's a good idea. And so we are very well organized as an industry against that. But the other thing to be thoughtful about is growth. I mean for our business to thrive, there needs to be growth and where you have a very anti-growth agenda and this is not a political comment, it's just a statement about how people activate themselves economically, that's a problem, too. So we're thoughtful about that. I would say that some states that are thought of as more red states have their own issues with corporates. I mean -- so I think it's a bit of a minefield. I think our strategy of being a little bit more diversified and being maybe not all coastal but also not all Sun Belt is well thought through. I think, again, I wouldn't -- if I could [ snap ] my fingers, I wouldn't be all Texas. I think Texas has significant resilience risk, even though probably at somewhat lower regulatory risk and tons of supply risk. New York has almost no supply risk but it certainly has regulatory risk. So I think we're in a world where we've got an undersupply housing that will drive the business for a long time and balancing those risks of supply resilience and regulation is what your management team does. And so they have a little bit of each of those risks. But Alec and I continue our search for the risk-free apartment market and we've not yet found it. But if you do find it, please, you don't let us know, we'll get you in on a deal. So we got a couple of more minutes here. Is there someone outside in the back? Please.

Speaking of risk-free markets. I was curious, your take, we discussed kind of the Tech Belt, West Coast, Seattle, San Francisco. How has the team looked at [indiscernible] for future growth? I know there's regulatory issues but longer term in terms of the tech economy, how does the team look at Portland?

Well, let me start and my colleagues may contribute, so it's sort of question about the tech economy in general with a little specific emphasis on Portland, presumably, Oregon. Yes. So the tech economy isn't a monolithic thing. There's fintech, proptech, social media. There's, of course, AI coming. So I think the fact that a lot of the job growth, high-end job growth in the U.S. has been tech and that there's been some, I would say, retrenchment lately in that, is less concerning to us because it's not like the auto industry, where it's super cyclical and super narrow. It's a very broad industry. It touches all businesses. Our sense is this is the pause that refreshes. They over hired. They're going to balance out. And the thing I'd also suggest that makes us feel good about our strategy, which is not totally tech dependent. We want to be in all places, New York, for example has some tech but it has a lot of the [indiscernible] a lot of the other high-quality financial services jobs. We want to be in places that our demographic wants to live, work and play, and make a good living, can pay for a great apartment experience and where we can raise rent in a way that compensates our investors. So I like the tech sector exposure. I would not want to be tethered to any one company. I wouldn't want to go into a town and it's -- and Portland, doesn't mean that but Portland is so similar in many regards to Seattle. And our operations team runs things better when it's concentrated. That dispersing that doesn't -- like what risk am I -- I don't have less political risk in Portland. Whatever resilience risk exists in Seattle, likely exists there. Now they've got the supply issue, probably is a little less in Portland, but it just -- we were in Portland, we own like 10 assets. And we sold just because it wasn't a differentiator, a diversifier, you might as well be deep in Seattle, if you want Northwest Pacific tech exposure. So I got time, I think, for a few more questions, please?

You talked about demand and supply in Sun Belt. How do you see that as an opportunity to gain more [indiscernible]?

The question was about coming supply in the Sun Belt and how it will help us expand in those markets. And it absolutely will. There's a historic -- as Mark mentioned, historic amounts of supply coming into many of these markets. And it's a magnitude of 6%, 7%, 8% of existing inventory, not just for 1 year but for 2 years and that's never happened before. So we feel like we're in a really good position in cities like Dallas and Atlanta and Denver, where we have a beachhead. We own assets there already but not a big, only 5%. All of those markets together make up 5%. We think we'll have an opportunity to expand pretty aggressively as all these units are delivered. So we view it as being well positioned now to take advantage of the coastal markets and well positioned to expand into these markets, which we also believe in the long run.

Just to go back to the tech and San Francisco specifically [indiscernible] get people physically back in San Francisco to support the city and bring it back [indiscernible] and how you fit in that?

So we have just a few seconds here. I'm going to go real quick. So the question is more just around San Francisco, the tech industry, the layoffs and how do you bring people back? What I will tell you is, first, we watch the migration patterns. So we never saw those folks leave San Francisco. They just went further out into the suburbs. The loyalty that our resident base has to the state of California is remarkable. 85% of residents that move out from our portfolio in California stays within the state of California. So the other fact we did is, on Page 51 in our deck that we have published, we just did a survey in the January. In the course of 2 weeks, we received 32,000 responses to this survey. Inside that survey, we have 1.7 million data points right now, the most fascinating we found is that 26% of our resident base works 100% remotely. And from that base, we started asking them like what features, amenities, things do we need to provide for them. We are meeting the needs of those resident base. So for us, it's not so much about bringing them back. It's really more about the lifestyle of that city, of that concentration in the downtown to feel vibrant and they will come -- move back into the city.

Well, we appreciate everyone's time today. Have a good rest of the conference. Thank you.