Equity Residential (EQR) Earnings Call Transcript & Summary

Okay. I think the clock just started. So good afternoon, everybody. My name is Rich Hightower, senior REIT analyst at Barclays. Very happy to be up here with the senior management team of Equity Residential. So to my immediate left is Mark Parrell, CEO; then Michael Manelis, Chief Operating Officer; and then to my right, Bob Garechana, the CFO. I think Mark has some initial comments, and then we'll get into questions after that.

All right. Great. Well, thanks, Rich. Thanks, everyone, for joining us today, both remotely and here together in New York. So in the investor presentation that we posted last week on our website, we said that operations were continuing to run on track and ahead of the expectations we put out there at the beginning of the year. And we can elaborate on that. I'm sure Rich will have plenty of questions for Michael Manelis on that. But we're feeling pretty good about the residential business and how operations are going this year. We also said in our presentation that we acquired an 8 property or we're under contract to acquire an 8-property portfolio in Atlanta, the Atlanta metro area, mostly north of the city. These are suburban assets, $535 million purchase price, 51 or so percent cap rate forward on our numbers. We're really excited to add these properties. They're very complementary to our existing portfolio. So now we'll be at scale. We'll be at 22 assets across the market, a little more than 4% of our NOI when it's again on the platform. So again, very exciting complementary acquisition for us. And we think the very substantial decline in supply in Atlanta, of all the Sunbelt markets Atlanta has one of the largest declines, and you can see that in our materials. So although we think the first year will be a pretty flat year, we think our team can operate the assets pretty efficiently, but rents continue to be challenged in Atlanta. But we expect going forward, year 2 on, this will contribute meaningfully to FFO. We're funding it with dispositions. We've sold about $350 million already of older assets in some of our coastal markets that we thought had less desirable return characteristics, and we're using those proceeds to buy these assets. And we have other properties under contract or in marketing. So quite exciting times in the apartment industry. We feel very well positioned for the rest of the year. And then going in -- going forward, solid demand picture, good demographics, as we talked about at Investor Day. And this supply picture, which is already good in our East Coast markets, is getting a lot better all across the other markets, including in the West Coast. So I'll kick it back to you, Rich.

All right. Great. So I'll just kind of go off of what you kind of started with there. But Equity Residential owns some of the most productive multifamily real estate on the planet. There are a lot of high-quality apartment REITs in addition to EQR. So what makes EQR unique?

Yes. Great question. So I think we have a unique collection of assets and a unique opportunity in front of us. So we are the most urban owner of apartments, and I can tell you -- in the public space. I can tell you that was pretty challenging during the pandemic, but that's really turned around. Here in New York, over 97% occupied, feeling really good. D.C. continues to feel really good. The fundamentals are really strong. And what's very distinguishing for us is our West Coast exposure. We certainly have suburban exposure, but we have a lot of urban exposure, particularly in San Francisco and Seattle. And we're seeing very good recoveries there that again we can elaborate on in a minute, and that's distinguishing for us. Again, in our deck, you can see us quantify that opportunity in terms of dollars going forward. And we feel that recovery strongly in San Francisco and also in Seattle. So I think that's a very unique thing for us, that urban collection of assets.

And then just taking a step back, not everybody in the room might be sort of totally familiar with the basic fundamental setup for apartments. So just maybe walk us through supply-demand, maybe break it up across Sunbelt and coastal just so we kind of understand what are the indicators for rent growth, how do you get there.

Yes. So I'll take that quickly. We're really excited about the fundamentals within the multifamily space. Starting, let's say, first and foremost, with supply. So we already see declines in supply across all of our markets, but in particular, just very limited supply in our existing coastal markets. And we're benefiting from that from an operational standpoint, as Mark alluded to in his opening remarks, in a lot of the coastal markets already. But we also see, much like the portfolio that we're acquiring, declines in supply coming forward in the expansion market. So that is in the markets of Atlanta, Dallas, Austin to a lesser degree, where we have a small presence, but also Denver. So that supply dynamic is really great from the next 3- to 5-year time horizon. When you couple that with good demand, meaning we have millennial cohorts that are staying in our units longer, we've reported record levels of retention, and you also have this Gen Z population entering the rentership basis, you have really good demand coupled with the low supply, and we think that, that can lead to some of the best years in multifamily that we've seen in quite some time. And in fact, we talked a fair amount about that at our Investor Day presentation in February and also included some of that dynamics and some of those -- that information in Page 10 of our book. But we think we're really well positioned, Rich, for the market.

And just to add a little bit to that, again, with this urban exposure and the uniqueness, supply goes where demand was. I mean, capital is going to fund a lot of suburban development over the next few years to the extent there is any. And I think there'll be a lot less development in urban centers. And I bet you that hiatus is going to be longer. So I think our runway of outperformance will be longer in these urban markets where we have -- in these markets, we have a larger urban concentration. The other thing I just want to point out is it's not just revenue that matters, though that's certainly in a high-margin business the most important things. We are extremely good managers of expenses, overhead and CapEx. So we push more of each dollar down to the bottom line than our competitors. So we think the combination of a portfolio that is, I think, well positioned for the future here with supply declines as well as the recovery in the urban centers, combined with the operating platform, overhead and CapEx efficiency is a unique opportunity to own the company going forward.

So let's just dig into demand a little deeper for a second. So you guys have a couple of good slides in your Investor Day deck around the sort of growing core multifamily cohort. Historically, 22 to 34 and then people move out, buy a house, whatever. Tell us why that core demographic is expanding and maybe what that means for the business over the next 3 to 5 years.

Sure. So there's really two components to that. First, there's the millennials. So these are the folks now into their 40s, later 30s who would be out buying homes at this point in a lot of cases. But because of lifestyle reasons we do a good job elaborating, as Rich said, in our book, people are getting married later if at all, they're having children later if at all, half of our residents live alone in their units. So you've got a lot of the population that's chosen a lifestyle that doesn't need as much space, doesn't need yards, values a lifestyle where we're doing the repair work for them, and they're able to be in places, whether it's dense suburban or these urban nodes where there's a lot of things to do and they can feel very activated while still being a single person. So we feel like we're sort of positioned right, rentership is right now for the times. And with single-family housing so expensive, with units less available, a lot less production, we think that's a really significant tailwind for the industry and our company. I also say that the Gen Z generation, so these are my kids, these are people 13 to about 25 years old, 28 years old actually at this point. So they're just entering the work world. They're just entering rentership. We're seeing them manifest their desires by wanting to live, again, in urban centers. We see a fair bit of that younger demographic. So that group is somewhat smaller, but not much than the millennials. So you've got a pretty big demographic in Gen Z. You've got the millennials staying longer. And the combination of that is we see the rentership pool being about 7% larger in 2030 than it is today, so going up to around 84 million, 85 million individuals.

So it's really not a zero-sum proposition between homeowners and apartment renters. It's kind of a bleeding and a blending of categories.

Sure. There's a lot of great research on why people buy homes. And people buy homes mostly for social reasons. They got married. They have their second kid. Having a second child is a very high predictor of you buying a home that generally costly for you to pay for private education, that would usually reach trigger. And I think Michael would tell you that usually moving out to buy a home would be 12% of our move-outs. And now it's an all-time low of 8% of move-outs. So buying a home is just expensive. And it's not consistent with the social desires of our residents. It's not the lifestyle they wish to have, by and large.

Did you have anything, Michael?

No.

Okay. So what I'll do, I'm going to -- we're going to walk through maybe a summary of EQR's key markets, and then maybe I'll open it up to audience questions. And there is a mic right there if anybody wants to start lining up at that point. But predominantly coastal portfolio. So we'll start with those markets then get into the expansion markets. But San Francisco and Seattle are a key part of the growth story for EQR this year. So maybe walk us through what you're seeing in the marketplace, where we are on the post-COVID recovery, especially in the Bay Area. And I'll just let you go from there.

Okay. Great. So I think I'll just start off and say, as Mark alluded to, I mean, we have some amazing unique urban-centric portfolios in both Seattle and San Francisco. We included materials in the management presentation that we posted as to what a very reasonable 3% trend line recovery would look like from a dollar opportunity for us in the portfolio over the next couple of years. We modeled for improvement in 2025 in both of the markets, Seattle and San Francisco. Seattle to date, we're kind of right through the spring leasing season heading into peak, right on track with kind of the improved expectations that we laid out. We knew in Seattle, we were going up a little bit against supply in Redmond and in the city of Seattle. We've got to work through some of that absorption. But sitting here today, we got sequential build in leasing velocity, meaning each week, we're adding more and more applications. We have pricing power in the marketplace, in line with the improvement that we expected and feel really good about the recovery track that we're seeing. In San Francisco, we modeled for that similar improvement. And I would say, to this date, it continues to exceed those expectations. Across the downtown San Francisco market, we are seeing very strong pricing power, very strong application volume. We're seeing migration patterns showing us people coming into the market from the outer ring of the MSA, meaning they're coming back into the city from further out. We also have a lot of RTO, not just the main tech companies' return to office policies changing, but it's all those other companies that kind of follow suit. So we're seeing this pullback from the RTO. You also have a huge improvement in the quality of life that's occurred in San Francisco, along with the city of Seattle. Both of those markets really put forth a lot of effort over the past 1.5 years to change the quality of life in the market, and we're seeing that play out. They are vibrant markets, and we're very pleased with that trajectory that we see.

Great. D.C. is a big market for EQR. Strangely, the headlines obviously would suggest that things are dropping off a cliff, but it turns out to be one of the strongest apartments markets in the country right now. What's the disconnect?

Yes. I mean I think there's headline risk for sure still in D.C. with the DOGE cuts and trying to understand just the overall employment levels. For us, we really tell our on-site teams, focus on your dashboards, not on the headlines. And these dashboards have a market that's over 97% occupied. They've got strong sequential builds. They've got pricing power. So we're watching to see kind of the headline risk play out. And to this day, I will tell you, we just haven't seen it. We look for kind of any signs of weakness in the financial health. That's residents coming in, wanting to downsize their unit, transfer to lower-cost units, take on roommates, give us their keys back, like notice to vacate and leave their lease early. We're just not seeing kind of any of that activity play out. What I'll tell you, and this is interesting because we saw this the last time we saw massive job cuts, we actually just saw this in Seattle with Microsoft announcing. So Microsoft just announced major job cuts. We had one of our residents come in and said, yes, they indeed did lose their job. Their job is being eliminated at the end of August and they have 6 months of severance. So these types of individuals have confidence that they're going to be reemployed. They tend to bunker down when there's these periods of ambiguity. And just like in D.C., there's a lot of headline risk. Everybody is watching. Retention goes up. People bunker down. They're not willing to make big lifestyle changes, and that's kind of what we're seeing play out.

The resident stays.

Yes. The resident stays. Yes, the resident in Seattle said no intention of leaving, renewed their lease and really had a lot of confidence that they would be employed.

New York.

On fire. We're here. This market continues to exceed expectations. I think this is a place where people want to be. Clearly, I know recent college grads, I have a couple that are in that mix, are really excited about the potential to come to this kind of market to be employed. There's just no supply here. And whether even if we go into Jersey, to the Hudson Waterfront, all of the submarkets around here are just performing very well for us.

Southern California.

Okay. So Southern California, it's a little bit of a tale of two cities here. I'll tell you for Orange County, San Diego, they're performing like you would expect, normal seasonality, normal sequential build, normal pricing power kind of building throughout the leasing season. L.A., we came into the year, we did not have high expectations for it. We kind of understand the impact on the overall demand because of the lack of kind of momentum that we're seeing in the film industry there. L.A. is also a market that really hasn't put forth the effort and the focus on the quality of life. So some of that urban-centric portfolio, we're just not seeing any pricing power. We didn't expect to see pricing power. What I will tell you is the last several weeks, we have noticed a pickup in demand in West L.A. So for the whole year, right now, we've looked across these submarkets and outside the deep suburban submarkets of like Ventura County and Santa Clarita. We really haven't had any pricing power. We're now starting to see a little bit of that come into the West L.A. submarket for us. We'll just see how long that lasts for us.

Okay. This one is maybe a little more recent in terms of the headline risk, but Boston obviously has a huge educational contribution to the renter pool. What are you seeing? What are you hearing?

Yes. So I would put Boston up there like D.C. from a headline risk standpoint, the pullback on funding, a lot of the press around kind of students and foreign students. So first, to clarify, student population in our portfolio, it's a very small subset. It's like 3% of our overall units are housed with students. What we saw in Boston is a little bit of a slower start to the leasing season in April, and then we turn the corner into May and it's like off to the races. So Boston is very well positioned right now both from an overall occupancy standpoint as well as from a pricing power, what you would expect to see at this time of the year.

Okay. And then so that kind of rounds out the coastal markets. I'm going to ask a question on expansion markets. But again, if anybody would like to ask a question, there's a mic over there, so maybe start lining up. But just take us through the expansion market thesis. Is this -- there's a lot of reasons why this might make sense. Is it structurally higher job growth? Is it regulatory arbitrage? You talked about the waning of supply, which has obviously been a big overhang in the last couple of years. So just walk us through the overall thesis there.

So just to talk about why are we invested in the Sunbelt markets, I'll start by saying it's not all the Sunbelt markets. We picked Atlanta, we picked Dallas, we picked Austin, we picked Denver because we really like the job growth. We really like the high housing costs. So the ability to quickly switch into owned housing is more challenging. So we used to be owners in Atlanta 10, 12 years ago. And that was the case, our best resident would move after 6 months and buy a home because homes were cheap, $200,000 homes. Now they're $600,000 to $800,000 homes and our worst resident would move out in the middle of the night. That was the story of Atlanta. There was a ton of supply, that was true in Dallas, and that was the Sunbelt story. But what's changed is the quality of life. The quality of jobs has changed and the cost of housing, and those are all positive characteristics. So we remain consistent with our theme of basically catering to a higher earning resident but in more cities. So we think of ourselves as in the 12 or so best places to live, work and play. And our younger sort of 25- to 40-something year-old demographic likes to be in those cities, and those cities do include places like Atlanta, and they stay for a while with us because, again, it's not cheap to just immediately go and buy a house. So we're really excited about that portfolio balance. We are trying to balance out regulatory risks. Regulatory risks are certainly higher in New York and California than Texas and Georgia. There's resilience risks in some of the markets, wildfire risk in California, certainly heat risks in Texas. So I think having a portfolio like ours, our goal is to compound cash flow growth for you at the highest possible rate with the least amount of volatility, being levered to a higher-end consumer across these 12 markets that have these kind of characteristics I just spoke of is, to us, the best way to do that. And the final ingredient is you got to sit in on top of a super efficient operating platform. And our operating platform, again, taking into account overhead which is the lowest in the space, CapEx which is relatively low as a percentage of each rent dollar and then as well just operating expenses. So to us, Rich, that's the whole story of how those pieces all sort of fit together.

You did mention the Atlanta portfolio deal, I think, in your prepared comments. Walk us through that underwriting. How do you think about returns, growth? How should we think about it?

Sure. So again, to just sketch those, about 2,000 units, 8 properties. If you look straight north of Atlanta, up Route 400, it's basically along that route, in places like Cumming and as well as -- what's the other?

Alpharetta.

Alpharetta. Thank you, Bob. Alpharetta. These are places that have pretty significant office nodes now, including places like Home Depot and Cox Communications. So good job bases in the areas. These are more B+, A- assets. We often own just A assets, but this is a little bit of a variety for us. We like these assets because places like Alpharetta, there is land to build but the town doesn't want new apartments. A lot of very expensive single-family homes, so there's a lot of pushback. It may not be California in terms of nimbyism, but it's got some aspects of it. So we like the supply picture. We're not competing a lot with single family. We don't expect a lot of new units. We didn't see a lot recently. The demographic is still good. We did a lot of diligence on their employment, and we feel really good about it. And these are assets that again, on top of the 14 we have already, we can run efficiently. So year 1 underwriting, we looked at it and we said, you know what, we can run it more cheaply on expenses, particularly payroll, insurance. We're just a more efficient operator than private operators. On the rent side, we do expect rents to decline for the next 6 months or so in Atlanta. There's still a lot of supply. And even though these properties don't have supply right by them, the market has supply and housing is a substitutable good. So we do expect the first year to be kind of flat year 1 to year 0. And then as you go forward, we think rents are going up because the amount of supply is so low and the demand characteristics in that market have been so good. So that's the sort of ramp-up. And I think when you buy a little bit older assets, the thing to be really careful about is your CapEx underwriting. These assets are 16 years old. They need money. There's a fair bit of money upfront to bring them up to EQR standard. There's a couple of renovations in the pro forma. So I think, Rich, we're underwriting to a mid-8s unlevered IRR over 10 years, and we feel very confident those are numbers we can attain.

That's good. Questions from the audience? I think -- sure.

I noticed you didn't mention Florida, where the housing costs have changed a lot. It used to be [indiscernible] because it's cheaper in Florida. [indiscernible]. So can you talk about that market? And [indiscernible] what you did not like about it?

Sure. So the question was about Florida and whether we have interest in that market and obviously housing is much more expensive. They're similar to my comment about Atlanta. So we did own Florida as well. And the -- when we sold out of Florida, and our last portfolio was Southeast Florida, so think Fort Lauderdale through Miami, our perspective was the quality of jobs is not good. And a lot of those jobs were in our minds related to tourism, honorable professions but just not well-earning jobs. We had delinquency issues that were relatively significant in the market and in our portfolio. So that was the knock on the market. I think Florida has changed in the sense that housing -- single-family housing is much more expensive. The quality of jobs is better in that market. But what also changed was insurance costs. When we left in 2015, 2016, our insurance cost per unit per year were $300, and now they'd be closer to $3,000 per unit per year. You need to have a lot of rent growth to offset that. And I'd also say that even though it's common and we do that when there's disasters, you sort of exclude some of those costs, but shareholders bear that cost. Insurance companies are not going to ensure to the bottom dollar. And you're going to have a fair bit of hurricane activity, it feels like to me, in Florida. And if you keep seeing that sort of activity, those costs should be in your pro forma. So I would say I probably feel better about demand in Florida than we did 2, 3, 4 years ago when we were focusing on Atlanta, Dallas, Austin and Denver. And the supply picture in Florida has been mixed. There hasn't been that much around Fort Lauderdale, been a lot in places like Orlando and Tampa. But I still feel a little uncomfortable with this, I'll call it, resilience risk and even more these insurance costs. So again, we'll keep our eye on Florida. I'm open to it. But I just think right now with these other markets, they'd probably be better to fill those in and not at that pretty significant, I'll call it, contingent liability of fixing up your property after a big storm. Thanks for the question.

Other questions? Okay. We'll keep rolling along. I'm going to give Bob here a shot on goal, okay, unless he wants to hand it off to somebody else. Capital allocation. We talked about Atlanta. Maybe walk us through sources, uses whether -- in the form of uses, we could talk about geographies, types of investment. You've talked about ramping up development. So what are you thinking on that front?

Yes, I'll start with some of this and the rest of the team can answer. But maybe starting with sources and uses. Our guidance shows that we -- or implies initially that we anticipated acquiring $1.5 billion and disposing of $1 billion with a net acquisition component of $500 million. And as we've indicated to the market often, like that's a guidance assumption. That's not necessarily -- market conditions will dictate what happens, right? And I would tell you that in today's market conditions, we're probably more of an equal buyer and seller just because of the overall aggregate cost of capital when you look at relative sources. So for us, we are a very low levered company. We have a lot of debt capacity. Net acquisitions would likely be funded with debt. But debt cost, even for a borrower that is very well priced relative to the rest of the market, are high relative to cap rates. So for instance, just to give you a real live example, you have cap rates that are probably -- market cap rates are probably in the high 4s. You apply our platform and you maybe can juice that to a low 5. But debt costs are probably mid-5s or above that. And so as such, we think it's probably most prudent to be more of an equal buyer and seller in this environment and achieve our strategic objective of expanding in these markets for all the conditions that Mark kind of outlined, et cetera, but do so by selling some older assets.

And if I can just make a pitch, I mean, we see in real time all these prices for these assets. And we own 320 of these well-located properties that we think the cap rate on these assets would be in the high 4s, some in the mid-4s, some maybe a little above 5. Yet I don't know on your numbers, Rich, the company's stock is probably trading, because today was not a wonderful day in our sector, in the high 5s. So I would say the argument on cash flow growth is clear to us, and we made it in our Investor Day. But the entry point is also excellent when you compare it to just what values are in the private market. And it's just -- again, I don't always make that point because there's fewer and fewer NAV-focused investors in our world. But I would tell you, buying at a discount is a good thing. And I think right now, high-quality companies in the residential space, especially our company, are a bit on sale.

Just a quick clarification for me. Are you saying that you're going to buy less or sell more? Or are you saying equalizing would be [indiscernible]?

So the question from Rich Paoli, which we always get insightful questions from Rich. A question from Rich was whether we were going to lower our guidance, again, $1.5 billion buys, $1 billion sales, which meant we were going to borrow $500 million. So what are we going to do with that? We won't revise guidance until July. If I was doing it right now, I'd say it's more likely to be $1 billion and $1 billion-ish, Rich, just because there's -- the volume has not been quite what we had hoped. But if we can get to $1.5 billion match fund, our goal is not to materially dilute our current investors. We like our cash flow growth. We're like raising that dividend. So we'll manage that a little bit, Rich. But right now, I think it's going to be more of a match funding, maybe a little down exercise then -- but if we see a portfolio we like, like we did with Blackstone, this portfolio we just did. It was 45 days from date of agreement to the day we closed in a week or so. I mean, we're capable of moving very quickly and we have certainty. So we are a preferred partner for a lot of private guys who need to sell. So we'll keep our eyes open.

[indiscernible]

I'm sorry, I didn't quite hear.

[indiscernible]

So the question was how we're doing with the negative leverage in real estate. Well, we hate it. And it's the reason why you're seeing us match fund. So last year, where Bob and his capable treasury team could borrow at a modestly lower rate than cap rates, we were a net borrower to the tune of $500 million or $600 million. And we bought more than we sold and we grew the company and got scale, and it was all that awesome kind of flywheel starting to work. This year because, again, we probably borrow above 5.5% and cap rates are a bit below 5%, taking that much dilution doesn't make sense as it relates to current shareholders in our mind. So the effect that, that negative leverage is having on us is to slow down our transformation into those other expansion markets because, again, we have such a good story on the West Coast right now with the urban recovery. There's just no need to dilute that story.

Right. We've got about 60 seconds left in the presentation. So maybe one more.

Say, if you have fewer [indiscernible] shareholder, what [ part ] do you think your shareholder base is focused on?

Growing cash flow as quickly as possible while raising the dividend. I think that the shareholder base is interested in total of return for sure, including the value of the assets. But they're more interested, I think, in that sort of growth and income focus, compounding cash flow growth and the dividend over time with the least amount of volatility possible.

[indiscernible]

So the question relates to just this, I'll call it, perpetual public market discount. So that kind of does come and go. We've been at points we issued when we did the Toll Brothers deal, was it 3 years ago, Bob?

Yes.

We did issue $150 million or $200 million of equity. So it just kind of comes and goes a little bit. But I agree, we're -- as a sector, we trade at a discount. And that's probably because of the existence of Fannie Mae and Freddie Mac. In sectors like health care, where you have a capital cost advantage that the big REITs have because they have an investment-grade credit rating, our investment credit rating is worth 10, 20 basis points, theirs is worth 1, 2 percentage points. So I think it's the existence of the GSEs. On the other hand, we're super liquid and health care sector isn't. So there's -- and we trade at lower cap rate for a reason the space does.

Okay. Thank you, guys. Let's wrap it there.

Thank you.