High Quality Multi-family REITs - EQR, CPT, ESS, AVB

[Spekulatius]

Any idea why EQR appears to be the dog in the apartment Reit space? MAA seems to be the top performer.

[fareastwarriors]

Recession Proof’ Apartment Buildings Set for $12 Billion Test

 JLL is marketing deals to investors on promise of rent growth
 Layoffs, expiring unemployment benefits pose new hurdles

https://www.bloomberg.com/news/articles/2020-07-28/-recession-proof-apartment-buildings-set-for-12-billion-test?srnd=premium

[thepupil]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

[HalfMeasure]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

No position here, but doesn't it seem like a 5-10% rent decline across the portfolio is already priced in at today's levels? Does anyone have a good sense for what kind of cap rate these assets would transact at in normal times on a stable rent base?

[BG2008]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

Pupil, what's your take on the offsetting effects of lower interest rates vs lower rent/occupancy?  I feel like they wind up being a draw.  Thoughts?  I'm talking specifically multi-family. 

Heck, maybe we should hedge our MF exposure with some homebuilders as post 2009, there was a decade where young people moved into the city to work and fornicate.  That huge demographics group now has kids and are likely looking to buy houses. 

[thepupil]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

Pupil, what's your take on the offsetting effects of lower interest rates vs lower rent/occupancy?  I feel like they wind up being a draw.  Thoughts?  I'm talking specifically multi-family. 

Heck, maybe we should hedge our MF exposure with some homebuilders as post 2009, there was a decade where young people moved into the city to work and fornicate.  That huge demographics group now has kids and are likely looking to buy houses.

I think rates are an important consideration.

The most obvious would be in what EQR pays on its borrowing:

EQR primarily issues in the unsecured IG bond market and its bonds have spreads ranging from 52-170 which at current rates leads to absolute yields of 0.5% - 2.6%. the actual coupons are higher (3.5% or so), so over time EQR's cost of interest should come down. 

But whether EQR pays 3.5% or 2.5% on its debt isn't really that important from an income statement perspective in that EQR only has about $105K of debt per unit. So on a unit level it's a question of whther you are paying $2.5K or $3.5K/year (which isn't really important or material). Considering that each unit commands about $33K of rent / year and has $11.8K of cash opex + g&a / year, changes in either rent or opex are far more important. A 10% decline in rent has 3x the impact of a 100 bp decline in interest expense AND EQR's interest expense is mostly locked in because a lot of the "high" coupons of say 4% are locked in for as long as 30 years; EQR would have to tender for bonds at a premium.

Where low rates are important is simply supporting the whole market for high quality multi-family and helping control cap rate expansion. EQR operates with very low leverage, but obviously not all multifamily people do. As an example, we know that FRPH and MRP own Dock79 which has $295K / unit of debt ($90mm / 305 ) at 4.125% w/ 4 years of interest only. this is much more typical. As a former Agency CMBS trader, I can tell you that the vast majority of Fannie Mae DUS and Ginnie Mae project loans and Freddie K deals that I was buying for securitization / trading had DSCR's of 1.1-1.3x often with rosy occupancy assumptions.

The availability of that extremely low cost and favorable debt supports the whole multi-family market (and single family market for that matter) and is the reason why EQR can exit its lower quality apartments at <5% cap rates. They're selling to a leverage junkies running 80%+ non recourse LTV who still is getting a decent cash flow/total return to equity because of the great financing. I do not look down on the leverage junkies; I am one myself with my personal residence.

In sum, low rates are simply a market support for the value, but aren't important to the income statement, particularly for EQR. From a stock perspective, they also support the demand for yieldy REITs.

[rb]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

No position here, but doesn't it seem like a 5-10% rent decline across the portfolio is already priced in at today's levels? Does anyone have a good sense for what kind of cap rate these assets would transact at in normal times on a stable rent base?

They would transact around a 4% cap. You can get a better idea from the annual reports as EQR does transact fairly regularly and release the info.

[thepupil]

http://investors.equityapartments.com/Cache/IRCache/e03b3c04-78b4-8606-37bf-384a94da468a.PDF?O=PDF&T=&Y=&D=&FID=e03b3c04-78b4-8606-37bf-384a94da468a&iid=103054

looks okay to me. i mean definitely some impact, but the apocalypse is at least on the come rather than here. rents are dropping though. see slide 15 with the same store rent changes. -5% to -10%. that's how they're maintaining occupancy.

No position here, but doesn't it seem like a 5-10% rent decline across the portfolio is already priced in at today's levels? Does anyone have a good sense for what kind of cap rate these assets would transact at in normal times on a stable rent base?

If Mr. Market was given perfect foresight ans was told that rents would decline by 7.5% and nothing else would change, then the stock would probably go up. But that's really not the extent of the risk.

I see EQR at a 5.8% cap rate right now with a high 6's cash on cash return to the equity. If I shock all rent down 10%, I get about a 5 cap. At 30%, I get a 3 cap. At 15% decrease in rent plus a 10% increase in opex / unit (from a 25% hike in property taxes for example), I get to a 4% cap. All of those are assuming current and high occupancy levels. 

For context, if I had to put one number on what cap rate high quality multi-family transacts, I'd say 4.5%; the lowest I've seen was 3.7% on national landing multi-family private deal after AMZN where the underwriting baked in big rent growth/redevelopment (shameless plug for JBGS here which trades FAR wider). Others can chime in. EQR generally prints 4-4.75 caps when they sell Search the Q's / K's for "disposition yield".

This data says its above 5 though.
https://www.nar.realtor/blogs/economists-outlook/2020-q1-nar-commercial-survey-shows-early-impact-of-coronavirus
https://mf.freddiemac.com/docs/multifamily_2020_outlook.pdf

If you start to tweak the cap rate up and bake in declines in rent/NOI, there's still plenty of downside that's not priced in.

But I think it's also important to consider it all on a per unit basis and what that would imply. For example, if someone said "i think rent goes down 15%, opex goes up 30% and it should trade at a 7% cap rate, this would imply a value of $217K per unit (down from $370K now and $530K at peak price of $87).

$217K per unit would represent an extreme value proposition for end users of highly amenitized well located modern apartments and the argument for EQR to start doing condo conversions would be compelling. Recall that EQR's tenants make $165K / year. Even if that drops, think how affordable such apartments would be with a 30 year mortgage at 3%.

I guess what I'm saying is, one can very easily dream up negative scenarios that are not priced in; these aren't insanely cheap and one could easily argue fundamentals are only starting to come down, but I think the underlying pure real estate value starts to bail you out at those negative scenarios (assuming urban living is desirable again at some point).

[rb]

Just thinking a bit about occupancy here. I don't have the numbers handy. But as I recall in ancient times (pre-covid) vacancy was really low in EQR's markets. So it doesn't make much sense that a big occupancy drop is coming. Where would these tenants actually go to live? No way you get a lot of new supply coming to mark if rents are soft.

I guess the only wild card is the airbnbs coming into the rental market. I have no idea how many of those are around.

[thepupil]

Just thinking a bit about occupancy here. I don't have the numbers handy. But as I recall in ancient times (pre-covid) vacancy was really low in EQR's markets. So it doesn't make much sense that a big occupancy drop is coming. Where would these tenants actually go to live? No way you get a lot of new supply coming to mark if rents are soft.

I guess the only wild card is the airbnbs coming into the rental market. I have no idea how many of those are around.

Well 50% of EQR's NYC moveouts gave an out of state forwarding address.

Be trigger warned of my overprivileged statements below, but just to give some anecdotal flavor
I live in wealthy DC Burbs. Two software engineers from NYC just bought a $2mm+ house down the street from me. they aren't going back. the headwinds are real as it relates to the 30+ year old accelerating their moves to the burbs. EQR has also noted international students as an issue. My sister went to school in Boston and rented at an Archstone owned apartment (now owned by EQR). She rented a $2K / month apartment. to the extent college kids aren't going back (temporarily) that hurts. I know some investment banking graduates that are training remotely. There's a a big disruption coming. Will this be important in 3 years or 5 years, maybe not (I would wager not). But we should acknowledge the headwinds. The 30+ year olds are buying houses and the 23 year olds are at their parents' house.