2 Big Rental REITs Acquire the Jewel in Lehman’s Crown

It took some time, but Equity Residential (NYSE: EQR  ) finally got its wish: a big stake in Archstone, a huge portfolio of high-end rental units that stretches from the Northeast to southeast Florida. Along with AvalonBay Communities (NYSE: AVB  ) , a peer that had also expressed an interest in Archstone, Equity bought out the jewel in the former Lehman Brothers' crown for a cool $6.5 billion.

Equity's eyes were on this prize for some time
Earlier this year, Equity had made a move to buy out its huge rival, which was owned at the time by Lehman, Bank of America (NYSE: BAC  ) , and Barclays. At the time, Archstone was the center of a tug-of-war between Equity and Lehman, with the latter trying to buy out its partners with an eye toward going public. Lehman acquired all of Archstone, likely brokering no argument from B of A, which has been steadily trimming its property portfolio under the auspices of Project New BAC. Ultimately, Lehman decided against the IPO in favor of selling to the two persistent suitors.

On their own, both Equity and AvalonBay are heavy hitters in the apartment REIT industry. Both own and manage properties in high-rent areas, with formidable barriers to entry for competitors. Equity, with its 60% stake in Archstone, will acquire an additional 78 top-drawer properties in areas such as Washington, D.C. and New York, while AvalonBay will take on 66 complexes in California and the mid-Atlantic.

The rental business is still booming -- for now
Being in the landlord business has been especially sweet since the housing bust, and recent news from the National Association of Realtors indicates that the good times are far from over. The association sees apartment vacancy rates declining from the current 4% to 3.9% in Q4 of next year, with rent increases of 4.1% this year rising to 4.6% in 2013.

Some see clouds on the horizon, however. Bloomberg notes that its apartment REIT index has dropped by 13% since July, which represented its high watermark since 2008, buoyed by a rise in renters due to the foreclosure crisis. Other analysts note that apartment REITs, particularly AvalonBay and Equity, are quite expensive on a price to funds-from-operations standpoint -- and question how well these companies will weather the approaching housing turnaround.

One Fool's take
At $6.5 billion, the purchase of Archstone looks like a bargain, particularly when you consider that Lehman bought it for over $23 billion in 2007. The portfolio had been slimmed a bit since then, but not by much; Lehman knew that Archstone was valuable, and didn't decimate it. Apartment values have rebounded beautifully since the financial crisis, making the deal even sweeter for the buyers.

Of course, Equity and AvalonBay bought not only apartment complexes, but the company's debt, as well -- $9.5 billion worth. In addition, the deal gives Lehman a 9.8% stake in Equity, and a 13.2% investment in AvalonBay. Even so, this deal has only strengthened the positions of the two titans, whose market base of well-heeled tenants are not apt to be dislodged from their apartments because of a drop in the foreclosure rate. Even as housing rebounds, this corner of the rental REIT sector still looks like a winner.

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