The COVID-19 lockdowns over the past 18 months were particularly hard on apartment real estate investment trusts (REITs), as many had tenants who were unable to work and pay rent. Urban density fell out of favor as well, which hit urban apartment buildings particularly hard.
Equity Residential (EQR 0.39%), one of the leading apartment REITs in the country, has been working to resolve the difficult situation and its management recently reported that its recovery from pandemic-related shortfalls is almost complete.
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Equity Residential specializes in luxury apartments
Equity Residential specializes in high-end urban apartments in some of the most attractive markets in the United States. It has a presence in Boston, New York City, and Washington, D.C., on the East Coast, and Seattle, San Francisco, and southern California on the West Coast. The company also has buildings in Denver, Dallas, and Austin, Texas.
Equity Residential chooses locations based on job growth, income growth, and the concentration of workers in knowledge industries. In addition, it focuses on locations where single-family homes are expensive, which helps give the company more pricing power. In many of these places, government regulation and space limitations prevent additional supply, which again feeds through to the ability to raise rents.
COVID-19 forced Equity Residential to cut prices to maintain occupancy
The COVID-19 pandemic put companies like Equity Residential into the position where they had to "buy occupancy," which means cutting prices to keep people in their apartments. If a tenant's apartment lease expired during the COVID-19 pandemic, the tenant had the upper hand in negotiations. Equity Residential would rather have someone paying reduced rent than a vacant unit.
Since lease terms are a year, the reduced rent would affect earnings for the company into 2021, and Equity Residential has referred to this as a "year of recovery." On the latest earnings conference call, Equity Residential management said that 86% of the REIT's tenants were paying below-market rents. As these leases expire and get reset at market prices, the company will see an uptick in revenue.
In many of Equity Residential's markets, workers are only slowly returning to the office. The company is reporting "unprecedented demand" right now, and additional workers returning to the office will only lift demand further.
For the third quarter of 2021, Equity Residential reported funds from operations (FFO) per share of $0.76. This was flat on a year-over-year basis. REITs generally use funds from operations instead of net income because non-cash charges like depreciation make the company appear less profitable than it really is. The company also upped its guidance for 2021 FFO per share by 2% to a range of $2.95 to $2.97. Equity Residential won't give 2022 guidance until the fourth-quarter earnings call in February 2022.
Equity Residential's dividend looks safe
Equity Residential pays a quarterly dividend of $0.603 per share, which gives the stock a yield of 2.8%. The annual per-share dividend works out to be $2.41, which is 81% of the company's guidance for 2021 per-share FFO. The dividend divided by FFO gives the payout ratio, which is a good metric to use to analyze the potential for a dividend hike.
In this case, Equity Residential's payout ratio is just over 81%, which is on the high side. This would indicate that earnings need to grow a bit more before the company hikes its dividend. Earnings should increase as we head into 2022 and rents are reset to market levels.
Investor takeaway
Equity Residential is trading at 29 times 2021 FFO per share, which is on the high side for a REIT, but earnings should pick up next year as the submarket leases expire and are reset to market rates. Since many of Equity Residential's markets have only begun to see employees return to the office, demand should increase as workers return to urban living. It is hard to get too excited about the stock given the multiple, but it appears that the worst is over for the company's financials, and earnings should begin growing again.
