The economic theme of this year has been inflation and the Fed's actions to bring it back under control. Along with rising inflation, we have seen rapid home-price appreciation, with prices rising 18%, according to the government's FHFA House Price Index. This is good news for some apartment real estate investment trusts (REITs), especially Equity Residential (EQR -2.29%), which specializes in luxury urban apartments. 

Picture of luxury apartment buildings

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Equity Residential rents to the affluent

Equity Residential specializes in luxury rentals for young, affluent tenants in select urban areas. These cities are characterized by a high percentage of highly-compensated knowledge workers, strong job growth, and a shortage of single-family houses for sale.

The company has a presence in Southern California; San Francisco; Seattle; Austin, Texas; Denver, and the Northeast. All of these markets have experienced rapid home-price appreciation over the past decade. 

Funds from operations are rising smartly

Equity Residential recently reported its second-quarter earnings. Normalized funds from operations (FFO) rose 19% over the past year. Normalized FFO per share rose 24%.

FFO is the typical metric that REITs use to characterize their earnings. Generally accepted accounting principles (GAAP) require firms to deduct depreciation and amortization, which is a noncash charge. Real estate companies tend to have a lot of depreciation and amortization, which makes their GAAP earnings per share understate the cash the company is actually generating.

Its typical tenant has a lot of income and is less rent-stressed than most

On the earnings conference call, CEO Mark Parnell discussed the state of the economy. While inflation is a risk, especially if it begins to hamper job growth, so far the labor market remains quite strong.

Parnell mentioned that the income for the REIT's typical tenant was 13% higher in June of 2022 than it was a year ago. These tenants are paying 19.8% of their income in rent, which is well below the threshold that has typically been considered comfortable. 

Equity Residential raised full-year guidance

In the most recent quarter, the REIT boosted its guidance for normalized FFO per share from a range of $3.40 to $3.50 to a range of $3.48 to $3.58. If you look at "same store" revenue (basically a way that companies measure apples-to-apples growth), the company sees it increasing between 10% and 11% this year. This is a function of strong occupancy, record resident retention, and pricing power. 

At the midpoint of the company's guidance, Equity Residential is trading at 22 times normalized FFO per share, which is a reasonable multiple for a residential REIT. It pays a $0.625 quarterly dividend, which works out to a yield of 3.1%. This is somewhat on the low side for a REIT, but the company is expanding into newer markets, so it is reinvesting cash into the business.

The annual dividend of $2.50 is easily covered by the midpoint of the company's $3.53 normalized FFO per share. Even if we hit a recession, the dividend is largely safe. Overall, the company is not worried about a recession given that rising home prices give it the leeway to raise rents, and its tenants are less likely to suffer financial distress if we do hit a recession.