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Where Will Equity Residential be in 3 Years?

Jun 05, 2020 by Matthew DiLallo

Equity Residential (NYSE: EQR) is one of the largest multifamily REITs in the industry. It has grown into a leader by actively managing its portfolio to increase its net operating income (NOI), including swapping out older assets for newer ones that generate higher returns. That strategy has been highly successful over the years as Equity has steadily grown its funds from operations (FFO) and dividend, enabling it to produce market-beating total returns.

The company's differentiated approach sets it up for continued success over the next few years. Here's a look at where Equity Residential will likely be in 2023.

Equity Residential today

Equity Residential currently owns 306 multifamily properties with about 79,000 units. The company concentrates on owning properties in urban and high-density suburban locations in major U.S. cities and areas, including Boston, New York, Washington D.C., Seattle, San Francisco, Southern California, and Denver. These cities are ideally suited for multifamily properties due to the high prices for single-family homes. Equity Residential primarily focuses on owning higher-quality apartment buildings that attract high-earning professionals. These characteristics drive superior rent growth.

The Equity difference

Equity Residential has a differentiated growth strategy compared to most of its multifamily peers. While many of them place a heavy emphasis on developing new properties, Equity Residential's main growth driver is improving the NOI of its existing portfolio. This internal growth comes from rental increases and cost savings initiatives.

Because it operates in supply-constrained markets and focuses on higher-earning tenants, Equity Residential can raise rents more readily than other multifamily owners. It also leverages technology, which helps drive down costs. It has been a leader in deploying and investing in property technology solutions such as online leasing, which has helped increase its income. It expects to produce $5 million in incremental same-store NOI this year and $15 million by 2021 as it implements its current operating cost-savings initiatives.

Equity Residential's other main growth driver is active portfolio management, which comes in many forms. While it doesn't have an extensive development pipeline, the company currently has $603 million of properties under construction and can start another $500 million to $650 million of projects depending on market conditions. The company also invests some capital on redevelopment projects. Larger ones focus on increasing the densification of existing properties by selectively adding more units when possible. Meanwhile, it spends about $50 million per year across its portfolio on kitchen and bath renovations. Finally, Equity Residential is an active buyer and seller of multifamily units in its core markets. It typically sells older properties and uses the proceeds to purchase newer ones that have more income upside.

Value-creating math

In Equity Residential's estimation, it can grow its same-store NOI by about 2% to 4% per year through rent increases. On top of that, investments in its platform to decrease costs and improve same-store NOI should add another 1% to the bottom line. Finally, it can add another 1% to 2% to its FFO per year via external growth drivers such as development projects and acquisitions. It finances this growth with excess cash after funding the dividend and other investments and incremental borrowings while maintaining its strong balance sheet.

Add it all up. Equity Residential should be able to increase its normalized FFO at a 4% to 7% annual rate over the next three years, assuming there isn't a prolonged economic downturn due to the COVID-19 outbreak. That would provide it with the funds to continue steadily increasing its dividend, which currently yields 4%.

A more valuable portfolio of multifamily properties

Equity Residential has a long history of creating value for investors. It has done that by focusing on owning properties in regions that can produce outsized rental growth. Sprinkle in a little development activity and some M&A upgrades, and in three years this multifamily REIT will likely own a portfolio of properties that's generating more income, enabling it to pay an even higher dividend.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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