Equity Residential (NYSE:EQR) Q3 2023 Earnings Call Transcript

Equity Residential (NYSE:EQR) Q3 2023 Earnings Call Transcript November 1, 2023

Operator: Good day, and welcome to the EQR 3Q ’23 Earnings Conference Call and Webcast. This call is being recorded. At this time, I would like to turn the conference over to Mr. Marty McKenna. Please go ahead.

Martin McKenna: Good morning, and thanks for joining us to discuss Equity Residential’s third quarter 2023 results. Our featured speakers today are Mark Parrell, our President and CEO; and Michael Manelis, our Chief Operating Officer. Bob Garechana, our Chief Financial Officer; and Alex Brackenridge, our Chief Investment Officer, are here with us as well for the Q&A. Our earnings release is posted in the Investors section of equityapartments.com as is a management presentation for the quarterly call. Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events. Now I will turn the call over to Mark Parrell.

Aerial view of a standard residential neighborhood with multiple rows of relatively new houses representing the company’s real estate investments.

Mark Parrell: Thank you, Martin. Good morning, and thank you all for joining us today to discuss our third quarter 2023 results. As you can see from the press release and management presentation, the business continues to do well in most of our markets, with our East Coast markets outperforming our West Coast markets. New York, Boston and Washington, D.C., comprising a bit more than 40% of our net operating income are all having very good years and are meeting or exceeding our expectations. Our target renter demographic remains well employed. Unemployment for the college educated is at 2.1%, with increasing pay levels and a continuing high propensity to rent, given elevated single-family ownership costs, low for-sale inventory and lifestyle reasons like delayed marriage and smaller families that favor our business.

We’re also seeing lower levels of new apartment construction in most of our established markets where we have 95% of our net operating income versus the Sunbelt markets, a pattern that will continue for the next several years. Consistent with this view throughout the primary leasing season, our pricing followed a trajectory that was pretty typical for a normal pre-COVID year. And as you can see in the management presentation, on par with our guidance assumption, the normal rent seasonality would return in 2023. We saw our portfolio-wide rents peak in early August and then begin to decelerate as we expected. However, we recently saw a deceleration in pricing in San Francisco and Seattle that was more pronounced than usual seasonal patterns. The main culprit here seems to be a lack of job growth for our target renter demographic.

Michael will have more detail on this as well as the building blocks for 2024 that are laid out in the management presentation in a moment. In Los Angeles, we are working through the impact of a drawn-out process to normalize delinquency levels and to reduce bad debt. We continue to make good progress here, portfolio-wide bad debt before application of rental relief funds in the third quarter was about 1.3% as compared to 2.4% in 2022. But the process is uneven, and it is lengthy. Evictions are now taking six months or more in Los Angeles versus the two months to three months prior to the pandemic. Given the underperformance in San Francisco and Seattle and the lumpiness and improvement in bad debt as well as the impact from the noncash write-off of a $1.5 million straight-line rent receivable in the quarter due to the bankruptcy of Rite Aid, which is a retail tenant of ours, we have adjusted our same-store revenue guidance expectation for the year to 5.5% from 5.875% at the previous midpoint.

See also 12 Best Asian Stocks To Buy Now and 30 Most Popular Wine Brands in America.

Q&A Session

We have also adjusted our EPS, FFO, and NFFO guidance accordingly. Turning to 2024, the long-term health and outlook of our business remains positive, with favorable tailwinds that should support performance. While job growth expectations for 2024 are lower than 2023 levels, we’ll continue to benefit from demand from a well-employed resident demographic, we think are going to rent with us longer, given the cost of single-family ownership and powerful social trends like delayed marriage and smaller families that I previously mentioned. We also see a significant benefit from lower deliveries of new supply in our established markets compared to the elevated deliveries in the Sunbelt markets over the next few years. Switching to capital allocation.

While the overall market remains quiet, we did have some activity in the quarter. We sold a 30-year-old asset in downtown Seattle during the quarter at a 5.4% disposition yield as we continue to lighten the load in the urban centers of our West Coast markets. We also continued to invest in our expansion markets by acquiring two assets in suburban Atlanta. One property was built in 2019 and was acquired from a large private equity real estate player. The transaction is a 5.1% acquisition cap rate, including the impact of the mark-to-market on some low-cost debt that we assumed as part of this transaction. This property is located in an upscale mixed-use development, though we acquired none of the retail with a resident base having high-paying jobs at the large education, and medical employers nearby.

The other asset we acquired is in Gwinnett County, with easy access to the I-85 employment corridor, and was acquired for $98 million. This asset is brand new and is still in lease-up, and we expect it will stabilize at a 5.4%-year two acquisition cap rate. The median home price in the desirable area where the property sits is $600,000 which assuming a normal down payment in current interest rates equates to an all-in housing cost at 2.5 times our pro forma rents. Median household incomes in the area and among our residents at the property are around $100,000, making rentership a good financial and quality of life decision. It is important to note that our 2023 acquisition activity was paid forward capital from our asset sales without incurring any dilution as we took a cautious approach to transaction activity given the pricing uncertainty and low volumes in the marketplace.

We sold properties that averaged 30 years old, and that we expect will have more capital needs and lower go-forward IRRs than the properties that were acquired, which were one year old on average. We are well positioned to further our portfolio diversification by taking advantage of acquisition opportunities that we believe are likely to arise from the substantial development pipeline that is delivering in our expansion markets over the next two years. And now I’ll turn the call over to Michael Manelis.

Michael Manelis: Thanks, Mark, and thanks to everyone for joining us today. This morning, I will review the third quarter 2023 operating performance in our markets, our outlook for the remainder of the year, and some views into 2024, and that we included in our management presentation. We continue to produce very good results with residential same-store revenue growth of 4.4% in the third quarter driven by generally healthy fundamentals in our business and some improvement in delinquency, although not as much as we expected. The East Coast markets continue to outperform the West Coast. Demand and occupancy remain healthy, especially across our East Coast markets and absorption and our results in the Washington, D.C. market continue to impress.

As I will discuss shortly, San Francisco and Seattle are experiencing more pricing pressure than we previously expected. Before I get to that, let me touch upon October leasing spreads, new lease, renewal and blended. The stats we published through October 27 captures almost all the months activity, and as we mentioned, are consistent with seasonal declines outside of Seattle and San Francisco. New lease change is negative, which is normal for the month, and will continue to get more negative as pricing trend, which is presented on Page 6 of the management presentation, continues to decline for the balance of the year. In a normal pre-pandemic year, by the time you get to December, it is not uncommon to see new lease change be negative 4% or 5%.

Given the weakness in our Seattle and San Francisco portfolios, we will likely be slightly more negative than that. Renewal rate achieved should moderate slightly, but remain relatively stable and make up more of the transaction mix. Put it all in the blender and Q4 blended rate will continue to moderate. In terms of the specific conditions on the ground in San Francisco and Seattle, as we stated previously, we have had little to no pricing power throughout the year. However, the peak leasing season did demonstrate an increased volume of demand and some moderation of concession use, which led us to what we initially thought could be the beginning of better stability. Over the last six weeks, however, these markets have slowed more than normal, which has resulted in larger price reductions than seasonally expected, characterized by both declining rates and increased concession use.

This is most pronounced in the downtown areas of both markets, though there are other suburban pockets experiencing pressure like Downtown Redmond in Seattle. The uncertainty of back to the office from the big tech employers, combined with their slowdown in new hiring is keeping a lid on demand. In order for these markets to fully recover, we will need to see the vibrancy that comes to these areas when the offices are active, employment increases, and residents want to enjoy the city lifestyle and easy commute to the office. Both cities are making progress on improving the quality of life issues, and we are seeing signs that a few of the major tech employers are slowly adding positions back, especially in Seattle, but the improvement in both of these areas need to accelerate in order to generate enough in migration to these markets, which will allow pricing power to return.