Equity Residential (NYSE:EQR) Q4 2023 Earnings Call Transcript

Equity Residential (NYSE:EQR) Q4 2023 Earnings Call Transcript January 31, 2024

Equity Residential isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day, and welcome to the Equity Residential Fourth Quarter 2023 Earnings Conference Call and Webcast. Today’s conference is being recorded. At this time, I would like to turn the conference over to Marty McKenna. Please go ahead, sir.

Marty McKenna: Good morning, and thanks for joining us to discuss Equity Residential’s fourth quarter 2023 results and outlook for 2024. Our featured speakers today are Mark Parrell, our President and CEO; Michael Manelis, our Chief Operating Officer; Alec Brackenridge, our Chief Investment Officer; and Bob Garechana, our CFO. Our earnings release is posted in the Investors section of equityapartments.com. 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.

Mark J. Parrell: Thank you, Marty. Good morning, and thank you all for joining us today to discuss our fourth quarter 2023 results and the outlook for 2024. I will start us off, then Michael Manelis, our COO, will speak to our operating performance and 2024 operating expectations, and followed by Alec Brackenridge, our Chief Investment Officer, who’ll give some color on our capital allocation activities in the transactions markets. And then finally, Bob Garechana, our CFO, will review our 2024 guidance and our balance sheet, and then we’ll take your questions. We are pleased with our fourth quarter performance, which was in-line with our October expectations. Our performance in 2023 was supported by a strong employment situation, more than 2.7 million new jobs created.

And while the 2024 outlook for overall jobs is more muted, we should benefit from a continued low unemployment rate for the college educated, which currently sits around 2.1%, as well as continued good real wage growth. We will also benefit in 2024 from having low exposure to new supply in the vast majority of our markets, particularly when compared to the Sunbelt markets, as well as the customer comfortably able to pay our rents with current rent income levels at about 20%. Overall, with low unemployment and rising real wages, our target renter demographic remains in good shape. They are likely to rent with us longer as the prospect of homeownership in the near-term seems less likely with scarce inventory and relatively high mortgage rates.

Less than 8% of our residents who moved out gave bought home as a reason to depart in 2023, which is the lowest we have seen since we started tracking the number. And over the next decade, the significant net deficit of housing across our country sets us up for good long-term demand. Drilling down on the West Coast, we do see clear signs of improvement in quality of life and energy on the street in the urban centers of Seattle and San Francisco. We continue to believe a recovery in rental rates in the downtown submarkets of these metros is coming and expect our shareholders will benefit from catch up rental growth in these places, where rents are still at or a fair bit below 2019 levels and where incomes, both on a nominal and real basis, have risen substantially since 2019.

So, while we have not baked the material improvement in Seattle and San Francisco performance in our 2024 guidance expectations, we do note that other urban centers damaged by the pandemic and other negative trends, for example, New York City, reignited quickly and sharply off of depressed rent levels once quality of life and employment conditions improved. Switching to the cost side of the equation, our consistent ability to grow expenses and overhead more slowly than our competitors. We’ll preserve cash flow for our shareholders as rent growth slows across the country and positions us well once growth picks back up. As it relates to capital allocation, before Alec, goes through the details of our recent transaction activities and our view of forward market conditions, I do want to highlight that we bought back some of our stock in the fourth quarter for the first time in many years.

We bought back a little more than 864,000 EQR common shares for a total of about $49 million spent at about $57 per share. We funded this repurchase activity with proceeds from sales during January of less desirable assets that were on average 40 years old and we’re sold at a 5.6% disposition yield and believe that at this stock price and funded with these disposition proceeds, buying our shares makes a very good investment, especially given the lack of available assets to acquire at reasonable prices. Before I turn the call over, I want to thank our teams across the company for their continued hard work and dedication to serving our customers and producing strong results for our shareholders. Now I’ll turn call over to Michael Manelis.

Michael L. Manelis: Thanks, Mark. This morning, I will review our fourth quarter 2023 operating performance and our outlook for 2024. We produced same store revenue growth of 3.9% and same store expense growth of only 1.3% in the fourth quarter, both of which were in-line with our expectations. On the expense side, our low growth in the quarter and full-year 4.3% growth were helped by modest property tax cost as well as the savings produced as we continue to roll out initiatives focused on creating operating efficiencies and a seamless customer experience. On the revenue side, the momentum in December was a little better than we thought as sequentially we grew revenue in the fourth quarter by holding onto more occupancy, while maintaining positive blended rate growth.

This set us up for a good start in 2024. Demand was solid across our markets and consistent with seasonal expectations. We finished the year with same store physical occupancy at 96% as we focused on building up occupancy in the slower part of our leasing cycle. Today, the portfolio is above 96%. As expected, we saw new lease rates go negative in the quarter as they typically do. Meanwhile, renewal rates for the quarter came in at 5.1%, which was slightly above our expectations. Together, this resulted in a fourth quarter blended rate growth of positive 80 basis points. These healthy fundamentals led to outstanding revenue growth in our East Coast markets and good growth in Southern California. As has been the case all year, the East Coast markets outperform the West Coast and by and large will likely continue to do so in 2024.

As you saw in our earnings release, we have provided 2024 same store revenue guidance range of up 2% to 3%. The building blocks for this growth starts with embedded growth of 1.4% and a midpoint assumption that both physical occupancy and cash concessions remain consistent with that of 2023. We expect the year to follow the traditional pre-COVID historical patterns with rent growth sequentially picking up in the spring and likely peaking in August. Our midpoint assumes renewals for the year averaged just over 4%. New lease change is relatively flat, which together produces blended rate growth of about 2%. This is more modest growth than the 2023 full-year blended rate growth of 3.1% and is reflective of a slowing job growth environment offset by a mostly positive supply situation in our coastal market, where we have about 95% of our NOI.

As you can see from the stats in the release, January is starting out the way we would expect with new lease change improving, a strong percent of residents renewing, and a renewal rate achieved that is healthy, albeit moderating a bit. While still early, all of these January trends support our outlook for the year, which includes a view that resident retention remains very good, as a result of both the benefits of a centralized renewal process, our enhanced data and analytics insights and the high cost and low availability of owned housing in our markets. Turnover in the portfolio remains some of the lowest that we have seen in the history of our company and we expect that trend to continue in 2024. Orange County, San Diego, Boston, and Washington DC will lead the pack with expected revenue growth of approximately 4%.

New York and LA will follow closely behind. At the moment, we expect slightly positive same store revenue growth in San Francisco and Seattle, and in our expansion markets, which reflect only about 5.5% percent of the total company NOI, we expect to produce negative same store revenue growth given the unprecedented levels of supply being delivered. As we look to the individual markets, starting with Boston, with high occupancy and limited new competitive supply. This market should continue to perform well in 2024. The market is supported by a strong employment base and finance, tech, life science, health and education. New supply deliveries will be about the same this year as they were in 2023, and this is a market where our urban assets have outperformed suburban ones lately and we expect that trend to continue in 2024.

New York should continue to perform well this year, but won’t reach the high rate growth achieved over the last few years. Occupancies remain high and competitive new supply is limited, which led to record high market rents, causing some rate fatigue to be observed in late in ’23. New supply deliveries will be similar to last year with very little being delivered in Manhattan, where a large part of our portfolio is located. Washington DC continues to outperform our expectations despite the delivery of a good amount of new supply. The market delivered over 13,000 units in 2023 and saw the great majority of those units absorbed. This year, the market will see a similar amount of deliveries, but demand has been strong and we expect this good performance to continue.

We are starting the year with occupancies above 97%, which is a great position to be in. In Los Angeles, we expect the tailwind to growth as we work through the delinquency and bad debt issues that have been concentrated here. We continue to make progress, although the court system remains slow, taking at least six months from our court filing to being able to get the unit back. Bob will give some more color on the impact of bad debt net on our 2024 earnings expectations. New supply deliveries will be slightly higher this year with our Mid-Wilshire Koreatown and San Fernando Valley portfolio seeing the largest impact from this new supply. Strong retention and solid demand will continue to aid our ability to fill vacant units with paying residents in this market.

Rounding out Southern California, San Diego, and Orange County should be some of our highest growth markets this year, driven by high occupancies and a general lack of housing. High homeownership costs make renting in these markets a more attractive option. San Diego will see more competitive new supply in 2024, while Orange County will see similar amounts to last year. In San Francisco and Seattle, we had little to no pricing power throughout 2023 and our base case expectations for this year assume that situation continues. We have seen periods of stability and then pullbacks. Concession use in both markets is widespread. We have strong physical occupancy with both markets being above 96%, which tells us there is demand, although it is very price sensitive.

As Mark mentioned, the downtown areas of both markets continue to see improvement in the quality of life, but are still lacking the catalyst of return to office and or job growth. New supply in San Francisco this year will be up from last year levels, mostly due to an increase in the South Bay, although continued healthy demand in this submarket should aid the absorption. Seattle is likely to be the most impacted of any of our markets when it comes to new supply deliveries with increases in both the City of Seattle and the Eastside. The lack of expected job growth combined with this new supply has driven our low expectations in Seattle for 2024. Both Seattle and San Francisco continue to see less than normal inbound migration. Seattle in the fourth quarter, however, did see some relative improvement with new residents coming to us from out of state.

This positive trend is something that we will keep an eye on as we move through the spring leasing season. Drawing new residents back to the MSAs in both Seattle and San Francisco would be a catalyst for these markets to outperform our expectations. In the expansion markets, our long-term outlook remained positive. That said, high levels of new supply are already pressuring rents and is likely to continue throughout 2024. At present, we are operating from a defensive position and starting the year with occupancies that are two to three percentage points above the market averages. Denver has demonstrated the most stability despite having limited pricing power in the portfolio, and we expect the market to produce slightly positive same store revenue growth in 2024.

Currently, Atlanta is using the least demonic concessions, but we expect a few of our assets to be very challenged due to the sheer number of lease ups in close proximity, which will likely lead to negative revenue growth for the year. In Texas, Dallas and Austin have widespread concession use, and we expect all of our assets to experience direct pressure from new deliveries all year long, resulting in negative same store revenue growth in these markets. So, putting all of these factors together, our overall same store revenue outlook for 2024, right now anticipate solid growth led by the East Coast markets and Southern California, which collectively is almost 70% of our NOI. We expect our coastal existing markets to outperform our expansion markets where unprecedented supply will impact operations near-term.

On the initiative side, in 2024, we will continue to focus on producing operating efficiencies and driving other income with projects tied to flexible living options, parking, renter’s insurance, and monetizing technology deployed for the benefits of our residents. We are almost complete with the rollout of smart home technology across our portfolio, which will create further opportunities to share teams across properties and enable additional self-service options for residents. This, along with other ancillary income, should lead to total other income growth of 30 basis points excluding bad debt. As we sit here today, we like our positioning and look forward to capturing the opportunities the spring leasing season brings, which will help frame pricing power for the full year.

I want to give a shout out for our amazing teams across our platform for their continued dedication to their residents and focus on delivering these results. With that, I will turn the call over to Alec, to walk through our capital allocation activities and the transaction market.

Alexander Brackenridge: Thank you, Michael. Despite an unsettled transactions market, we remain steadfast in our efforts to continue to reposition our portfolio by increasing our presence in markets like Dallas-Fort Worth, Atlanta, Austin and Denver and expect to see more opportunities to do so as the year progresses. As we underwrite potential acquisitions, we are always mindful of heightened levels of supply pressuring rents in our expansion markets and reflect tempered rent growth and concessions as needed in our projections. Currently, the transaction market remains unusually choppy with volumes down 60% to 70% compared to 2022 and down 40% to 50% compared to a more typical year like 2019. Nonetheless pressures on sellers to transact continue to mount as does the volume of new developments being delivered in these markets.

New developments in particular are often not capitalized to be held for the long-term, and even with rates decreasing over the last few months, carry costs are high. Owners of stabilized assets will also see pressure to transact, as loans mature and extensions that were agreed to with lenders last year expire. Despite the short-term operating challenges in our expansion markets, we remain committed to broadening our footprint in markets that will see strong job growth and household formations over time and lower regulatory risks. As regards our own transactions activity, we didn’t acquire any assets in the fourth quarter, but we did sell three, a small property in Seattle, one in the Bay area and one in LA. On average, the properties were 40 years old and total sales proceeds were $185 million at an average 5.8% disposition yield.

While transaction volume overall is very light, we are seeing some opportunities to lighten the load of non-core older assets primarily in our West Coast markets. Since the beginning of 2024, we’ve sold two additional properties, one in Southern California and a small deal in Boston for a total of $189 million at an average 5.6% disposition yield. We’ve allocated a portion of the capital from these sales to the share buyback activity Mark just mentioned. With ample access to capital either through asset sales or debt issuance and a property management presence in our expansion markets, we are well-positioned to take advantage of opportunities as they arise. In terms of anticipated volume, our guidance for 2024 is $1 billion for both acquisitions and dispositions, but market conditions will dictate whether we can hit or even exceed these goals.

Turning to development, in 2024, will complete six new apartment properties with a total cost expected to be $624 million and consisting of 1,982 units with lease ups commencing for two of those projects in Q1 and four in Q2. Three of those lease ups all through our joint venture program with Toll Brothers are in Dallas, while the remaining three, two in Denver and one in suburban New York City are JVs with other developers. Given the timing for completion and lease up, we don’t expect meaningful contribution to NFFO growth in 2024, but would expect these projects to contribute more to 2025 growth. While our suburban New York project will see limited competition from new supply, not unexpectedly our lease ups in Dallas and Denver will see substantial new competition.

We acknowledge that the competition may be challenging and anticipate as we may have to adjust pricing and concessions to meet the market, our projected stabilized yields, which at initial underwriting were on average a mid six maybe closer to six. We believe these lease ups once stabilized and past the current supply glut will provide good cash flow growth and be solid long-term investments. Beyond these deliveries, we will be very selective about starting any new projects with a primary focus on locations where it’s hard to buy such as suburban Boston. I’ll now turn the call over to Bob.

Robert A. Garechana: Thanks, Alec. As Michael and Mark mentioned, 2023 ended up right in-line with our forecast last quarter. So, let’s get right to guidance. Michael gave you most of the building blocks for same store revenue, but I’ll finish up with bad debt, walk through drivers of same store expenses and normalized FFO and conclude with the balance sheet. In 2023, we were able to reduce bad debt significantly once the regulatory environment became more constructive. While we continue to work with non-paying residents, as we have during and after the pandemic, ultimately, we still ended up processing a high volume of skips and evicts. In fact, about 1.5 times pre-pandemic activity levels, which coupled with not adding significant amounts of new non-paying residents, helped us reduce bad debt as a percentage of same store revenue from well over 2% to just under 1.5%.

So, great progress overall, but still a long way from the 50 basis points we were accustomed to pre-pandemic. Much like last year, we expect 2024 to continue to show improvement. We also expect the pace of this improvement to be dependent on the speed of the court systems, primarily in Southern California, where delinquency remains highest, to quickly process evictions, which is a hard thing to predict. As a result, our guidance assumes that 2024 remains another transition year for bad debt and that we don’t get all the way back to pre-pandemic levels. Instead, our guidance midpoint assumes that full-year bad debt as a percentage of same store residential revenue is slightly above 1% or a 30 basis point contribution to 2024 growth overall. If that plays out, by the end of 2024, we would expect to be a little under two times pre-pandemic levels.

Turning to expenses. Expense management is core strength at Equity Residential as evidenced by the historical performance Mark referenced. Our same store expense guidance of 4% is also reflective of that discipline. This year, the individual drivers of growth are a little different than those from 2023. So, let me give you a high level assessment, and we can get into more detail in Q&A if required. In 2024, we expect real estate taxes and utilities to grow faster than they did in 2023, in part due to some 421-A step ups and commodity prices, while payroll and repairs and maintenance should be slower due to various initiatives and an expected normalization of inflationary pressures. Insurance, a small category at less than 5% of total expenses, but a topic often discussed should grow more slowly than last year, but remain above the long-term trend with growth in the low-double-digits.

Turning to normalized FFO, Page 2 of the release provides a detailed reconciliation of our forecasted contributors to NFFO growth. As is typical, same store NOI performance is the primary driver of growth, but let me provide some color on transaction activity. We are assuming $1 billion in both acquisitions and dispositions for 2024 with limited dilution, yet we show a $0.03 reduction in normalized FFO growth there. This is due to our assumption that our acquisition activity mostly occurs later in the year than our dispositions. This is also partially offset in interest expense and interest income as disposition proceeds are used to pay down debt or invested in interest bearing 1031 accounts while we await acquisitions. Now a very brief comment on the balance sheet, because we’re in really great shape here.

We have no debt maturities until the middle of 2025, modest outstanding balances on our commercial paper program and less than 10% floating rate debt. So, we’re very well-positioned. In fact, over 50% of our existing debt doesn’t mature until after 2030. The work we’ve done over the last number of years has reduced our interest rate exposure and allows us for ample debt capacity to run and grow our business. With that, I’ll turn it over to the operator.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question is going to come from Steve Sakwa from Evercore. Please go ahead.

Steve Sakwa: Great. Thanks. Good morning. I guess, wanted to just maybe go through some of the building blocks of growth in 2024 either for Michael or Bob. But as you kind of look through the moving pieces here. It seemed like maybe the new rate growth that kind of flattish might be one that could pose maybe a bit more of a challenge here of job growth slow. So, just curious how you sort of sized all up those components and how did you think about the new lease component with the fact that you kept occupancy flat, I guess, within the guidance?

Michael L. Manelis: Yes. Hi, Steve. This is, Michael. I’ll start. Maybe Bob can come over the top. So, I think when you look at the building blocks for the guidance, you need to realize, one, we’re giving you a range, and there’s a lot of different ways you can get there, but it’s really the top level themes that underline and pin those midpoint assumptions. So, when we thought about new lease change, we started with the fact that we know the job growth is moderating this year, and, therefore, we would expect market rents or asking rents just to be kind of less than normal across the large majority of our markets. So we kind of model a normal seasonal slope for our kind of rent trend to build, and then we plug that in and we say, okay, what does that equate to?

And right now, across our market, it’s balancing out to basically be about flat on new lease change for the full year. Some of our markets are still positive. Some of our markets are still positive three, and some of the markets are still coming in at a negative growth through the year. But I think when you start to pull on any one of those, you need to go back to the top level themes and ask yourself, okay, what’s really changing? So, if there’s a material shift in job growth, sure. I think we would experience more pressure than we underlined in that the midpoint of our range. But again, it’s, when does that happen in the year? And where are we? Because today, I’ll tell you, we have taking a defensive position. We’re starting the year with pretty strong occupancy that really gives us some confidence heading into the spring leasing season, and we’ll just see kind of what pricing power emerges from that.

Steve Sakwa: Great. And then just maybe one question on the transaction market. I know it’s not been terribly, robust, but maybe, Alec, can you just speak to where you think maybe IRR hurdles are today that the 10 year is sort of plus or minus 4% come down way off the high. I realize NOI and rent growth is slowing, but where do you think investment hurdles are today either for EQR or for the market broadly speaking?

Alexander Brackenridge: Hi, Steve, it’s Alec. Thanks for the question. Well, as you stated, it’s a pretty choppy market right now and there aren’t a whole lot of data points. As you know, the NMHC, conference is going on in San Diego right now. So, I have some pretty current time information, which is really a reiteration of what we’ve been experiencing in the last few months, which is a standoff between buyers and sellers. Buyers generally looking for a 5.5ish cap and sellers generally looking for something closer to five. So, not an insurmountable gap at some point, but right now, it’s hard to peg things. But, assuming things kind of land somewhere in between there at a 5.25. I think most people are shooting for an 8ish IRR and obviously it depends on the rent growth assumptions and the residual cap rate, but somewhere in that range, maybe a little bit less if they’re going to be more aggressive.

Steve Sakwa: Great. Thanks. That’s it for me.

Operator: And our next question is going to come from Eric Wolfe from Citi. Please go ahead.

Unidentified Participant: Thanks. It’s Nick here with Eric. Maybe just following up on that. So 8ish or so IRR, I guess, more specifically you talked about obviously the Sunbelt supply and the impact that has on your underwriting on those deals at least initially. So, when you’re underwriting deals both on the buy and sell side today, what are you underwriting for IRRs in the Sunbelt? And then what are the IRRs look like for the assets you’re planning to sell more coastal.

Alexander Brackenridge: So, Eric I’m sorry. It’s not Eric.

Unidentified Participant: It’s Nick.

Alexander Brackenridge: Nick. Sorry, Nick. It’s Alec. And, the IRRs don’t end up being that different, if you assume that, sure, there’s a glut of apartments in the Sunbelt right now, so the next couple of years are going to be tough. But after that, the start’s already down a lot. The demand story hasn’t changed. I think there’s still these cities that we’re interested in that some of which are Sunbelt cities, like Dallas, like Atlanta, like Denver and Austin, still our great job growth generators, still have a lot great long-term demand side story. So, I think you see a couple of years that are tough, but then you have a pretty good few years after that. And I think you run that through your pro-forma and you’re roughly the same.

The difference we’re seeing on a lot of things that we’re selling right now and why the IRR for us is lower in terms of the hold scenario and why we choose to sell it is a lot of older stuff. You saw that, we’re selling 40 years old property and that have very high capital needs. And some of that has our ROI on it. Some of it, it’s just preserving the asset. And, there may be a buyer that sees things differently, sees a little more upside. But in our case, we think the capital is better used elsewhere. So, in our eyes, it’s probably a 7ish something or other, and we think that money can be redeployed better elsewhere.

Eric Wolfe: Hi. It’s Eric. Sorry to keep switching people on you. But, maybe just talking about coastal rent growth for a second. You talked about supply being in check, homeownership, very unaffordable, solid real wage growth, job growth, okay, maybe getting a little slower. But I guess the question is why aren’t we seeing stronger rent growth today just given all of those positive dynamics? And is there anything that do you think in the future would turn it around such you see that sort of more than 3% type rent growth in those coastal markets.