Photo: James Schnepf

Equity Residential goes online to meet the needs of its Web-savvy customers

By Charles Keenan

Though residential real estate has endured a recent rough ride, David Neithercut sees a bright future for Equity Residential (NYSE: EQR), the largest publicly traded apartment REIT in the United States. The president and chief executive officer of the Chicago-based company tells investors the basic economics for apartments are looking strong. The number of Americans owning homes has been declining, and homeowners are still faced with much higher monthly payments than renters, making apartments a less expensive choice.

		Simple Beginings Equity Residential was founded in 1969. However, unofficially, the company got its start in the early 1960s when Sam Zell and Robert Lurie...

"It's a simple fact that the difference between the cost to own versus the cost to rent is more today in all of our markets than it was five years ago," Neithercut said. "It's no surprise that we continue to like our business and the markets in which we operate. They delivered for us in 2007. We expect them to deliver for us in 2008 and beyond."

Such performance owes to Equity Residential's experienced and conservative business approach. The company is mixing old strategies with new ideas to keep the income flowing and the balance sheet strong, making the case that its stock is undervalued. Equity Residential has aggressively bought back stock and has shunned pricy acquisitions. It has also invested in a technology platform to better reach its customers and emphasized customer service to set itself apart from its competitors.

Strength in Numbers

Equity Residential's diversified portfolio is one of the keys to its strength. It owns approximately 150,000 apartment units in 20 urban areas nationwide. The apartments, which include garden, mid-rise and high-rise assets, are situated in supply constrained areas, like New York and Seattle, where people want to live and work. They appeal to renters of all ages with amenities such as clubhouses, swimming pools, laundry facilities, saunas, whirlpools, spas and exercise rooms.

Additionally, most of its markets offer household and job growth prospects well above the nationwide average. "The drivers of the economies of these particular places will grow at a faster rate than the national averages," Neithercut says.

Photo: James Schnepf

“It is very difficult to rationalize buying assets today when we believe our stock price is trading at a material discount to those values.” —David Neithercut, Equity Residential

Equity Residential's portfolio with an occupancy rate of 94.5 percent enabled the company to deliver a modest increase in returns last year. The $15.7 billion-asset REIT reported funds from operations for 2007 of $2.39 per share, compared with $2.27 per share for 2006. However, the company's total return was -24.7 percent in 2007, versus -25.4 percent for apartment REITs and -15.7 percent for the FTSE NAREIT Equity REIT Index. So far in 2008, the company's total return has been 14.6 percent.

Yet, last year's price decline represented an opportunity. Equity Residential was buying back stock at a fast clip: it repurchased 27.5 million common shares last year at an average price of $44.62, for a total purchase of approximately $1.2 billion. Last December, its board authorized another $500 million for future share purchases. Meanwhile, the company is also trimming back acquisitions, using much of the proceeds from sales and debt raising to fund the buybacks.

"It is very difficult to rationalize buying assets today when we believe our stock price is trading at a material discount to those values," Neithercut says. "There is a terrific arbitrage there, one that will create a lot of value for our shareholders."

In the middle of the first quarter of 2008, Equity Residential's stock was trading at a 17 percent discount to net asset value, estimates Haendel St. Juste, an analyst at Green Street Advisors. That helped the company have one of the few "Buy" ratings issued by Green Street for apartment REITs. "You would be well served to capitalize on the arbitrage by selling at close to current values on Main Street and then redeploying the proceeds into share repurchases on Wall Street, where the stocks are trading at a considerable discount," St. Juste says.

Online Opportunities

Meanwhile, the company has focused on upgrading its use of technology. In 2006, Equity Residential completely overhauled its technology platform, including a revamped Web site, pricing system and procurement system. The transition has helped lead to lower vacancy rates and turnover, and it has enabled the company to streamline its management and reduce costs.

The company's Web site helps prospective tenants view available apartments and complete lease applications online. Given that its renters tend to be Web-savvy, conducting business online is more essential than ever, Neithercut says.

"Our residents can pay their rent online, watch service requests online and do all the sorts of things that make it easier for them to do business with us through our Web site," he says. "If you think about how technologically savvy renters are today, connecting with residents through the Web is an absolute priority."

“It has been proven statistically that customers having had a favorable move-in experience are more likely to renew leases at higher rents than are customers that have not had a favorable move-in experience.” —Fred Tuomi, Equity Residential

Adding to Equity Residential's focus on customer service, the company puts an emphasis on the customer's move-in experience. The company uses software to track satisfaction, sending out surveys to potential customers within 24 hours of a visit. It also sends out surveys within 45 days of a move-in, one at mid-term, and one when a tenant gives notice. Equity tracks maintenance orders online and relies on regional facilities managers to help develop best practices for the entire company.

"It has been proven statistically that customers having had a favorable move-in experience are more likely to renew leases at higher rents than are customers that have not had a favorable move-in experience," says Fred Tuomi, executive vice president who heads up Equity Residential's property management division. "We have wired our new systems and platforms to measure these things. We know every day if we are hitting our goals or not. We also have a lot of recognition and rewards programs zeroing in on that specific factor."

We get customers "in the zone of satisfaction loyalty, and they, in turn, reward us with higher value, which makes us more profitable," Tuomi says.

Analysts note that Equity Residential's focus on customer service sets it apart. "It's a point of differentiation for them," says Michael Salinsky, an analyst at RBC Capital Markets. "Unlike some of the other sectors, you are dealing with people face to face on a day-to-day basis in multifamily. You want to be up to date with the people you are servicing. You are dealing with people right out of college, Generation Y, who are technology-based. Equity Residential is keeping up with that."

Equity Residential also has adopted a real-time rent pricing system, dubbed "revolution LRO Lease Rent Optimizer," a Web-based application owned by software provider the Rainmaker Group Inc. The model, with modifications from the company, sets the rent for each apartment daily, using various inputs such as competitor rent levels, seasonal demand, the pace of new lease signings, traffic at the property, forecasted demand in the future and how many units are on the market.

Meanwhile, a new e-procurement system launched in 2006 gives the company an online catalog of appliances, equipment and supplies used by each property and helps boost purchasing power. Equity Residential has also boosted Internet advertising, helping it rein in costs of placing advertisements in traditional print media.

Benefits of the Housing Fallout

Still, some analysts worry a sluggish economy could cause some problems. Job growth is a fuel for tenant growth, yet the Federal Reserve in February lowered its U.S. economic growth forecast for 2008 to a range of 1.3 percent to 2 percent, down from 1.8 percent to 2.5 percent at its previous forecast in November.

“There is a meaningful amount of demand being created by people who were formerly owners. They are now renting.” —Haendel St. Juste, Green Street Advisors

Additionally, because home prices are falling, more homeowners are electing to rent instead of sell their homes, boosting a so-called shadow supply pipeline of rental housing. Vulnerable areas of Equity Residential's portfolio include Orlando, Phoenix, Tampa and southeast Florida, Salinsky says. "The portfolio is well positioned long-term, but short-term, there are some negative headwinds out there," he says.

Still, Equity Residential might stand to benefit from the housing fallout. The homeownership rate has been dropping since its peak of 69 percent in 2004, according to Green Street. Since then, it is down 150 basis points. Each 50 basis point decline drives demand for another 250,000 apartment units, according to Green Street.

"There is a meaningful amount of demand being created by people who were formerly owners," St. Juste says. "They are now renting. Some of them are going into shadow supply, such as condos and single family homes that are for rent, but a good number of them are renting apartments."

UPSIDE-DOWNSIDE Samplings of what analysts are saying about Equity Residential. Bank of America Rating: NEUTRAL (2/11/08) Target Price: $39 “We remain more bearish than EQR on 2008, despite management’s cautious optimism that the U.S. will not enter a recession, and that growth will re-accelerate in Phoenix and South Florida in the second half of 2008. Slower economic conditions and ongoing housing woes will likely put a strain on growth, in our view. As such, we are expecting 3.25 percent to 3.50 percent revenue growth in 2008.” Bear Stearns Rating: PEER PERFORM (2/8/08) Target Price: $38.57 “Equity Residential issued first quarter 2008 funds from operations (FFO) guidance of $0.56 to $0.60ps and fiscal year 2008 guidance of $2.45 to $2.60ps. Our updated fiscal year 2008 and 2009 estimates of $2.45ps and $2.59ps, respectively, imply year over year growth of 2 percent and 6 percent. Our first quarter 2008 FFO estimate is $0.59ps.” BMO Markets Rating: MARKET PERFORM (1/9/08) Target Price: $34 “Our positive impression of the company hasn’t changed, and we like the direction top management is taking the company. However, with markets like Florida, the Washington, D.C. metro area, Phoenix and Orange County on a downward trend, which collectively make up 30 percent of total NOI, we think EQR is vulnerable to dialing down expectations as the year progresses—despite the resiliency the company demonstrated during its third quarter 2007 results.”

Long-term Promise

Long-term, employment growth still looks promising. Cumulative job growth in Equity Residential's key markets will be 6.6 percent over the period spanning 2006 to 2010, versus 4.4 percent nationwide, the company estimates. "We believe that job growth, population growth and the economies of these particular locations will increase at a faster rate than the national averages," Neithercut says.

Caution, though, is still the magic word. While Equity Residential has approximately $1.7 billion in various stages of its development pipeline and $397 million of land held for development, the company will pursue some deals as planned. However, it may cancel some deals and consider selling some land or bring on joint venture partners.

"We are going to reduce our development expectations to preserve liquidity during these uncertain times," Neithercut says. "It comes at a time when I believe it is going to be extremely difficult to start new properties in the immediate future. Yet, companies that are able to deliver new products in 2010 and 2011 are going to do extraordinarily well."

While residential real estate recently has given investors the jitters, Equity Residential and other apartment REITs are likely to deliver better long-term returns down the road. "In today's world, with an aging population, yield is extremely important to much of the investment community," Neithercut says. "Apartments can provide a terrific current yield and grow over time. We believe that we have put together a portfolio of assets that will deliver that growing income stream for our investors."