The largest multifamily trust, Equity Residential, lowered its forecasted 2009 NOI growth expectation by -3.75% to -9.25% due to the growing rate of layoffs, particularly in its largest market, New York City. The Chicago-based company also dropped its FFO guidance to $2-$2.30, which is 19 cents below Merrill's estimate. The move, relates Steve Sakwa--a research analyst with Merrill Lynch--deals a blow to the entire apartment REIT group. "We expect the group to react very poorly to this outlook." Merrill Lynch's new NOI estimate of $2.14 assumes an NOI decline of 5.5%, versus a 3.6% drop previously anticipated.
During the fourth quarter, Equity Residential saw revenue and NOI growth of 2.4% and 2.8%, respectively. The firm's normalized 2008 FFO of $2.58 was up 6.6%, but is expected to fall by 17% this year to $2.14 and 13% in 2010 to $1.86, due partially to shortfalls in development yields. Sakwa decreased the price objective for Equity Residential from $26 to $19. He also reduced the 2009 NOI growth expectations for Equity Residential from -3.6% to -5.5%, and the estimate for 2010 is -5%, down from -3.4%.
The good news for Equity Residential is that Fannie Mae and Freddie Mac continue to lend to the apartment sector. The REIT closed out the year with $890 million of cash on its balance sheet, and $758 million in debt is due to mature in 2009. Further, the firm plans to sell $700 million of assets in non-core markets this year, and acquire just $250 million in communities as it recycles the capital it earns from sales into core markets.
Weak NOI projections for 2009-2011, along with a higher cap rate for the entire portfolio --8.25%--brings Equity Residential's unlevered IRR to 9.6%. Sakwa's $19 price objective assumes Equity Residential "trades at a slight discount to our forward NAV estimate of $19.52." Sakwa reduced the rating for Equity Residential to underperform.
Deteriorating fundamentals in the West Coast markets are putting pressure on Essex Property Trust, whose stock is looking expensive. Sakwa related that after IRR is adjusted for higher capital expenditures of $1,100 per unit and weaker NOI growth in 2009--a 4% decline--and 2010--a drop of 5%--the cap rate for the REIT rises 50 basis points to 8%. Continued weakness on the employment front has Sakwa expecting Essex to experience a worse 2010 than 2009. Therefore, he says, "We are lowering our '09 FFO estimate to $5.59--11 cents below the midpoint of guidance--from $5.97 and our '10 estimate to $5.17 from $5.81."
With an underperform rating, Sakwa gives Essex a price objective of $52, assuming the firm trades at a 5% discount to the forward NAV estimate of $54.59. "While the company's average to below-average rent rates should insulate it to some degree, a sharp slowdown in California and Seattle will impact all with West Coast exposure," he states. "The remaining development commitments are also relatively large."
Other REITs didn't fare much better. A price objective of $7.50 for Aimco assumes the firm trades at a 20% discount to forward a NAV estimate of $9.31, which is based on a 9.5% cap rate and a 10% unlevered IRR. "We believe that AIV should trade at a significant discount to the peer group due to its higher leverage, dependence on transactional income, and an outsized expected decline of FFO in 2009," says Sakwa. Meanwhile, the analyst says AvalonBay Communities' $53 price objective assumes the REIT trades in line with its forward NAV of $52.73, based on a 7.8% cap rate and 9.5% unlevered IRR. AVB is expected "to experience pricing power pressure for its high-rent-rate portfolio and a greater amount of rental concessions to complete lease-ups in the development portfolio."
For BRE Properties, Sakwa has a price objective of $22, which would imply a 3% discount to the forward NAV estimate of $22.70. That figure is based on a cap rate of 8% and an unlevered IRR of 9.6%. Camden Property's $29.50 price objective is also in line with Sakwa's forward NAV estimate of $29.56, which is based on a cap rate of 8.35% and an unlevered IRR of 9.6%. And for UDR Inc., Sakwa's $14.50 price objective is in line with his forward NAV estimate of $14.71, which is based on an 8% cap rate and unlevered IRR of 9.6%. "We believe that UDRs transformed portfolio will produce solid long-term growth," the analyst relates.
Among the upside risks to these REITs' price objectives, according to the analyst, are less-than-expected pricing power pressure in their core markets, less of a need to offer concessions on new projects and an improved deal market. Meanwhile, continued declines in employment and single-family home prices, a longer economic downturn and overbuilding, as well as a steep uptick in long-term interest rates, stand as potential threats.
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