Equity Residential (NYSE:EQR) Q1 2024 Earnings Call Transcript April 24, 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 1Q 2024 Earnings Conference Call and Webcast. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Marty McKenna. Please go ahead.
Marty McKenna: Good morning and thanks for joining us to discuss Equity Residential’s first quarter 2024 results. Our featured speakers today are Mark Parrell, our President and CEO; and Michael Manelis, our Chief Operating Officer. Alex Brackenridge, our Chief Investment Officer; and Bob Garechana, our Chief Financial Officer are here with us as well for the Q&A. 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 Parrell: Thank you, Marty. Good morning and thank you all for joining us today to discuss our first quarter 2024 results and outlook for the year. I will start us off, then Michael Manelis, our COO, will speak to our operating performance and how we see 2024 operations playing out. And then we will take your questions. We are pleased with our first quarter performance, which was ahead of January expectations and reflects the strong demand for the lifestyle our well-located apartment properties provide as well as little new competitive supply across most of our established markets. Our same-store revenues increased 4.1% in the quarter, and our same-store expenses rose only 1.3%, which led to same-store NOI growth of 5.5% and an increase in our NFFO per share of 6.9%.
So, overall, a very solid start to the year across all categories, with the company well positioned to capture increasing seasonal demand as we head into our prime leasing season. As is our practice, we have not revised our operating or FFO guidance and we’ll make adjustments as we get deeper into our primary leasing season. Digging under the hood a bit, the durability of the employment picture for our target affluent renter demographic is a continuing bright spot in our business as is the cost of owned housing. Unemployment for the college educated, a very sizable percentage of our residents, remains at around 2%, considerably lower than the overall average, supporting demand. This demographic, which is well employed in the growth engines of our economy, including technology, financial services, and other professional and business services, continues to grow in both our established and expansion markets.
We also see a little competition from owned housing as the high cost of homes, combined with elevated financing costs and rapidly rising insurance, real estate tax, and maintenance costs combine to make rental housing a very attractive option for many people. Social factors that we’ve discussed on prior calls like smaller households and delayed marriage and childbearing add to the attractiveness of rental housing. In the quarter just ended, the percentage of our residents leaving us to buy homes was 7.8%, a continuation of all-time lows. Strong demand and high single-family housing costs are consistent conditions across both our coastal established markets that represent 95% of our company’s NOI and our new expansion markets of Dallas-Fort Worth, Atlanta, Denver, and Austin, that collectively represent 5% of our NOI.
But on the apartment supply side, we see two very different pictures playing out in our established coastal markets versus our expansion markets. With the exception of Seattle and Central D.C. in our established coastal markets, we see the terrific demand I just mentioned being met with generally little new supply, leading to solid rent growth. Across our four expansion markets, we see robust demand as well, but it is being met by an overwhelming wave of new supply, leading to declining rent levels, high concessions, and occupancy pressure. We expect this pressure to accelerate as units continue to deliver in these oversupplied markets, especially once the prime leasing season concludes and demand seasonally declines. Switching to expenses, Michael is going to go over all that with you in a moment.
But I wanted to take a second to thank our teams across the company for their amazing work on expense management. We are very pleased to have produced a sector-leading 3.1% average growth rate of same-store expenses over the last five years. Our teams have embraced innovation and a customer service mindset and are not afraid of change, and it shows in these numbers. Well done, team. On the investment side, we are seeing properties that we would be interested in acquiring, well-located newer properties in our expansion markets in the suburbs of Seattle and Boston trade at high prices and in very low volume compared to pre-pandemic levels. Investment sales activity in the first quarter was over 60% below average pre-pandemic levels. Estimates from my colleagues who attended the recent ULI Conference indicate that there is over $200 billion of dry powder looking to invest in North American real estate, with a significant portion focused on apartments.
Recent data points from the pending AIRC transaction and apartment portfolio and one-off deals are similarly supportive of much higher values than the public market is currently suggesting. While this is a huge positive signal about the underlying value of our company, it has slowed our portfolio rebalancing efforts. And while pricing in most of the apartment transaction market is strong, buyer interest is not yet fully evident for some of the large urban West Coast assets that we want to dispose of as part of our strategic rebalancing. We expect that to change as these submarkets continue to show improved operations and better quality of life conditions. In the meantime, with the lack of actionable acquisition opportunities, we saw value in our own stock.
So, we continue to strategically deploy disposition proceeds from the sale of older inferior properties in our portfolio into repurchases of our stock. In the first quarter, we repurchased approximately $38.5 million of our own common shares at a weighted average share price of about $59 per share. Since we began this activity in the fourth quarter of 2023, we have repurchased approximately $87.5 million of our shares in what we see as an attractive valuation level of a bit below $58 per share. We are using the remaining disposition dollars to drive down our already low leverage, which will create more internal debt dry powder for when opportunities do emerge. We are going to continue to be disciplined in our transaction activities with a focus on growing cash flow over the long-term.
With regard to external growth, we are on track to deliver six newly completed joint venture developments in 2024. These six properties, three located in Dallas-Fort Worth, two located in Denver, and one located in suburban New York, will be delivered at a weighted average stabilized yield north of 6% and will contribute meaningfully to our normalized FFO starting in 2025 given their completion and lease-up timing. The three Dallas-Fort Worth developments are the first completed projects to come out of our partnership with Toll Brothers. With some of the other equity residential executives, I recently visited all six of these development projects, and I’m inspired by the enthusiasm on display from our lease-up teams and excited about adding these high-quality assets to our portfolio.
Before I turn it over to Michael, I wanted to make a quick comment on the new housing laws that were passed over the weekend in New York, though I know we are still digesting the law and its implications. The law allows for renewal increases of CPI plus 5% up to 10%, and provides for vacancy decontrol on the types of units we generally own in New York, which allows rents to move to market when a new resident moves in, and that’s similar to the rent laws that were passed a few years ago in California. Overall, new price controls on an already undersupplied good, in this case, rental housing, is not an effective way to attract private capital to help solve the housing supply problem in New York State. However, there are also tax incentives in the new law for new rental construction subject to a new higher wage scale required for labor on larger buildings as well as permanent affordability rules.
There are also some language on zoning reforms and some rules that aim to make office-to-residential conversions easier. While the rent control provisions are not helpful, we commend the governor and the legislature for focusing on a supply-based solution similar to recent legislation passed in such politically disparate states as Florida and California. We think focusing on supply, not heavy-handed regulation, has been recognized on both sides of the aisle as the long-term solution. While the new law adds to the complexity of operating in New York, a good portion of our portfolio in New York City is exempt either due to being built during or after 2009 or meeting the luxury exemption thresholds. We’ll be happy to discuss all this further in Q&A.
And with that, 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 our first quarter 2024 operating performance and our positioning as we start the leasing season. We’re off to a very good start thus far. As Mark mentioned, demand remains good across all of our markets, supported by a continuing solid job market and high employment in our affluent renter target demographic. One of the real highlights of the quarter was our turnover, which is the lowest we have ever seen. Our focus on customer satisfaction, harnessing data, and leveraging our centralized renewal team to drive results is definitely having an impact here. In the first quarter, we renewed more than 61% of our residents, which is one of the highest percentages that we have seen.
A special shout-out to New York, Boston and Seattle, who set their own high marks and greatly contributed to this result. Our first quarter same-store revenue growth exceeded our original expectations, including very good performance in San Francisco and Seattle, which I will discuss in a moment. This positions us very well for the year, but we acknowledge that this is just the beginning of a critical primary leasing season. Our efforts to build occupancy in the fourth quarter of 2023, coupled with continued strong demand and high resident retention, have resulted in both slightly above average rent growth since the beginning of the year and a 50-basis point quarterly sequential gain in physical occupancy. At 96.5% occupied this month, which is one of our highest reported occupancies in April, we have a lot of confidence that we will be able to continue to grow rates through the leasing season.
The high percentage of residents renewing that I previously mentioned is also a big factor in this strength. In terms of market same-store revenue growth, the East Coast markets in Southern California are producing leading growth, as we expected, with San Francisco, Seattle, and the expansion markets following in that order. As we think about these markets’ performance relative to our expectations, New York and Washington, D.C. are running ahead of expectations, while Boston and Southern California and the expansion markets are in line. San Francisco and Seattle are also running ahead, but remember, these markets have been historically volatile. So, we remain cautiously optimistic that we will hold on to the gains in these markets for the remainder of the year.
Now, a little more color on the individual markets before closing out with expenses and commentary in other income and initiatives. Starting in Boston, year-to-date revenue performance is in line with the expectations. City of Boston is currently 97% occupied and we have very little competitive supply to deal with. Concession use is little to none in this market. And overall, we continue to expect Boston to deliver some of the best full year revenue growth in the portfolio. As I mentioned, New York is performing well, with both strong demand and pricing power. The market is over 97% occupied and has very little competitive new supply. So far, we seem to have moved past the rent fatigue we saw in the market in late 2023 and expect good things from this market in 2024.
Hats off to Washington, D.C. as this market is outperforming our revenue growth expectations even after a strong 2023. We’re benefiting from a very solid employment picture here, particularly in the defense sector, which is driving consistent, stable high occupancy and real strength in our retention. We see good results across the whole market, but the district has recently begun lagging our suburban assets, likely due to nearby supply. Overall, we still expect Washington, D.C. to deliver a good amount of new supply in 2024 with nearly 13,000 competitive units. So, we do anticipate the pressure to continue to grow as the year progresses. In Los Angeles, we see good demand, but not a lot of pricing power at the moment due to the additional units being brought back to the market through the eviction process.
Our portfolio is 96% occupied, and we continue to make progress on the delinquency and bad debt situation, which should be a tailwind for growth in 2024. Timeframes for processing evictions have recently improved from nine months to six months, which should help us make more progress going forward. But they still do remain nearly twice as long as they used to be. That being said, we are very encouraged by the recent improvement. Rounding out the rest of Southern California, San Diego and Orange County are continuing to be very strong performers. The general lack of housing is keeping occupancies high. Home ownership costs are also high here, which makes renting in these markets the more attractive option. San Diego will see more competitive new supply in 2024, while Orange County will see similar amounts to last year, with limited pressure at a few of our Irvine locations.
Now, for the markets that may be of most interest: San Francisco, Seattle and the expansion markets of Dallas-Fort Worth, Denver, Atlanta and Austin. For the two West Coast markets, remember that we entered the year with relatively modest expectations but potential for upside. So far, both markets are doing better than we expected, but it’s early and both remain show-me stories as we saw periods of stability and pullback in 2023. In San Francisco, we are well occupied but would like to see continued improvements in pricing power. The South Bay, East Bay, and Peninsula continue to perform better than our Downtown portfolio. The situation here remains the same as the market lacks the catalysts, either job growth or more robust return-to-office policies, to create true pricing power.
Concessions remain prevalent in the Downtown submarket, but are being issued at a lower rate than they were in the fourth quarter, consistent with what you would seasonally expect. In Seattle, we carried strength from December into the early part of the year, leading to improved occupancy and the ability to move up rental rates, which is evident in our new lease growth for the quarter. That being said, we do expect a fair amount of competitive new supply in the market in 2024, which could temper growth. The East Side is performing better than the City of Seattle, and our Redmond assets are performing very well despite having some direct pressure from a new lease-up. Overall, the downtowns of both markets are showing real improvement in the quality of life, and the local political situation continues to get much more constructive as a focus on bringing these cities back to the thriving environments they were prior to the pandemic remains front and center with both policymakers and citizens.
Recent primary elections in San Francisco were very encouraging as voters supported candidates who are focused on addressing safety and the quality-of-life challenges. Finally, some commentary on our expansion markets. Strong demand and a favorable regulatory environment continue to confirm our positive long-term outlook for these markets. Unfortunately, however, in the near-term, we are seeing the pressures from high levels of new supply being delivered in 2024. Market occupancies are lower than our established markets and concessions are prevalent. So far, concession usage at stabilized asset properties in Atlanta, Dallas-Fort Worth, and Denver are running at about 30% of applicants getting about four to six weeks. And in Austin, it’s 60% of applicants getting about six weeks.
Operating conditions are challenging across all of these markets, but Dallas appears to be more resilient, followed by Denver, Atlanta, and then Austin. The job growth numbers in both Austin and Dallas are some of the highest in the country, which is clearly aiding in the absorption of some of the new supply. But the volume of deliveries is high and going to continue to grow throughout the year. With regards to bad debt and delinquency, the first quarter results were in line with our expectations. As I mentioned, we continue to see improvements in the time it is taking to process evictions in L.A., which is where the majority of our delinquent residents are, which is resulting in a decrease in the number of long-standing delinquent residents that we have.
This is an encouraging sign and continues to support our view that we will see overall improvement in bad debt net contribute 30 basis points to our same-store revenue for the full year. Now, let me hit on some highlights on expenses. Our 1.3% growth in the quarter was better than expected and driven by a decrease in both utilities and repairs and maintenance, coupled with pretty flat on-site payroll expense growth. On the utility expense, we primarily benefited from lower commodity pricing. We also intend to take advantage of federal and local incentive programs to continue to accelerate our sustainability efforts and moderate future utility growth. For example, we have 26 future solar installations planned, in addition to our 55 active systems, which will help reduce our future overall assumption.
Our repairs and maintenance expense decrease was driven primarily by lower turnover costs and, to a lesser degree, maintenance expense, which was unusually elevated in the prior year. Once again, our disciplined approach to expense management has continued to pay off. On the innovation front, as we have previously discussed, we will be focused on a number of initiatives to drive both revenue growth and operating efficiencies. Specific to other income, our expectation remains unchanged that this will be a contributor of 30 basis points to our full year same-store revenue growth. During the quarter, we delivered 60 basis points, which was slightly ahead of our original expectations and mostly due to faster implementation of our parking revenue optimization program.
In addition to our efforts around other income, we have been very focused on areas of opportunity like leveraging artificial intelligence into our business process. As early adopters of these AI interactions, we are thrilled with the performance of these tools. Over the past year, our AI leasing assistant, Ella, has engaged with just over 600,000 customer inquiries, set 2 million responses addressing prospect questions, and booked over 80,000 appointments. Leveraging this type of automation at the top of our demand funnel has been incredibly effective, allowing us to be nimble with increasing initial traffic demand without impacting our remaining on-site employees’ ability to provide high-touch customer interactions when needed. We’re excited to share that in the coming quarter we will begin testing an AI resident assistant, helping existing residents 24/7 with common questions about their community service and even their account statements.
I want to give a shout out for our amazing teams across our platform for their continued dedication to innovation and enhancing customer service. As we sit here today, we’re 96.5% occupied and continue to see strength in our renewal process, which positions us very well to capture the pricing power opportunities that the peak leasing season will bring. With that, I turn it over to the operator for Q&A.
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