Download Weighted Average Cost of Capital

EQUITY RESIDENTIAL (EQR)
Ye Jiang
Rajani Meka
Tim Schmelzle
Prateek Sharma
November 18, 2010
Photograph provided by Equity Residential
REIT = Real Estate Investment Trust
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Equity : Raised capital from many investors
to purchase and manage property,
includingnleasing, development and tenant
services. Acquisition and development of
properties for their own portfolio rather
than resell them once developed.
Mortgage: Lend money directly to real
estate owners or indirectly through the
acquisition of loans or mortgage backed
securities.
Hybrid : Both Equity REIT and mortgage
REIT
REIT – Tax Treatment




No corporate tax on income so long as 90% of its taxable income is
dispersed as dividends
Must invest 75% of its assets into real estate
Dividends usually taxed at normal income rate not special dividend
rate
Return of capital distribution is treated as L-T capital gains when the
stock is sold
Segmentation
Measures of Performance:
FFO / AFFO / FAD
•
•
Net Income per GAAP
- Gains from disposal of real estate
+ Depreciation and amortization
= FFO (AFFO adds back only a portion of gains or
depreciation)
AFFO
- Capital improvements
+ Rent adjustments
= FAD (Funds Available for Distribution)
REIT Accounting: FCF

FAD
- R.E. acquisitions
- Change in net working capital
- Principle payments
+ Gain on sale of R.E.
+ Equity issued
= FCF
Industry Overview
•
Capital intensive
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•
Highly levered
Importance of debt management
Market concentration


Top five accounts for 29.4% of total market
Access to capital markets is often restricted based on the size
Source: Industry report: Real estate Investment Trusts in the US, Reference Code 52593
http://www.ibisworld.com/industryus/default.aspx?indid=1344
Key drivers
•
Revenue largely affected by economic condition

House Price Index
Reflect: Asset value
Affect: rental price and capital gains

National unemployment rate

Per capita disposable income

Number of businesses

Corporate profits
Reflect: Demand for residential, retail and commercial space
Affect: rental rate, vacancy rate

10 year Treasury yield
Reflect: Interest rate
Affect: cost of capital and demand
Annual growth rate from ’10-’15 is estimated to be at 4.4%
Source: Industry report: Real estate Investment Trusts in the US, Reference Code 52593
http://www.ibisworld.com/industryus/default.aspx?indid=1344
Home Ownership
Impact
Upside
Asset appreciates
High occupancy
Rising rental income
Rising
Revenue
Low demand
Asset depreciation
Falling rental rate
Shrinking
Revenue
downside
Unemployment
Companies out of
business
Industry performance





Prior to 2010
REIT industry had benefited from the real estate bubble since ‘05 and prior to ‘08
the industry revenue grew at 15.9%
After the sub-prime mortgage crisis developed, the industry lost 26.2% of their
value in ‘07 and ‘08
REIT market capitalization decreased by 56.3%
The growth of the industry declined since ‘07 but the revenues have been stable due
to long-term lease contracts

2010

Revenue in 2010 has been $52.3 billion

Profit in 2010 has been $5.2 billion

Annual growth from ‘05-’10 has been 6.8%
Historical Source of Returns
Money Flow, Mutual-style Investing
Stock Purchases
Dividends
EQR
Acquisitions & Maint.
Trademarked property of Hasbro Inc.
Rents
Company Overview
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

Equity Residential was founded in 1993 and is headquartered in Chicago
Real estate company focused on acquisition, development and management of apartment
properties
Key products: Properties are leased out on a yearly basis




Garden style properties
Mid/High rise properties
Military housing
Key services:



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Maintenance and upkeep
Asset Management
Property Development
Rental services
Strategic Purchasing
The company owns or has investments in 548 properties in 23 states and 147, 244
units in District of Columbia, favors properties less than 20 years old, targets
acquisitions in areas expected to have high population growth
Housing images are the trademark property of Hasbro Inc.
http://www.simplymap.com/map.php?entry=first#
M & A Activity- 1998 to 2009
Announced Date
Jul-08-1998
Jun-30-1999
Jan-13-2000
Jul-15-2000
Jul-21-2000
Nov-06-2000
Closed Date
Oct-19-1998
Oct-01-1999
Jul-07-2000
Dec-21-2000
Jul-21-2000
Nov-06-2000
Role
Buyer
Buyer
Buyer
Buyer
Buyer - Parent
Buyer
Target
Merry Land LLC
Lexford Residential Trust
Equity Corporate Housing, Inc.
Grove Property Trust
Temporary Quarters, Inc.
Viva Group, Inc.
Size ($mm)
2,117.34
718.06
140.69
490.38
3.3
17.3
Mar-07-2001
Mar-07-2001 Buyer
OpsTechnology, Inc.
Nov-11-2005
Jun-28-2006
Dec-31-2006
Jan-10-2007
Apr-25-2007
Jul-30-2008
Oct-05-2006
Dec-31-2008
Jan-10-2007
Apr-25-2007
Jul-30-2008
Target
Seller
Buyer
Buyer
Buyer
Buyer
Equity Residential (NYSE:EQR)
Equity Residential, Lexford Housing Division
304 Property Units in Phoenix, Arizona
NYC Upper East Side Apartments
Eagle Real Estate Group, Teresina Apartments
Mosaic at Metro in Hyattsville
Oct-14-2008
Oct-14-2008
Seller
OpsTechnology, Inc.
Dec-31-2008
Dec-31-2008
Buyer
7 Properties including 2,141 Apartment Units
Dec-31-2008
Dec-31-2008
Buyer
Uncompleted Development Property in U.S.
56.6
Feb-11-2009
Feb-11-2009
Seller
436 Apartments Portfolio
42.7
Jun-25-2009
Sep-22-2009
Oct-29-2009
Oct-30-2009
Jun-25-2009
Sep-22-2009
Oct-29-2009
Oct-30-2009
Seller
Seller
Seller
Buyer
Vista del Lago Apartments in Dallas
The Carlyle Apartments
Saddle Creek Apartments
Metropolitan at Pentagon Row
Source: Capital IQ
1,700.0
1,086.0
43.8
65.0
90.3
380.68
100.0
Total: $7052.15 mm
M&A Activity- 2010
Announced Date
Jan-13-2010
Closed Date
Jan-13-2010
Role
Buyer
Target
Property At Tenth Avenue And West
23 Street
Size ($mm)
11.25
Jan-28-2010
Jan-28-2010
Buyer
Vista on Courthouse Apartments
Jan-29-2010
Jan-29-2010
Buyer
River Tower and 777 Sixth Avenue
-
Jan-29-2010
Mar-31-2010
Buyer
Longacre House
-
Feb-09-2010
Feb-09-2010
Buyer
Rianna Apartments
33.4
Mar-15-2010
Mar-15-2010
Seller
Hidden Oaks Apartments and the
Woodbridge Apartments
40.5
Mar-16-2010
Apr-07-2010
Buyer
559-Unit Dumont Complex at 401
and 425, Massachusetts Avenue
167.0
Mar-23-2010
Mar-23-2010
Seller
Bainbridge in the Park Apartment
Complex in South Durham
10.7
Mar-31-2010
Mar-31-2010
Seller
Eight Consolidated Properties
Jun-30-2010
Jun-30-2010
Buyer
183-unit Property in Fullerton, CA
43.3
Jun-30-2010
Jun-30-2010
Seller
Eagle Rim
18.6
Sep-28-2010
Sep-28-2010
Buyer
Vantage Pointe in San Diego
85.0
145.94
200.0
Source: Capital IQ
Total: $755.69
Sources of Revenue
99.45%
2000
99.46%
1950
1900
99.49%
1850
1800
Amount (mm$)
1750
99.47%
1700
1650
1600
1550
2006
2007
2008
Year
Total Revenue
Total Rental Revenue
2009
Key Financials
Year
2006
1,702.5
2007
1,801.8
2008
1,952.6
2009
1,921.0
13.8%
5.8%
8.4%
(1.6%)
Gross Profit
992.8
1,060.9
1,165.0
1,149.1
Margin %
58.3%
58.9%
59.7%
59.8%
709.7
741.0
787.6
771.9
2.8%
2.3%
2.1%
2.0%
946.0
1,019.7
1,124.4
1,111.5
55.6%
56.6%
57.6%
57.9%
463.2
494.5
571.0
535.4
27.2%
27.4%
29.2%
27.9%
30.3
(54.0)
(50.1)
0.4
1.8%
(3.0%)
(2.6%)
0.0%
Net Income
1,072.8
980.2
407.6
362.3
Margin %
63.0%
54.4%
20.9%
18.9%
Total Revenue
Growth Over Prior Year
SG&A
SG&A Margin %
EBITDA
Margin %
EBIT
Margin %
Earnings from Cont. Ops.
Margin %
All dollar figures are in millions
Same Property Metrics
2000
1600
1200
Amount (mm$)
800
400
0
2004
2005
2006
2007
Year
Same Property Revenue
Same Property Expense
Year
2004
2005
2006
2007
2008
2009
Same Property
revenue Growth
(1.5%)
(3.2%)
3.4%
6.9%
3.2%
(2.9%)
Same property
expense growth
1.7%
(5.9%)
(1.5%)
4.0%
2.2%
(0.1%)
Funds from Operations - FFO
FFO
750
716.1
713.4
700
Amount in $mm
650
618.4
615.5
2008
2009
600
550
2006
2007
Residential Segment
Industry
EQR
Avalon
UDR
Camden
Essex
(as of 11/15/10)
Market Cap
Market Share
Op. Margins
$793.0 B
$ 13.8 B
$ 8.9 B
$ 3.9 B
$ 3.4 B
$ 3.3 B
1.74%
1.01%
1.05%
0.43%
0.41%
25.13%
29.67%
-19.34%
23.54%
28.43%
Stock Performance
Source: Capital IQ
SWOT


Strengths
• Well positioned
• Large market share
• Sound management and goals
Weaknesses
• Sensitive to interest Rate changes
• Investments have low liquidity
• Opportunities
• Interest rates currently at an all-time
low
• Willingness to enter joint venture
• Threats
• Interest rates will go up sometime
• Thin margins, competitive market
Porters 5

New Market Entrants
Medium

Supplier Power
Low

Buyer Power
High

Product and Technology Dev.
Low

Corporate Rivalry
Medium
WACC
Wacc (CAPM)
Beta (Bloomberg)
1.21
Beta (Yahoo Finance)
1.28
Beta average
1.25
Capital Structure
Total Debt ( in millions )
Total Equity ( in millions )
Total Capital ( in millions )
Weight of Debt
Weight of Equity
10269.907
4748.623
15018.53
68.38%
31.62%
Wacc (ROE)
Market Return
Risk Free Rate (U.S 10 yr
government bond)
Market Risk Premium
Cost of Equity (CAPM)
Cost of Debt
Tax Rate
Weighted Average Cost of
Capital
10.63%
3.27%
7.36%
12.44%
6.98%
0%
8.7%
Cost of Equity (Historical)
Cost of Debt
Weighted Average Cost of
Capital (ROE)
Wacc (Goal Post)
Cost of Equity
11.25%
6.98%
8.33%
11.85%
Cost of Debt
6.98%
Weighted Average Cost of Capital
8.52%
DCF and DDM Valuation
Summary

Why select a REIT?
 Real
estate is currently cheap but expected to appreciate
 Believed to have some counter-cyclical characteristics that
would benefit the fund

Why this REIT?
 EQR
is a star performer
 Strong
skilled management
 History of superior margins
 Superior growth
 Good positioning
Observations

Company matches S&P 500 performance
 Investor
could invest in an S&P 500 index fund and have better
diversification while realizing the same return
 Investor is seeking alpha, not market returns

Dividends would disadvantage investor
 Income
dividends represent a large portion of the stock’s value
 Normal investor tax rate = 35%, special dividend rate = 15%
Conclusion
This company is the best performing REIT within its
segment. While it would make an excellent
investment for many investors, this company does not
meet the basic needs of our client.
Do not purchase