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EQUITY RESIDENTIAL (EQR) Ye Jiang Rajani Meka Tim Schmelzle Prateek Sharma November 18, 2010 Photograph provided by Equity Residential REIT = Real Estate Investment Trust 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 • 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 $5.2 billion Annual growth from ‘05-’10 has been 6.8% Historical Source of Returns Money Flow, Mutual-style Investing Stock Purchases Dividends EQR Acquisitions & Maint. Trademarked property of Hasbro Inc. Rents Company Overview Equity Residential was founded in 1993 and is headquartered in Chicago Real estate company focused on acquisition, development and management of apartment properties Key products: Properties are leased out on a yearly basis Garden style properties Mid/High rise properties Military housing Key services: Maintenance and upkeep Asset Management Property Development Rental services Strategic Purchasing The company owns or has investments in 548 properties in 23 states and 147, 244 units in District of Columbia, favors properties less than 20 years old, targets acquisitions in areas expected to have high population growth Housing images are the trademark property of Hasbro Inc. http://www.simplymap.com/map.php?entry=first# M & A Activity- 1998 to 2009 Announced Date Jul-08-1998 Jun-30-1999 Jan-13-2000 Jul-15-2000 Jul-21-2000 Nov-06-2000 Closed Date Oct-19-1998 Oct-01-1999 Jul-07-2000 Dec-21-2000 Jul-21-2000 Nov-06-2000 Role Buyer Buyer Buyer Buyer Buyer - Parent Buyer Target Merry Land LLC Lexford Residential Trust Equity Corporate Housing, Inc. Grove Property Trust Temporary Quarters, Inc. Viva Group, Inc. Size ($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