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Neutral on Equity Residential

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On Apr 11, 2013, we reiterated our long-term recommendation on Equity Residential (EQR - Free Report) , an apartment real estate investment trust (REIT), at Neutral. The move reflects the company’s decent fourth-quarter results as well as successful completion of the Archstone acquisition deal.

However, the continued acquisition spree of Equity Residential involves significant upfront operating expenses, as the new properties usually take time to generate revenues and consequently drag down the margins till they get established.     

Why the Reiteration?

Equity Residential’s core FFO (funds from operations) per share in the fourth quarter of 2012 reached $0.75, in line the Zacks Consensus Estimate and surged 15.4% from the prior-year quarter. The results were primarily driven by higher net operating income and lower total debt costs.

Moreover, in 2012, according to its repositioning strategy, the company, along with AvalonBay Communities Inc. (AVB - Free Report) , entered into an agreement with Lehman Brothers Holdings Inc. to acquire the entire ownership stake of Archstone Enterprise LP. The deal closed this month. The acquisition is expected to generate decent revenues for Equity Residential in the long run.

Equity Residential has assets in some of the leading apartment markets of the U.S. and has a fully implemented state-of-the-art operating platform that enables it to manage the operations on a synchronized basis and deliver a market-leading performance. In addition, the recently completed Archstone acquisition will strengthen Equity Residential’s position in key markets including Washington D.C., San Francisco, South California, New York, Boston, Seattle and South Florida. This, in turn, will help expand the company’s top-line going forward.

The home ownership cost in most of the markets of Equity Residential is significantly higher than the national average. In addition, financing for new apartment construction has become relatively harder due to the challenging macroeconomic environment resulting in scarcity of new supply. Such an environment is expected to endure, and hence, we expect this to provide an upside potential to the company going forward.

However, to outweigh stiff competition, Equity Residential has to continually invest in value-drivers that in turn increase its operating expenses. In addition, the company is repositioning its portfolio to focus on high-barrier markets, which leads to near-term earnings dilution, as new properties usually take time to generate revenues. Thus, the company is continually under stress to maintain profitability through stringent cost-cutting measures.

Over the last 30 days, the Zacks Consensus Estimate for full-year 2013 fell marginally to $2.83 per share. Also, the Zacks Consensus Estimate for full year 2014 slightly decreased to $3.12 per share. Hence, the company now has a Zacks Rank #3 (Hold).

Other Stocks to Consider

REITs that are currently performing better than Equity Residential include Federal Realty Investment Trust (FRT - Free Report) and Cousins Properties Incorporated (CUZ - Free Report) . Both carry a Zacks Rank #2 (Buy).

Note: FFO, a widely used metric to gauge the performance of REITs, is obtained after adding depreciation and amortization and other non-cash expenses to net income.

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