November 29, 2017 / 8:51 PM / 2 years ago

Fitch Upgrades Equity Residential to 'A'; Outlook Stable

(The following statement was released by the rating agency) NEW YORK, November 29 (Fitch) Fitch Ratings has upgraded the ratings for Equity Residential (NYSE: EQR), including the company's Issuer Default Rating (IDR) to 'A' from 'A-'. The Rating Outlook is Stable. A full list of ratings follows at the end of the release. KEY RATING DRIVERS The upgrade is based on Fitch's expectation that EQR has the willingness and capacity to maintain current credit metric levels through-the-cycle, which are supportive of an 'A' IDR. Fitch views EQR as having sector-leading access to capital, and a portfolio that, while geographically concentrated and prone to more operating volatility than its peers, should demonstrate above-average growth and transactional liquidity as well as sufficient access to financing through cycles given its high quality and location in markets with strong long-term demand. Commitment to Superior Credit Metrics: Fitch expects EQR to operate at or below the lower-end of the company's publicly-communicated updated target leverage range of between 5.5x-6.5x through 2019 despite operating fundamentals continuing to decelerate. This compares to leverage of 5.7x for both the trailing-12 months ending Sept. 30, 2017 and 2016 periods, respectively. EQR's commitment to a lower leverage (previously 6.5x-7.5x) target and Fitch's expectation of maintenance of current credit metrics through-the-cycle supports Fitch's decision to upgrade the rating. Fitch expects fixed charge coverage to 3.8x by 2019. Fixed charge coverage was strong at 3.6x for the last 12 months ending Sept. 30, 2017, up from 3.4x in 2016. Portfolio Consolidated Within Core Coastal Markets: In early 2016, EQR sold non-core, primarily suburban assets to Starwood Capital Group. This transaction completed the company's exit from two markets and consolidated the portfolio within the markets that it wishes to focus on long-term. EQR's portfolio is almost 100% contained within Boston, Los Angeles (including Orange County), New York, San Diego, San Francisco, Seattle and Washington, D.C., markets, which generally have above-average growth and transactional liquidity as well as sufficient access to mortgage financing through-the-cycle. Measured Development Exposure: The company's total development pipeline and unfunded development pipeline as a percentage of gross assets remain smaller than many of its closest peers, with projects focused in its core markets of San Francisco, Washington, D.C., and Seattle. The size of the pipeline and the unfunded portion increased to pre-recession levels from 2013-2014, but EQR has since reduced development exposure significantly as the cycle matures. As of Sept. 30, 2017, total development and unfunded development as a percentage of gross assets stood at 2.4% and 0.5%, respectively, down from the recent peak of 8.5% and 4.1% in 2014, respectively. Soft New York and San Francisco Fundamentals: San Francisco (19.3%) and New York (17.7%) are the company's largest and third largest markets, respectively, as measured by third quarter 2017 (3Q17) same store net operating income (SSNOI) contribution. New York is the company's weakest market year-to-date, with SSNOI declining 2.5%; however, concession activity has receded. Fitch expects EQR's New York assets will continue to have negative rent growth into 2018 coinciding with a peak in supply and remain the worst performing of EQR's markets. San Francisco has typically been one of the company's best performing markets (+2.5% YTD SSNOI growth); however, softer fundamentals due to increased supply and weaker demand have weighed on the portfolio's overall cash flow growth. Fitch expects San Francisco rent growth will continue to decelerate in 2018, albeit at a slower pace than previous years, but still to remain positive. Strength in Seattle and Southern California should keep overall portfolio SSNOI growth positive throughout the projection period. Muted Washington, D.C. Growth: Washington, D.C. is EQR's fourth largest market at 17.6% of 3Q17 SSNOI and may also continue to weigh on the overall portfolio performance. SSNOI increased by 0.7% for the first nine-months of 2017, the second worst-performing market in EQR's portfolio. Washington, D.C. was one of the strongest real estate markets during the global financial crisis; nonetheless, the metro district has been hurt by an abundance of new supply (likely in response to the early cycle growth) coupled with tepid job growth and uncertainty surrounding near-term government job growth. Fitch expects this market to improve modestly throughout the projection period. Preferred Unit Notching: The two-notch differential between EQR's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'A'. Based on Fitch criteria in 'Non-Financial Corporates Hybrids Treatment and Notching Criteria', dated April 27, 2017 and available at, these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default. Stable Outlook: The Stable Outlook reflects Fitch's expectation that EQR's leverage should sustain within the expected 5.5x-6.5x range over the longer term and that the company has some cushion relative to its current metrics to absorb operating weakness. DERIVATION SUMMARY EQR along with peers Avalon Bay Communities and UDR, Inc. own high-quality assets in bi-coastal markets, with Essex 'BBB+/Stable) maintaining a strong position in West Coast markets. EQR's trophy assets in top stable markets, long-dated operating and financing history, as well as market-leading access to capital allow EQR to maintain higher leverage than similarly rated peer Camden Property Trust (A-/Stable). Despite current weakness in the company's top revenue generating markets, EQR has maintained average SSNOI growth roughly in-line with the multifamily universe's peers since 1999 at 2.9%. Fitch links and synchronizes the IDRs of the parent REIT and subsidiary operating partnership, as the entities operate as a single enterprise with strong legal and operational ties. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: --SSNOI growth of 1.8%, 0.6%, and 1.5% respectively for 2017, 2018 and 2019, driven by supply peaking in 2018; --Acquisitions are match funded by dispositions; --Percentage of secured debt to total debt gradually diminishes as unsecured issuance replaces mortgage debt; --Market portfolio composition remains relatively unchanged. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action --Fitch's expectation of leverage sustaining below 5.0x (leverage was 5.6x for quarter ended Sept. 30, 2017); --Fitch's expectation of FCC sustaining above 4.0x; --UA/UD above 3.5x; Future Developments That May, Individually or Collectively, Lead to Negative Rating Action --Fitch's expectation of leverage sustaining above 6.5x; --Fitch's expectation of FCC sustaining below 3.5x; --A change in financial strategy resulting in less conservative policies. LIQUIDITY Good Contingent Liquidity: EQR's unencumbered cash NOI stressed at a 7% capitalization rate covered its net unsecured debt by 3.3x as of Sept. 30, 2017. The company has consistently maintained net UA/UD above 2.5x. The quality of the unencumbered portfolio is consistent with the quality of the overall portfolio, based on location and age. EQR has a liquidity coverage ratio (total sources divided by total uses) of 2.7x and should be able to refinance or repay its upcoming indebtedness via accessing the public markets. FULL LIST OF RATING ACTIONS Fitch has upgraded the ratings as follows: Equity Residential --Long-Term IDR to 'A' from 'A-'; --Preferred Stock to 'BBB+' from 'BBB'. The Rating Outlook is Stable. ERP Operating Limited Partnership --Long-Term IDR to 'A' from 'A-'; --Short-Term IDR to 'F1' from 'F2'; --Unsecured revolving credit facility to 'A' from 'A-'; --Senior unsecured notes to 'A' from 'A-'; --Commercial paper notes to 'F1' from 'F2'. The Rating Outlook is Stable. Contact: Primary Analyst Peter Siciliano Director +1-646-582-4760 Fitch Ratings, Inc. 33 Whitehall Street New York, NY 10004 Secondary Analyst Steven Marks Managing Director +1-212-908-9161 Committee Chairperson Britton Costa Senior Director +1-212-908-0524 Summary of Financial Statement Adjustments --Historical and projected recurring operating EBITDA is adjusted to add back non-cash stock-based compensation and include operating income from discontinued operations and Fitch's estimate of recurring cash distributions from joint venture operations; --Fitch has adjusted the historical and projected net debt by assuming the issuer requires $40 million of cash for working capital purposes, which is otherwise unavailable to repay debt; --Fitch has included 50% of the company's cumulative perpetual preferred stock as debt in certain ratios. 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