Equity Residential (NYSE: EQR), a real estate investment trust (REIT) focused on apartment communities, is teaming up with luxury homebuilder Toll Brothers (NYSE: TOL) on a new apartment development joint venture. They plan to acquire and develop sites for apartment rental communities in seven metro areas. The partnership will marry Equity Residential's market knowledge and balance sheet strength with Toll Brothers' development capabilities.
Here's a closer look at the partnership and what it means for real estate investors.
Details on their strategic partnership
Equity Residential and Toll Brothers plan to initially focus on the following metro markets: Atlanta; Austin, Texas; Boston; Denver; Orange County/San Diego; Seattle; and Dallas-Fort Worth. Both companies have a significant or growing presence in the first six markets, while Equity Residential recently re-entered the Dallas market. That's the company's third new Sun Belt market this year. It has also moved into the Atlanta and Austin markets, following its return to Denver in 2018 as it focuses on expanding beyond major coastal gateway cities.
The partners expect to initially invest $750 million of equity into the joint venture over the next three years, with Equity Residential contributing 75% and Toll Brothers the remaining 25%. They plan to use about 60% leverage, implying nearly $1.9 billion of investment capacity. Toll Brothers is jump-starting the venture by contributing three properties with a total projected cost of $242 million.
Toll Brothers will manage each construction project, earning fees for development, construction management, and financing. It will also receive a promoted interest realized on the sale of each property. It also agreed to exclusively develop apartment projects for Equity Residential, with some limited exceptions. Meanwhile, Equity Residential will earn fees for property management, leasing and marketing services, and construction oversight. It also has the option to purchase the properties upon stabilization.
A mutually beneficial partnership
This strategic partnership will benefit both partners. It will allow Toll Brothers to increase the capital efficiency of its Toll Brothers Apartment Living division, enabling it to complete more units while investing less capital from its balance sheet. That will improve its returns on equity while allowing it to generate higher and more predictable income through recurring fees and the likely future sales of stabilized communities to Equity Residential, enabling it to better compete with rival homebuilders.
Several have recently secured large sales of single-family homes to institutional investors. That's helping mitigate the impact of market conditions for homebuilders while providing investors with a pipeline of single-family rental (SFR) investments.
This deal has a similar benefit for Equity Residential. It's getting an acquisition pipeline of newly built communities. That's helping reduce its development risk and providing visible growth since it can purchase these properties at a set price upon stabilization. Because of that, Equity Residential's CEO Mark Parrell says he "expect[s] this venture to create significant value for our shareholders." He says the deal will work to "accelerate our diversification efforts and to allow us to efficiently scale up our development efforts."
While Equity Residential has extensive development expertise, it isn't as focused on construction as some of its rivals. Instead, acquisitions have been a bigger growth driver in recent years. This year, the company's focus has been on recycling capital out of some of its major coastal markets into inland ones with better demographics and growth potential. For example, the residential REIT sold $435 million of assets in the first half, primarily older properties in California. It used those proceeds to purchase $646 million of properties in Austin, Atlanta, and Denver.
A smart move
Equity Residential has made it clear that it wants to diversify its portfolio by expanding into markets with better affluent renter growth profiles. That's leading it to join forces with Toll Brothers to build new apartment communities in markets with some of the best demographics. The deal is a win-win for each side as it reduces risk, improves returns, and provides visible growth. Because of that, it should help create value for investors in both companies.