Equity Residential (NYSE: EQR) currently has a concentrated portfolio. The residential REIT, or real estate investment trust, primarily owns apartment communities in the urban cores of major coastal gateway cities Boston, New York, Washington, D.C., Seattle, and San Francisco as well as Southern California. It focuses on those urban areas because they typically benefit from steady demand with limited new supply, which yields high occupancy levels and steadily rising rental rates.
However, the pandemic has accelerated a shift away from those high-cost markets toward more affordable ones in the suburbs or the Sun Belt region. That's leading Equity Residential to consider making a similar move by diversifying its portfolio.
Time to diversify
Equity Residential's CEO Mark Parrell discussed the company's relocation plans on the first-quarter conference call. He said that while the company didn't close any deals during the quarter, "we have been active in the transaction market, and we expect to have a considerable amount of activity to report on next quarter."
He said, "In order to create the most stable, growing cash flow stream possible for our investors, we are broadening our portfolio over time to increase our exposure to suburban properties in our existing markets, where the resident demographic is similar to our existing affluent urban resident population. We are also working on increasing our investment in Denver and continuing to consider a select number of new markets that have large and growing affluent resident bases, favorable long-term supply and demand characteristics, and lower political risk."
As Parrell points out, the REIT is taking a multipronged approach to reduce its concentration to the urban cores of high-cost coastal markets. First, it plans to acquire more properties in the suburban areas of those coastal markets. They benefit from a similarly affluent resident population that chooses to live outside the city because it's more affordable.
Second, the company wants to increase its investment in Denver, which is its only non-coastal market at the moment. The REIT currently gets 2% of its net operating income (NOI) from that city. However, Parrell stated on the call that Equity plans to expand its Denver presence "pretty significantly over the next few quarters."
Finally, the REIT is open to new markets. While Parrell didn't hint at where it's looking on the call, an analyst at Piper Sandler suggested that they "wouldn't be surprised" to see the REIT make acquisitions in Sun Belt markets like Texas, Florida, Arizona, and even Nashville, Tennessee. These areas are benefitting from significant migration as companies and people move into large Southern cities because of their better business climates and weather.
Trading its way to a more diversified portfolio
While Equity Residential has a top-notch balance sheet, giving it ample flexibility to go on a shopping spree, it's planning to take a different approach to shift its portfolio mix. It intends to sell assets in select urban markets and reinvest those proceeds into new communities in the suburbs, Denver, and potentially new markets.
Parrell stated that the company is taking this approach because, "while asset prices are high in the locations in which we seek to invest, our funding source for these acquisitions comes from sales of existing properties, especially in California, where we are obtaining pricing that exceeds our pre-pandemic valuations." He noted that they're getting "really terrific pricing" on assets they're selling in California and elsewhere.
He further commented that the company is able to sell assets in locations where it has too much concentration at "pretty low cap rates" and that values were, in many cases, higher than they'd ever seen. By cashing in on those high prices, he said the company can then "buy assets we really like at the same cap rates," even if they are high prices. In Parrell’s view, that's still a good trade for them because, as he added, "We still think that gives us that diversification we talk about, maybe a little better growth going forward."
This capital recycling approach will enable the company to "complete this transaction activity with minimal dilution and to stay consistent with our strategy of acquiring newer assets with modest capital expenditure burdens." That will enable the REIT to maintain its financial strength while diversifying its portfolio, putting it in a better long-term position.
Aiming for a bit more balance
The pandemic impacted urban core areas as remote workers opted to move to cheaper apartments in the suburbs or the Sun Belt region. That's leading Equity Residential to follow in their footsteps by broadening its portfolio. It believes that this strategy will generate steadier cash flow over the long term, making it an even better investment option for REIT investors.