Earlier this week, UDR was the first REIT to declare its third-quarter earnings. The numbers surprised some analysts. Fundamentals are weakening, but the firm still held occupancies above 95 percent in all four regions. Its revenue came in line with forecasts from Robert W. Baird & Co., a Milwaukee-based wealth management, capital markets, asset management, and private equity firm, but its operating line was better than some analysts expected thanks to some cost savings.
“They were able to push through a continued focus on cost savings,” says Paula Poskon, a senior research analyst with Robert W. Baird. “That pushed the operating margin to come in about 165 basis points above where we forecast.”
Over the next two weeks, the industry will get to see if the other companies in the multifamily REIT space will also beat their expectations for the quarter. As usual, analysts don’t expect any great surprises. But the calls could shed some light on the REITs' plans for 2010 and beyond in what has become a rapidly changing marketplace. Here's a look at the three things analysts will be eyeing in the upcoming calls.
1. Portfolio Expansion
Remember those distressed opportunities everybody, including REIT CEOs, started talking about last year? Well, they haven’t materialized yet. As long as banks extend and pretend, Poskon thinks it will keep REITs on the sidelines. “Many of these REITs would like to buy,” Poskon says. “We’re not seeing the distressed level of pricing that the market anticipated a year-and-a-half ago.”
In fact, some people are seeing cap rates falling and 40-plus bidders on deals. "On good, A-quality, core deals, pricing has been high and cap rates have been surprisingly low," says Andrew J. McCulloch, an analyst for Green Street Advisors, a Newport Beach, Calif.-based consulting and research firm. "I think the REITs are getting more active in the acquisition hunt; they're just getting outbid."
If REITs can't find buying opportunities and there is increased confidence that fundamentals are nearing bottom, McCulloch thinks they may turn to development a little sooner than expected to add units in anticipation of what should be good growth years in 2012 and beyond. "If you think fundamentals are going to be good in late 2011, 2012, and beyond, you may start looking at putting a shovel back in the ground next year" McCulloch says. "The REITs are in a better position than many private developers due to stronger balance sheets and better access to capital. An AvalonBay [Communities] can start development tomorrow if they wanted to."
2. Blocking and Tackling Strategies
So far, Poskon thinks the REITs have been holding up pretty well, given occupancy challenges. “They’re giving up on rental rates in an effort to maintain occupancy,” Poskon says. “That has been pretty successful. We saw decent numbers in occupancy in the second quarter, and I think we'll see that in the third quarter as well.”
So far, though, REITs have been able to stay in the good graces of their analysts by cutting costs. “We continued to be surprised on the expense lines,” Poskon says. “The companies have clearly put a big focus on cost-containment.”
Some REITs, as is the case with UDR, are focusing on technology applications that will reduce costs in areas such as advertising. Poskon says some companies are also cutting staff and renegotiating contracts with vendors to help boost the bottom line. Utility costs are down, and a lot of companies are pushing hard on insurance renewals and tax appraisals.
But Poskon wonders how long REITs can continue cutting costs. “Stretching into next year, I think that expense savings will be more and more challenging to perpetuate,” she says. “There’s only so much you can cut into before you get into muscle.”
3. Balance Sheet Moves
Unlike their commercial peers, apartment REITs are in pretty solid shape. "Their balance sheets are not littered with large, near-term maturities," McCulloch says. "The REITs have done a lot of work over the last year pushing out maturities."
The presence of Fannie Mae and Freddie Mac in the sector also has had a lot to do with this. "As long as a company has a balance sheet with some unencumbered assets, they have some access to funding, even if we have another credit crunch," Poskon says.
REITs had been going almost exclusively to secured financing through Freddie Mac and Fannie Mae until AvalonBay recently pulled the trigger on an unsecured offering. McCulloch could see other REITs such as UDR follow suit if the spread on unsecured debt versus secured debt continues to tighten. “Avalon got some pretty good pricing,” McCulloch says.
Still, not everyone will be flocking to the unsecured market. For instance, Memphis-based Mid-America Apartment Communities has generally shied away form that market. “Some companies don’t do unsecured,” Poskon says. “They’re fully committed to a secured strategy. Some companies prefer unsecured because it gives them more flexibility with what to do in their portfolio of assets.”
A number of REITs have also put "slo-mo" equity programs in place throughout the year. "The issuances to date have been geared more toward fortifying their balance sheets as opposed to funding opportunistic acquisitions," McCulloch says. "But that could change as we move into 2010."
McCulloch wonders if this will continue. "I'm curious to see how active they'll be with the slo-mos," he says. "UDR was active, but not overly aggressive."