Heading into the REITs' first-quarter conference calls, fundamentals, debt, and cash generation were all on the mind of apartment industry analysts. Now that all of the apartment REITs have reported their figures, it’s obvious they’re preparing for things to get worse before they get better, both in the credit markets and in fundamentals. Here are three things that came to light during the conference calls.

1. Pressure on Fundamentals
The first quarter could have been worse. Massive job losses spurred dramatic declines in both rents and occupancies around the country. But as the quarter progressed, those losses moderated. "The rate of rent decline appears to be moderating," says Alexander Goldfarb, associate director of equity research of REITs for New York-based Sandler O'Neill + Partners. "From the data that we see, rents are still declining, but that rate of decline appears to have slowed."

That doesn't mean things couldn't take a steep fall again this summer, which is what worries Goldfarb. "The question is, will rents hold through the summer leasing season, or will they take another leg down?" Goldfarb asks. "That's what everyone is focused on. It's certainly what we're focused on. In either case, revenues will be under pressure as older rents reset to the new lower levels. If REITs can hold rental rates and this moderating decline hangs in there, that will be a good thing for the companies. If it takes another leg down, it's not a good thing."

With unemployment levels expected to continue to rise, Andrew J. McCulloch, an analyst for Green Street Advisors, a Newport Beach, Calif.-based consulting and research firm, thinks apartment REITs will continue to feel pain into 2010. That's why he predicts cumulative net operating income (NOI) declines of at least 10 percent between 2009 and 2010. "The economy will start to recover before the job picture does," McCulloch says. "We wouldn't expect to see any kind of recovery in apartment fundamentals before the second half of 2010 unless the economy stops losing jobs immediately. I don't see that happening."

Most of the REITs are reacting to the deteriorating job picture. Chicago-based Equity Residential, Palo Alto, Calif.-based Essex Property Trust, and San Francisco-based BRE Properties have all lowered their expectations for the year. “There was a mixed bag of confidence,” says Stephen Swett, an analyst at Keefe, Bruyette, and Woods in New York. “A couple of companies adjusted their expectations downward on their core growth targets for this year.”

2. Burning Out of Secured Debt
Traditionally, apartment REITs have preferred unsecured debt, even if they’re paying a little more for it. The reason: flexibility. They don’t have to deal with mortgage documents and can shuffle properties in and out of their portfolio at will.

But as the spreads between secured debt from Fannie Mae and Freddie Mac and unsecured debt have widened to between 250 and 300 basis points (bps), that freedom has lost much of its appeal. That’s why, for more than a year, the REITs have been surrendering the flexibility of unsecured debt and tapping into Fannie Mae and Freddie Mac secured facilities. And, in many cases, they’re using those proceeds to buy their unsecured notes with near-term maturities.

But some analysts and executives fear that REITs may soon be tapping out the secured well. To get these secured lines, REITs are sacrificing their unencumbered assets. This alarms the rating agencies. Already, New York-based Fitch Ratings has dinged Houston-based Camden Property Trust, Birmingham, Ala.-based Colonial Properties Trust, and Denver-based AIMCO for this exact reason. “The problem is the unsecured debt rating is, in part, based on what level of assets the unsecured debt looks like through the company,” Swett says. “The rating agencies have said, ‘You’re taking out the [unencumbered] assets and encumbering them. We’re going to cut your rating.’”

And that could be a problem if a REIT wants unsecured debt again. "They will want to keep their rating as long as they can because, at some point, that market will become attractive again," McCulloch says. "They'll want access to the unsecured market because it gives them more options."

Another less pressing concern is bank covenants. If a company encumbers too many of its assets, it could trigger a default. But analysts agree that, right now, that's not a concern. "When they talk abut how much secured debt they can layer on, most companies are thinking about that in terms of additional debt before putting their rating at risk as opposed to how much they can layer before they bust a covenant," says McCulloch, who think REITs can continue adding Fannie and Freddie facilities.

3. Issuance of Equity
Heading into earnings season, analysts speculated that the apartment REITs would issue equity. Despite many REITs in other sectors already issuing equity, the apartment REITs haven’t followed suit. But eventually, a couple of REITs will take that step. In the past couple of weeks, Dallas-based American Campus Communities and Camden both announced such offerings.

BRE followed up with the announcement of a “slow mo” deal. Instead of putting the whole slug of stock up for sale at once, the company will put it on the market on a piecemeal basis, depending on the pricing. McCulloch likes the move and thinks it's a good time for REITs to think about equity issuances. While REITs have been using Fannie and Freddie lines of credit to push back maturities, they're essentially swapping out one kind of debt for another. Equity issuances can help lower their leverage.

"Because there's a lot of uncertainty out there, we think this is as good a time as any to bring your leverage down," McCulloch says. "We also think you will see distress next year and think it would be good for these companies to have dry powder."

Others aren’t sold on equity offerings. “I think it's tough for apartment REITs to justify equity because they have had access to agency debt at a fairly attractive rate,” Swett says. “Why sell stock at a substantial price below your NAV at higher implied costs of capital if you can access Freddie and Fannie debt?”

Ernie Freedman, AIMCO’s deputy CFO, says the firm has no designs to issue equity right now. “We don’t see that today,” he says. “Obviously, all options are on the table. If it made sense, and we thought it wouldn’t be dilutive to our current shareholders, it would be something we would consider.”