The news that Chicago-based REIT Equity Residential was selling 23,300 units for $5.4 billion to Starwood Capital Group brought a lot of reactions.
Given Starwood’s purchase of Landmark Apartment Trust last week, one narrative could be Starwood’s frantic acquisition pace of the past 12 months. The deal also left some folks wondering if EQR chairman Sam Zell had once again timed the top of the real estate market, after his sale of Equity Office Properties to Blackstone Group in 2007.
Beyond those initial reactions, three takeaways from the deal:
The Market for B Is Strong
Newport Beach, Calif.–based real estate research and advisory firm Green Street Advisors had an observation about the EQR–Starwood deal that many apartment owners across the country will want to hear: The deal is a win for apartment owners, specifically those that have Class B assets.
“The EQR–Starwood transaction carries favorable implications for apartment cap rates. The buyer’s forward nominal cap rate of approximately 5.3% compares favorably to the 5.5% cap rate that we apply to the portfolio,” Green Street wrote in a report that came out after the sale. “While the Starwood purchase represents just one data point and is isolated to Class B, suburban assets primarily in South Florida and Denver, the data point is a big one that requires further evaluation so as to formalize implications for applied cap rates across apartment REIT NAVs.”
The portfolio includes a mix of mid-rise and garden-style apartment buildings in five states, with major concentrations in South Florida; Denver; Washington, D.C.; Seattle; and the Inland Empire, Calif.
“These assets would generally be described as older, mostly suburban in nature, with limited access to public transportation services,” said EQR CEO David Neithercut on the company’s earnings call. “The majority of which are surface-parked, two- to four-story, walk-up, garden properties—not the high-density urban assets, but [with] high Walk Scores—that we've been focused on the past 10 years or so.
Starwood Is Betting Big on Apartments
The EQR purchase is the company’s largest nonhotel deal ever, and it continues what has been a busy year for the firm. Counting last week’s deal (in concert with Canadian REIT Milestone) to purchase nontraded REIT Landmark and the EQR purchase, Starwood will control more than 88,000 units.
“The purchase by Starwood makes sense, given [that] ultra-low debt rates create a wide current-income spread with NOI growth,” wrote Sandler O'Neill + Partners.
In the past 12 months, Starwood has acquired approximately 67,800 multifamily units. The company says South Florida; Denver; Washington, D.C.; Seattle; and the Inland Empire, Calif., have posted annual rent growth of more than 4% over the past five years and have strong job growth potential.
“The size of this transaction underscores our conviction in multifamily housing’s continuing ability to offer superior risk-adjusted returns. The strong underlying demographics for apartments and positive leverage—resulting in robust cash-on-cash yield—make this portfolio a very attractive investment,” said Barry Sternlicht, chairman and CEO of Starwood Capital Group, in a statement. “We're excited to increase our exposure to these growth markets, and to add such high-quality assets to our rapidly expanding portfolio of multifamily properties.”
Green Street speculates that last week’s announcement that the FHFA will maintain the current rate of Fannie and Freddie lending volume in ’16 probably gives Starwood confidence in the size and pricing of the loan it will seek to obtain on the unencumbered EQR assets. Sandler looks to past Starwood deals as a guide to its financing strategy.
“While we don't know how Starwood will structure in this instance, we note Starwood often uses floating-rate or short-term debt, not only because of the cost advantage but also because it lines up well with the life of the investment fund [easier to let a buyer acquire assets free and clear rather than pre-encumbered],” Sandler wrote in its report.
EQR Capitalizes on Private Interest
EQR partnered with AvalonBay Communities to buy Archstone two years ago. Now, it seems to be taking advantage of the private appetite for multifamily. Said Neithercut: “The strong institutional demand for core assets in gateway coastal cities, and the competitive pricing that's a result of that demand causing very dilutive trade between what we wanted to sell and [what] we'd like to buy,” drove the sale.
Concerns about the future of Fannie and Freddie and interest rates also played into EQR’s decision to sell.
In addition to selling 23,300 units to Starwood, the REIT plans to sell 4,700 units in Connecticut and suburban Massachusetts for $700 million. Equity is also marketing a Manhattan property and its Berkeley, Calif., student housing portfolio. Green Street estimates that these dispositions could total approximately $7 billion, or 17% of operating assets.
“For EQR, the transactions accomplishes portfolio management objectives that include the exit of South Florida, Denver, and a reduced exposure to older, suburban assets,” Green Street wrote. “The remaining portfolio is largely comprised of urban, walkable, luxury assets, as reflected by $2,650 average rents, or -10% above the rents of both EQR’s existing portfolio and AVB’s portfolio.”
Other analysts had similar sentiments. “We like that EQR is taking advantage of the strong asset pricing to sell assets and reward shareholders with a special dividend,” wrote Sandler. “EQR is also planning another $700 million of sales in 2016 to essentially complete its portfolio transformation to a pure bi-coastal portfolio of just six markets.”
In the report, Sandler speculated that other REITs might not follow EQR, given the seemingly insatiable appetite for multifamily among private buyers. “We expect more management [teams] across REITland to increasingly look at similar dispositions given the strong pricing for real estate in the private market,” Sandler said.