After three months filled with weakening occupancies and more balance sheet acrobatics than acquisition and disposition activity, analysts expect nothing earth-shattering when the apartment REITs announce their first-quarter results in the coming weeks.
“I don’t honestly think there will be a whole of surprises,” says Stephen Sweet, senior vice president at New York-based Keefe, Bruyette & Woods.
Even without any surprises, however, there are a number of key things analysts will be watching when the public companies report their results.
Despite a flurry of job losses in January and February, analysts don’t think rental operators have felt the brunt of the unemployment fallout quite yet. There are signs of trouble: Unemployment was a factor in the first-quarter results at Birmingham, Ala.-based Colonial Properties Trust, which saw its same-store net operating income (NOI) drop 3.2 percent.
“It takes a little while for layoffs and weakness to flow through the system,” says Taylor Schimkat, a senior associate with Green Street Advisors, a Newport Bach, Calif.-based REIT consulting and research firm.
But there’s still valuable information about market fundamentals that can be gleaned from the first-quarter calls. “We’ll all be looking for anecdotal information that is more predictive such as, what is traffic relative to past years?” Swett asks. “What are concessions for new residents versus what you have to do now to keep existing residents? It’s just trying to gauge what the management teams are seeing.”
Mid America Apartment Communities, a REIT based in Memphis, Tenn., recently released guidance expecting funds from operations (FFO) to exceed expectations. That’s the exception, not the rule. Analysts expect all of the other REITs to push their expectations south.
“I think for the apartment guys, you may start to see caution for the rest of the year,” he says. “Everybody is a little shell-shocked by the job losses that got reported.”
2. Debt Positions.
The rush for credit facilities with Fannie Mae and Freddie Mac hasn’t subsided. Since early April, three REITs (Alexandria, Va.-based AvalonBay Communities, Houston-based Camden Property Trust, and San Francisco-based BRE Properties) announced deals totaling approximately $1.8 dollars with Fannie and Freddie. The average interest rate was 5.6 percent.
“That’s lower than what we’ve seen for the last year from Fannie and Freddie,” Schimkat observes. “Generally, they had been in the low- to mid-6 percent range. This recent issuance shows that pricing in the very near term is coming down.”
REITs are using these pools of cash to buy back notes, as BRE recently did, and to pay down maturities. They’re lowering their cost of debt and pushing maturities out further but taking on more restrictive debt. That’s a trade they’re willing to make, given the markets.
“The focus for most companies is making sure they’re ready for 2011,” says Rod Petrik, managing director at St. Louis-based Stifel, Nicolaus and Co., a regional brokerage and investment banking firm. “It’s going to be ongoing as long as Fannie and Freddie are lending.”
Swett does have questions about how long REITs can continue borrowing against their unencumbered assets to provide collateral against these credit facilities. That could be an issue in the upcoming conference calls. “If the unencumbered asset pool shrinks to something much smaller than it has historically been, there’s some concern for corporate debt holders,” Swett says.
Others have questions about whether highly leveraged REITs such as Denver-based AIMCO, Richmond Heights, Ohio-based Associated Estates Realty Corp., and Colonial Properties Trust can avoid breaches in their covenants. REITs also may be quizzed on their plans if Fannie and Freddie support of the industry slows. “Companies are going to have to address what their alternative plans are if they secured market either slows down or companies’ balance sheets hit the limits in how much they can take down,” Swett says.
3. Cash Generation.
Without Fannie and Freddie, analysts think many apartment REITs would be going through equity raises right now—just as their peers are doing in other real estate sectors. But that could change.
With his concern over how many more unencumbered asset pools REITs can borrow against, Swett also wonders about equity raises. “What are their alternate plans [to generate cash],” he asks. “Is it asset sales? How would they look at equity issuance at this point? Given the fact that most of the companies have access to reasonably low-cost debt, I don’t expect most of those companies to be predisposed to issue equity.”
So far, dispositions have been the clear second choice. Companies such as AIMCO, Highland Ranch, Colo.-based UDR, and Chicago-based Equity Residential were very active selling assets in 2008 and into 2009. “I have a sense these companies have internal valuation on their assets,” Petrik says. “When they get a price over that, they sell it. In older assets that are in secondary markets, even if it doesn’t meet their internal valuations, they may say their internal valuation is wrong and sell it anyway.”
But Petrik wonders if this will remain the next-best choice if valuations continue to deteriorate. “Continued reduction in valuations will be a burden on apartment REITs,” Petrik says. “Where do they think it settles?”
That’s yet one more thing he and the other industry analysts will have to wait to learn over the next two weeks.