3 Takeaways from the Third-Quarter Earnings Reports

The apartment REITs finished up their third quarter reporting this week. As far as market fundamentals, there were no real surprises. But there were three prime takeaways, from the recovery to an increasing deal pace to a major move from UDR.

1. The recovery is continuing.
For some analysts, the third quarter began with questions. “Early on, there were a lot questions about how sustainable the recent rent gains would be as we headed into the third quarter against some weak economic data,” says Haendel St. Juste, an analyst with Keefe, Bruyette & Woods (KBW), an investment banking and security brokerage firm based in New York. “We’re heading into the final stretch of this year and the net job gains have been minimal. Yet, you look at the sector, and we’ve had a pretty significant improvement over the course of the year.”

In fact, the apartment sector as a whole saw year-over-year same-store NOI stabilize to -0.5 percent after seeing it fall -3.1 percent in the second quarter and -6.3 percent in the first quarter, according to KBW. Year-over-year, same-store revenue was up 0.2 percent, which was an improvement from the -1.7 percent in the second quarter and -3.3 percent in the first quarter.

“Some markets in the country, like New York, Boston, Austin, and Washington, D.C., are starting to surpass the peak rents achieved in mid-2008,” St. Juste says. “There are still a lot of markets are well below peak. A lot of these markets are in the Southeast, places like Atlanta and Orlando, as well as places like San Francisco and Seattle out West.”

In fact, occupancies improved so much earlier in the year that some REITs were willing to give up occupancy to push rents. Cleveland, Ohio-based Associated Estates, Alexandria, Va.-based AvalonBay Communities, Chicago-based Equity Residential, and Denver-based UDR reported sequential occupancy declines, but saw rental rate increases. Palo Alto, Calif.-based Essex Property Trust and Rochester, N.Y.-based Home Properties reported sequential revenue increases coupled and occupancy declines, according to Robert W. Baird & Co., a Milwaukee-based wealth management, capital markets, asset management, and private equity firm.

“For those portfolios that had really high occupancies, I think management teams were more willing to push rents,” says Paula Poskon, a senior research analyst with Robert W. Baird.

2. UDR’s still making big deals.
One theme of the conference calls was construction and the rise of one-off transactions. That was until, just prior to its quarterly earnings call, UDR announced that it acquired Houston-based The Hanover Co.'s interests in the existing Hanover/MetLife Master Limited Partnership, which includes 26 properties with 5,748 units and 11 land parcels that could potentially house 2,300 additional homes.

On the surface, that’s a lot of units, but dig deeper and some analysts thought the deal generated a little too much attention on the company’s conference call. UDR paid $93 million for a 12.27 percent weighted average partnership in the 26 properties, a 4.14 percent weighted average partnership interest in the 11 land parcels, and the property and asset management agreements for the partnership.

“The initial 9 percent return is akin to a high-octane fee deal,” says Alexander Goldfarb, associate director of equity research of REITs for New York-based Sandler O’Neill + Partners. “If you look at the NOI yield, it’s 4 percent on a GAAP basis and in the 3 percents on a cash basis.”

Instead, Goldfarb, like other analysts, thinks the real story could come later if UDR is in position to secure the real estate. “I view it as option play,” Goldfarb said. “For $93 million, there’s the potential to get at $2.3 billion of real estate. If they can lease up the properties, burn concessions off, improve occupancies, and they can prune some assets, relever, and put long-term financing on (and take out MetLife), there’s a chance to create some real value there.”

The deal proves that UDR remains actively engaged with Hanover, a company that builds top-of-the-line buildings but is reported to have run into some problems. Earlier, this year it had made another purchase from the Houston-based company. CEO Tom Toomey indicated on the call that UDR remains in conversation with Hanover about development opportunities. On the call, UDR indicated that it has a right to acquire the deal if MetLife decides to sell properties in the portfolio.

3. Deal and transaction acitivity is going strong. 
After seeing transaction and new starts gradually rise throughout the year, it’s safe to say the apartment REITs are ramping up both acquisitions and new starts.

One of the leaders is Equity. The REIT acquired six assets in the third quarter, totaling nearly $550 million. For the year, the company bought 14 assets and $1.4 billion of acquisitions. Overall the company increased its acquisition guidance to $1.5 billion.

“I’ll tell you we have seen an increase in the number of deals being offered for sale in our core markets, but there remains considerable competition for most of these assets,” said Equity CEO David Neithercut in a transcription on SeekingAlpha.com.

Equity also bought six parcels of land this year and expects to begin construction on most of them in 2011, totaling $340 million of starts. AvalonBay also continued to add units, starting five projects in the third quarter, totaling $232 million and buying three properties for $240 million. It expects to start another $300 million worth of construction in the quarter. Camden bought two properties for approximately $41 million and started construction on two projects. Meanwhile, UDR acquired five assets from The Hanover Co. prior to its November announcement.

Some of the smaller companies are getting into the act. Home bought  purchased five properties for a combined $269 million. In September and October, Associated Estates secured two properties and announced it was building a 242-unit apartment community located in downtown Nashville, Tenn. Memphis, Tenn.-based Mid America Apartment Communities bought five properties, totaling $145 million.

“It doesn’t surprise me that volume has picked up,” Poskon said. "I think some people were surprised to see Mid-America close six deals in a matter of weeks late this summer."