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EQR > SEC Filings for EQR > Form 10-K on 27-Feb-2014All Recent SEC Filings

Show all filings for EQUITY RESIDENTIAL

Form 10-K for EQUITY RESIDENTIAL


27-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the results of operations and financial condition of the Company and the Operating Partnership should be read in connection with the Consolidated Financial Statements and Notes thereto. Due to the Company's ability to control the Operating Partnership and its subsidiaries, the Operating Partnership and each such subsidiary entity has been consolidated with the Company for financial reporting purposes, except for one unconsolidated development property, four unconsolidated operating properties and our military housing properties. Capitalized terms used herein and not defined are as defined elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2013.

Forward-Looking Statements
Forward-looking statements in this Item 7 as well as elsewhere in this Annual Report on Form 10-K are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations, estimates, projections and assumptions made by management. While the Company's management believes the assumptions underlying its forward-looking statements are reasonable, such information is inherently subject to uncertainties and may involve certain risks, which could cause actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Many of these uncertainties and risks are difficult to predict and beyond management's control. Forward-looking statements are not guarantees of future performance, results or events. The forward-looking statements contained herein are made as of the date hereof and the Company undertakes no obligation to update or supplement these forward-looking statements. Factors that might cause such differences include, but are not limited to the following:

?         We intend to actively acquire, develop and rehab multifamily properties
          for rental operations as market conditions dictate. We may also acquire
          multifamily properties that are unoccupied or in the early stages of
          lease up. We may


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be unable to lease up these apartment properties on schedule, resulting in decreases in expected rental revenues and/or lower yields due to lower occupancy and rates as well as higher than expected concessions. We may not be able to achieve rents that are consistent with expectations for acquired, developed or rehabbed properties. We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position, to complete a development property or to complete a rehab. Additionally, we expect that other real estate investors with capital will compete with us for attractive investment opportunities or may also develop properties in markets where we focus our development and acquisition efforts. This competition (or lack thereof) may increase (or depress) prices for multifamily properties. We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms. We have acquired in the past and intend to continue to pursue the acquisition of properties and portfolios of properties, including large portfolios, that could increase our size and result in alterations to our capital structure. The total number of apartment units under development, costs of development and estimated completion dates are subject to uncertainties arising from changing economic conditions (such as the cost of labor and construction materials), competition and local government regulation;

?         Debt financing and other capital required by the Company may not be
          available or may only be available on adverse terms;


?         Labor and materials required for maintenance, repair, capital
          expenditure or development may be more expensive than anticipated;


?         Occupancy levels and market rents may be adversely affected by national
          and local economic and market conditions including, without limitation,
          new construction and excess inventory of multifamily and single family
          housing, increasing portions of single family housing stock being
          converted to rental use, rental housing subsidized by the government,
          other government programs that favor single family rental housing or
          owner occupied housing over multifamily rental housing, governmental
          regulations, slow or negative employment growth and household
          formation, the availability of low-interest mortgages or the
          availability of mortgages requiring little or no down payment for
          single family home buyers, changes in social preferences and the
          potential for geopolitical instability, all of which are beyond the
          Company's control; and


?         Additional factors as discussed in Part I of this Annual Report on Form
          10-K, particularly those under "Item 1A. Risk Factors".

Forward-looking statements and related uncertainties are also included in the Notes to Consolidated Financial Statements in this report.

Overview

Equity Residential ("EQR"), a Maryland real estate investment trust ("REIT") formed in March 1993, is an S&P 500 company focused on the acquisition, development and management of high quality apartment properties in top United States growth markets. ERP Operating Limited Partnership ("ERPOP"), an Illinois limited partnership, was formed in May 1993 to conduct the multifamily residential property business of Equity Residential. EQR has elected to be taxed as a REIT. References to the "Company," "we," "us" or "our" mean collectively EQR, ERPOP and those entities/subsidiaries owned or controlled by EQR and/or ERPOP. References to the "Operating Partnership" mean collectively ERPOP and those entities/subsidiaries owned or controlled by ERPOP.

EQR is the general partner of, and as of December 31, 2013 owned an approximate 96.2% ownership interest in, ERPOP. All of the Company's property ownership, development and related business operations are conducted through the Operating Partnership and EQR has no material assets or liabilities other than its investment in ERPOP. EQR issues equity from time to time but does not have any indebtedness as all debt is incurred by the Operating Partnership. The Operating Partnership holds substantially all of the assets of the Company, including the Company's ownership interests in its joint ventures. The Operating Partnership conducts the operations of the business and is structured as a partnership with no publicly traded equity.

The Company's corporate headquarters are located in Chicago, Illinois and the Company also operates property management offices in each of its markets. As of December 31, 2013, the Company had approximately 3,600 employees who provided real estate operations, leasing, legal, financial, accounting, acquisition, disposition, development and other support functions.

Business Objectives and Operating and Investing Strategies

The Company invests in high quality apartment communities located in strategically targeted markets with the goal of maximizing our risk adjusted total return (operating income plus capital appreciation) on invested capital.


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We seek to maximize the income and capital appreciation of our properties by investing in markets that are characterized by conditions favorable to multifamily property appreciation. We are focused primarily on the six core coastal, high barrier to entry markets of Boston, New York, Washington DC, Southern California (including Los Angeles, Orange County and San Diego), San Francisco and Seattle. These markets generally feature one or more of the following characteristics that allow us to increase rents:
? High barriers to entry where, because of land scarcity or government regulation, it is difficult or costly to build new apartment properties, creating limits on new supply;

? High home ownership costs;

?            Strong economic growth leading to job growth and household
             formation, which in turn leads to high demand for our apartments;


?            Urban core locations with an attractive quality of life and higher
             wage job categories leading to high resident demand and retention;
             and


?            Favorable demographics contributing to a larger pool of target
             residents with a high propensity to rent apartments.

Our operating focus is on balancing occupancy and rental rates to maximize our revenue while exercising tight cost control to generate the highest possible return to our shareholders. Revenue is maximized by attracting qualified prospects to our properties, cost-effectively converting these prospects into new residents and keeping our residents satisfied so they will renew their leases upon expiration. While we believe that it is our high-quality, well-located assets that bring our customers to us, it is the customer service and superior value provided by our on-site personnel that keeps them renting with us and recommending us to their friends.

We use technology to engage our customers in the way that they want to be engaged. Many of our residents utilize our web-based resident portal which allows them to sign and renew their leases, review their accounts and make payments, provide feedback and make service requests on-line.

Acquisitions and developments may be financed from various sources of capital, which may include retained cash flow, issuance of additional equity and debt, sales of properties and joint venture agreements. In addition, the Company may acquire properties in transactions that include the issuance of limited partnership interests in the Operating Partnership ("OP Units") as consideration for the acquired properties. Such transactions may, in certain circumstances, enable the sellers to defer, in whole or in part, the recognition of taxable income or gain that might otherwise result from the sales. The Company may acquire land parcels to hold and/or sell based on market opportunities as well as options to buy more land in the future. The Company may also seek to acquire properties by purchasing defaulted or distressed debt that encumbers desirable properties in the hope of obtaining title to property through foreclosure or deed-in-lieu of foreclosure proceedings. The Company has also, in the past, converted some of its properties and sold them as condominiums but is not currently active in this line of business.
Over the past several years, the Company has done an extensive repositioning of its portfolio from low barrier to entry/non-core markets to high barrier to entry/core markets. Since 2005, the Company has sold over 162,000 apartment units primarily in its non-core markets for an aggregate sales price of approximately $15.6 billion, acquired over 66,000 apartment units primarily in its core markets for approximately $19.0 billion and began approximately $4.1 billion of development projects primarily in its core markets. We are currently seeking to acquire and develop assets primarily in the following six core coastal metropolitan areas: Boston, New York, Washington DC, Southern California, San Francisco and Seattle. We also have investments (in the aggregate about 11.9% of our NOI at December 31, 2013) in the two core markets of South Florida and Denver but do not currently intend to acquire or develop new assets in these markets. Further, we are in the process of exiting Phoenix and Orlando and will use sales proceeds from these markets to acquire and/or develop new assets and for other corporate purposes.

As part of its strategy, the Company purchases completed and fully occupied apartment properties, partially completed or partially occupied properties and takes options on land or acquires land on which apartment properties can be constructed. We intend to hold a diversified portfolio of assets across our target markets. As of December 31, 2013, no single market/metropolitan area accounted for more than 18.6% of our NOI, though no guarantee can be made that NOI concentration may not increase in the future.

We endeavor to attract and retain the best employees by providing them with the education, resources and opportunities to succeed. We provide many classroom and on-line training courses to assist our employees in interacting with prospects and residents as well as extensively train our customer service specialists in maintaining our properties and improvements, equipment and appliances. We actively promote from within and many senior corporate and property leaders have risen from entry level or


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junior positions. We monitor our employees' engagement by surveying them annually and have consistently received high engagement scores.

We have a commitment to sustainability and consider the environmental impacts of our business activities. Sustainability and social responsibility are key drivers in our focus in creating the best apartment communities for residents to live, work and play. We have a dedicated in-house team that initiates and applies sustainable practices in all aspects of our business, including investment activities, development, property operations and property management activities. With its high density, multifamily housing is, by its nature, an environmentally friendly property type. Our recent acquisition and development activities have been primarily concentrated in pedestrian-friendly urban locations near public transportation. When developing and renovating our properties, we strive to reduce energy and water usage by investing in energy saving technology while positively impacting the experience of our residents and the value of our assets. We continue to implement a combination of irrigation, lighting, HVAC and renewable energy improvements at our properties that will reduce energy and water consumption. For additional information regarding our sustainability efforts, see our December 2013 Corporate Social Responsibility and Sustainability Report at our website, www.equityresidential.com.

Current Environment

On February 27, 2013, the Company, AvalonBay Communities, Inc. ("AVB") and certain of their respective subsidiaries completed their previously-announced acquisition (the "Archstone Acquisition" or the "Archstone Transaction") from Archstone Enterprise LP ("Enterprise") (which subsequently changed its name to Jupiter Enterprise LP), an affiliate of Lehman Brothers Holdings, Inc. ("Lehman") and its affiliates, of all of the assets and liabilities of Enterprise (including interests in various entities affiliated with Enterprise), constituting a portfolio of apartment properties and other assets (the "Archstone Portfolio"). As a result of the Archstone Acquisition, the Company owns assets representing approximately 60% of the Archstone Portfolio. The consideration paid by the Company in connection with the Archstone Acquisition consisted of cash in the amount of approximately $4.0 billion (inclusive of $2.0 billion of Archstone secured mortgage principal paid off in conjunction with the closing), 34,468,085 Common Shares (which shares had a total value of $1.9 billion based on the acquisition date closing price of EQR's Common Shares of $55.99 per share) and the assumption of $3.1 billion of mortgage debt (inclusive of a net mark-to-market premium of $127.9 million) and approximately 60% of all of the other assets and liabilities related to the Archstone Portfolio. On February 18, 2014, Lehman publicly announced that it had sold the remaining Common Shares issued by the Company as partial consideration for the portion of the Archstone Portfolio acquired by the Company.

During the year ended December 31, 2013, the Company acquired 73 consolidated properties consisting of 20,914 apartment units, one unconsolidated property consisting of 336 apartment units, three consolidated master-leased properties consisting of 853 apartment units, four projects in various stages of development (two consolidated and two unconsolidated) and 15 land parcels for $9.1 billion. All but one of these properties and all but one of these land parcels were acquired in conjunction with the Archstone Transaction and the Company has completed the integration of these properties and their operations. We believe our access to capital, our ability to execute large, complex transactions and our ability to efficiently stabilize large scale lease up properties provide us with a competitive advantage, which was demonstrated in the Archstone Transaction. The Company currently budgets consolidated acquisitions of approximately $500.0 million during the year ending December 31, 2014 to be funded with proceeds from dispositions (see discussion below).

The Company started construction on seven projects representing 2,213 apartment units totaling approximately $880.9 million of development costs during the year ended December 31, 2013. The Company expects to increase its development activity as compared to the past few years and has budgeted approximately $750.0 million of new apartment construction starts on land currently owned during each of the years ending December 31, 2014 and 2015. We currently budget spending approximately $575.0 million on development costs during the year ending December 31, 2014. This capital will be primarily sourced with excess operating cash flow and availability on our revolving credit facility.

The Company continues to sell non-core assets and reduce its exposure to non-core markets as we believe these assets will have lower long-term returns and we can sell them for prices that we believe are favorable. The Archstone Transaction provided an opportunity to accelerate this strategy and do so efficiently through the use of Section 1031 tax deferred exchanges. The Company sold 94 consolidated properties consisting of 29,180 apartment units, seven consolidated land parcels and one commercial building for $4.6 billion and one unconsolidated land parcel for $26.4 million (sales price for the unconsolidated land parcel is the gross sales price and EQR's share of the net sales proceeds approximated 25%) during the year ended December 31, 2013. These dispositions combined with reinvestment of the cash proceeds in assets with lower cap rates (see definition below) were dilutive to our earnings per share. The Company defines dilution from transactions as the lost NOI from sales proceeds that were not reinvested in other apartment properties or were reinvested in properties with a lower cap rate. The Company funded a significant portion of the cash purchase price of the Archstone Transaction with capital raised through these significant dispositions of assets. While this accelerated disposition program was dilutive to our per share results, it also significantly mitigated the execution risk


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on the Archstone Transaction. Beginning in 2014 and going forward, the Company expects a decrease in dilution due to our reduced disposition expectations and the locations of our planned dispositions. The Company currently budgets consolidated dispositions of approximately $500.0 million during the year ending December 31, 2014.

As a result of the Archstone Transaction and the property sales to help finance the transaction, the Company's portfolio has changed significantly from the portfolio summary included in the Company's annual report on Form 10-K for the year ended December 31, 2012. The following table sets forth certain information by market relating to the Company's properties at December 31, 2013 as compared to December 31, 2012:

                             Portfolio Summary as of December 31, 2012                 Portfolio Summary as of December 31, 2013
                                                      % of         Average                                      % of         Average
                                      Apartment    Stabilized       Rental                      Apartment    Stabilized       Rental
Markets/Metro areas    Properties       Units        NOI (1)       Rate (3)      Properties       Units        NOI (2)       Rate (3)
Core:
Washington DC                 43        14,425          15.9 %   $    1,992             56        18,275          18.6 %   $    2,223
New York                      30         8,047          13.9 %        3,433             38        10,330          17.0 %        3,727
San Francisco                 40         9,094           8.6 %        1,902             51        13,210          13.2 %        2,227
Los Angeles                   48         9,815           9.9 %        1,879             57        11,960          11.3 %        2,064
Boston                        26         5,832           8.2 %        2,560             34         7,816          10.3 %        2,802
South Florida                 36        12,253           9.0 %        1,463             35        11,462           7.4 %        1,547
Seattle                       38         7,563           6.4 %        1,627             38         7,734           6.4 %        1,778
Denver                        24         8,144           5.5 %        1,226             19         6,935           4.5 %        1,321
San Diego                     14         4,963           5.0 %        1,851             13         3,505           3.2 %        1,906
Orange County, CA             11         3,490           3.3 %        1,660             11         3,490           3.0 %        1,723
Subtotal - Core              310        83,626          85.7 %        1,941            352        94,717          94.9 %        2,202
Non-Core:
Inland Empire, CA             10         3,081           2.4 %        1,491             10         3,081           2.2 %        1,514
Orlando                       21         6,413           3.5 %        1,086             10         3,383           1.7 %        1,130
New England
(excluding Boston)            14         2,611           1.3 %        1,174             11         1,965           0.8 %        1,212
Phoenix                       25         7,400           3.4 %          946              4         1,260           0.4 %          952
Atlanta                       12         3,616           2.0 %        1,157              1           336           0.0 %        1,301
Jacksonville                   6         2,117           1.1 %        1,005              -             -             -              -
Tacoma, WA                     3         1,467           0.6 %          951              -             -             -              -
Subtotal - Non-Core           91        26,705          14.3 %        1,099             36        10,025           5.1 %        1,248
Total                        401       110,331         100.0 %        1,737            388       104,742         100.0 %        2,110
Military Housing               2         5,039             -              -              2         5,113             -              -
Grand Total                  403       115,370         100.0 %   $    1,737            390       109,855         100.0 %   $    2,110

Note: Projects under development are not included in the Portfolio Summary until construction has been completed.

(1) % of Stabilized NOI for the 12/31/12 Portfolio Summary includes budgeted 2013 NOI for stabilized properties, budgeted year one (March 2013 to February 2014) NOI for the Archstone properties and projected annual NOI at stabilization (defined as having achieved 90% occupancy for three consecutive months) for properties that are in lease-up.

(2) % of Stabilized NOI for the 12/31/13 Portfolio Summary includes budgeted 2014 NOI for stabilized properties (including the Archstone properties) and projected annual NOI at stabilization (defined as having achieved 90% occupancy for three consecutive months) for properties that are in lease-up.

(3) Average rental rate is defined as total rental revenues divided by the weighted average occupied apartment units for the last month of the period presented.

We currently have access to multiple sources of capital including the equity markets as well as both the secured and unsecured debt markets. In April 2013, the Company completed a $500.0 million unsecured ten year note offering with a coupon of 3.00% and an all-in effective interest rate of approximately 4.0% including the effect of fees and the termination of certain interest rate hedges. In February 2013, the Company issued 34,468,085 Common Shares with a value of $1.9 billion based on the February 27, 2013 closing price of EQR Common Shares of $55.99 per share to an affiliate of Lehman Brothers Holdings Inc. as partial consideration for the acquisition of the Archstone Portfolio. In December 2012, the Company raised $1.2 billion in equity in a public offering of 21,850,000 Common Shares priced at $54.75 per share. On January 11, 2013, the Company replaced its existing $1.75 billion credit facility with a $2.5 billion unsecured revolving credit facility maturing April 1, 2018. The Company believes that the new facility, provided by a diversified and strong bank group, increases its balance sheet flexibility going forward. On January 11, 2013, the Company also entered into a senior unsecured $750.0 million delayed draw term loan facility which was


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fully drawn on February 27, 2013 in connection with the Archstone Acquisition.

In October 2013, the Company used cash on hand from dispositions to repay $963.5 million outstanding of 5.883% mortgage debt assumed as part of the Archstone Transaction prior to the November 1, 2014 maturity date. Also in October 2013, the Company closed a new $800.0 million mortgage loan from a large insurance company which matures on November 10, 2023, is interest only and carries a fixed interest rate of 4.21%. The Company used the loan proceeds from this new loan to simultaneously repay $825.0 million of a $1.27 billion mortgage loan assumed as part of the Archstone Transaction. The approximately $440.0 million balance will remain outstanding, continue to mature in November 2017 and continue to carry a fixed interest rate of 6.256%. In conjunction with the early debt extinguishment activity discussed above, the Company incurred cash prepayment costs of approximately $151.0 million and a net charge to earnings of approximately $42.9 million after consideration of the write-off of the Archstone-related debt premium. The Company believes it has obtained favorable interest terms on this long term debt and has substantially extended the duration of its debt maturities as well as reduced its 2014 and 2017 maturities as a percentage of outstanding debt.

We believe that cash and cash equivalents, securities readily convertible to cash, current availability on our revolving credit facility and disposition proceeds for 2014 will provide sufficient liquidity to meet our funding obligations relating to asset acquisitions, debt maturities and existing development projects through 2014. We expect that our remaining longer-term funding requirements will be met through some combination of new borrowings, equity issuances, property dispositions, joint ventures and cash generated from operations.

There is significant uncertainty surrounding the futures of Fannie Mae and Freddie Mac (the "Government Sponsored Enterprises" or "GSEs") and recent changes in leadership of the GSEs' regulator has heightened this uncertainty. . . .

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