Fitch Confirms and Withdraws Equity Residential Ratings; Stable outlook

Fitch Ratings confirmed the ratings of Residential Equity (NYSE: EQR), including the company’s long-term issuer default (IDR) rating of “A”, as well as long-term and short-term IDRs for ERP Operating Limited Partnership to ‘A’/F1’.

The rating outlook is stable.

The stable outlook reflects Fitch’s expectation that QRE’s leverage should remain within the expected range of 5x to 6x over the forecast period, and that the company has some cushion against current measures to absorb potential operational weakness on a prospective basis.

In addition, Fitch believes that EQR has access to capital, industry-leading transactional liquidity, as well as sufficient access to funding through cycles given its high-quality portfolio located in markets with strong long-term demand, despite the temporary difficulties it encountered in its urban markets in 2020 and 2021.

Notes have been removed for commercial purposes.

Main rating factors

Stabilizing leverage: Fitch expects REIT leverage (net debt to recurring operating EBITDA) to decline to a low of 5x over the forecast period, down from the average level of 5x in 2021. The company was able to continue to match fund divestitures with acquisitions in 2021 at similar capitalization rates, while SSNOI turned positive for the company in 4Q21. Fitch believes EQR will be able to take advantage of this momentum to slightly reduce leverage in 2022 and over the forecast period.

Fundamentals rebounding strongly: After experiencing weak urban rents over the past year due to weaker demand for smaller units, (generally) younger single tenants have benefited from flexible working policies and lack of restaurants/nightclubs, Fitch expects rents in urban areas of QRE markets to rebound strongly as towns and offices have reopened and become more desirable again. Historically, urban rents have been most volatile during a recession, but peak quickly after bottoming out; EQR looks poised to capitalize on strong underlying demand with the expectation of double-digit SSNOI growth in 2022 following a -8% decline in SSNOI in 2021.

Fitch believes the pandemic has accelerated some demand toward suburban and sunbelt locations to reflect aging demographics, particularly for larger unit types, and on the sidelines, EQR is shifting its portfolio in that direction. Occupancy has recovered strongly from the pandemic low, approaching 2019 levels in many markets, and pricing power has improved strongly in late 2021 and into 2022. leasing generally declined in most markets and bad debt costs normalized by the end of 2021 .

Efficient asset recycling: During 2021, the company was able to complete $1.7 billion in acquisitions and divestitures, demonstrating asset demand and improving portfolio quality. Transaction levels on acquisitions and divestitures both closed at capitalization rates of approximately 3.8%. However, properties acquired had an average age of two years, compared to an average age of 30 years for properties sold, as capital-intensive properties primarily in urban east coast markets were swapped for properties more in non-coastal suburban markets such as Atlanta, Austin, dallas, fort worthand denver.

The core strategy remains unchanged as EQR remains committed to attracting high quality tenants. However, the company continues to diversify its portfolio with suburban assets, targeting a 1/3 split between Northeast, California and Seattle/denver/ Sunbelt Markets, respectively.

Significant, high-quality portfolio: Fitch continues to expect strong growth throughout the cycle for QRE markets, but expects the company to continue to diversify its portfolio into other high-growth markets, such as than Atlanta, Austin, dallas, fort worthand denver. This can serve to mitigate portfolio volatility and reduce political risk. While general interest in the types of markets that EQR might seek to enter or grow has increased, thanks to better relative performance during the pandemic, investor demand for EQR’s existing portfolio remains strong and the company should be able to adjust its market exposure by recycling provisions.

The company focuses on the coastal entry door market: Boston, MA; Los Angeles, CA; Orange County, California; San Diego, California; San Francisco, California; Seattle, WA; washington d.c.; and New York, NY. These markets typically have above-average growth, transactional liquidity, and solid access to mortgage funding throughout the cycle.

Measured Development Exposure: EQR’s total development pipeline, as a percentage of gross assets, remains below that of many of its closest peers. Current projects focus on the main markets of Boston, MA, Bethesda, MDand Alameda, California as well as unconsolidated projects in the Toll Brothers joint venture in Denver, CO and Harrison, NY. After pursuing an increased development pipeline earlier in the decade, EQR has significantly reduced development exposure as the cycle has matured. From December 31, 2021total development was around 3.6% of gross assets, down from the last peak of 8.5% in 2014.

Relationship between parent and subsidiary: Fitch assesses the IDRs of the parent REIT and the subsidiary’s operating partnership on a consolidated basis, using the weak parent/strong subsidiary approach and access and open controls, based on entities operating as a single company with strong legal and operational capabilities. ties.

Preferred Unit Notching: The two-notch differential between EQR’s IDR and the preferred share rating meets Fitch’s criteria for legal entities with an “A” IDR. Based on Fitch’s hybrid non-financial corporate treatment and rating criteria, these preferred securities are deeply subordinated and have loss absorbing features that would likely result in low recoveries in the event of a corporate default.

Derivation Summary

EQR has a portfolio of excellent quality multi-family assets in the bi-coastal markets most comparable to its peers Avalon Bay Communities and UDR, Inc., both unrated. EQR’s ratings are able to withstand higher leverage than Camden, its ‘A’ grade counterpart, due to the company’s focus on the coastal market and limited supply and access to market-leading capital. EQR has the highest average rents in the peer group and its assets are generally highly sought after from a financial markets perspective.

Fitch applies a 50% capital credit to the company’s perpetual preferred securities given the cumulative nature of the coupon deferral with settlement by means other than equity (cash). Some metrics calculate leverage, including preferred stocks.

Key assumptions

SSNOI growth of approximately +11% in 2022, decreasing to a low/mid figure over the forecast years thereafter;

$2.0 billion divestitures per year at a capitalization rate of 4.0% to finance a similar amount of acquisitions at a capitalization rate of 4.0%, with acquisitions and dispositions financed in consideration decreasing to half of this amount by the end of the forecast period;

Development expenditure of $400 million per year;

No share issuance during the forecast period.

RATING SENSITIVITIES

Rating sensitivities are not applicable, given the withdrawal of ratings.

Best/Worst Case Evaluation Scenario

International credit ratings of non-financial corporate issuers have a best-case scenario for a rating upgrade (defined as the 99th percentile of rating transitions, measured in the positive direction) of three notches over a rating horizon three years; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured negatively) of four notches over three years. The full range of best-case and worst-case credit ratings for all rating categories ranges from ‘AAA‘ to ‘D’. Worst case and worst case credit ratings are based on historical performance. For more information on the methodology used to determine industry-specific best-case and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and debt structure

Sufficient liquidity, access to markets: the company had almost total availability on its $2.5 billion revolving credit facility, excluding the $315 million designated for the commercial paper program from December 31, 2021. (EQR has a policy of limiting its revolving facility in order to maintain liquidity support for its $1 billion CP program.) The company has a manageable debt schedule, with a weighted average maturity of 8.2 years.

EQR has a liquidity coverage ratio (total sources divided by total uses) of 1.4x (including commercial paper) until YE 2023 from December 31, 2021. EQR has demonstrated exceptional access to the unsecured and secured debt markets and should be able to refinance or repay its future debt by accessing the public market.

Fitch estimates that QRA’s net AU/DU was approximately 3.6x at December 31, 2021using a stressed capitalization rate of 7.0%, providing sufficient contingent liquidity to holders of debentures.

Issuer profile

Residential Equity (EQR) focuses on the acquisition, development and management of residential properties. EQR has 310 properties comprising 80,407 apartments, with an established presence in Boston, New York, washington d.c., Seattle, San Francisco and Southern Californiaand a growing presence in denver, Atlanta, Dallas/Ft. Value and Austin.

REFERENCES FOR A MOSTLY MATERIAL SOURCE CITED AS A KEY SCORING FACTOR

The main sources of information used in the analysis are described in the applicable criteria.

ESG considerations

Unless otherwise specified in this section, the highest level of ESG Credit materiality is a score of “3”. This means that ESG issues are credit-neutral or have minimal impact on the entity’s credit, either because of their nature or the way they are managed by the entity. For more information on Fitch’s ESG materiality scores, visit www.fitchratings.com/esg.