NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a credit rating of 'BBB+' to the following notes issued by ERP Operating Limited Partnership, a subsidiary of Equity Residential (NYSE: EQR):
--$450 million aggregate principal amount of 2.375% senior unsecured notes due 2019;
--$750 million aggregate principal amount of 4.500% senior unsecured notes due 2044.
The 2019 notes were issued at 99.900% of par value to yield 2.396% or 70 basis points over the benchmark rate, and the 2044 notes were issued at 99.297% of par value to yield 4.543% or 115 basis points over the benchmark rate. EQR expects to use the net proceeds of this offering for working capital and general company purposes, including repayment of all or a portion of the outstanding balance under its unsecured revolving credit facility and all or a portion of the outstanding balance under its unsecured term loan facility.
Fitch currently rates EQR as follows:
--Issuer Default Rating (IDR) 'BBB+';
--Unsecured revolving term loan 'BBB+';
--Preferred stock 'BBB-'.
ERP Operating Limited Partnership
--Unsecured revolving credit facility 'BBB+';
--Senior unsecured notes 'BBB+'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
EQR's rating is supported by the company's focus on high-quality properties in strong markets and sound financial management. The company is the largest multifamily REIT in the U.S. by market capitalization and is a leading owner/operator in many of the top markets in the U.S. including New York, San Francisco, Los Angeles and Boston. The company is focused on markets that have historically experienced above average growth and are expected to continue to exhibit strong growth in the future.
The company's ratings are further supported by its strong access to capital which has been demonstrated in multiple forms throughout various market cycles. In 2013, EQR greatly improved the quality of its portfolio by acquiring $9 billion of assets from Archstone Enterprise LP (Archstone) and selling almost $4.5 billion of non-core assets in secondary markets.
CREDIT METRICS NORMALIZED
EQR's leverage was temporarily elevated as a result of funding the Archstone transaction which closed in the first quarter of 2013 (1Q'13), but leverage has subsequently returned to normalized levels via asset sales and same-store net operating income (SSNOI) growth. Leverage as of March 31, 2014 was 6.8x, consistent with Fitch's expectations pre-Archstone transaction. Fitch expects the company's leverage to remain relatively steady from 2014 through 2016. Fitch defines leverage as net debt divided by recurring operating EBITDA.
EQR's fixed-charge coverage for the trailing 12 months (TTM) ended March 31, 2014 was 2.7x which is strong for the rating and flat from 2.7x at year-end 2013 and up from 2.4x at year-end 2012. Fitch defines fixed-charge coverage as recurring operating EBITDA less recurring capital improvements divided by cash interest incurred and preferred distributions. EQR has benefited in recent years by refinancing debt at historically low interest rates while achieving strong SSNOI growth. Fitch expects the company's fixed-charge coverage will increase to approximately 3.0x from 2014 through 2016.
EQR closed on the acquisition of $9 billion of assets in core markets during the 1Q'13 via the Archstone transaction at a 4.9% capitalization rate. In 2013, the company sold 94 apartment properties for an aggregate price of $4.5 billion at a weighted average capitalization rate of 6%. The Archstone transaction bolstered EQR's ownership of Class A properties in top markets such as San Francisco, New York, Seattle and Boston, among others. These markets tend to exhibit relatively strong long-term demand, limited buildable land and high construction costs, curtailing potential supply growth.
Dispositions were focused on non-core markets including Phoenix, Atlanta and suburban Maryland. The activity in 2013 accelerated what may have otherwise been a multi-year process, as the company has historically been active in pruning its portfolio. The higher quality portfolio is evidenced by an average rental rate per unit of $2,138 in 1Q' 14 versus $1,737 in 4Q' 12, a 23.1% increase. EQR purchased $149 million of properties and land in 1Q'14 and did not sell any assets.
POSITIVE SAME-STORE RESULTS
SSNOI growth remains strong relative to historical performance, although it has been decelerating. EQR's SSNOI growth was 7.6% in 2012, 5% in 2013 and 4.4% in 1Q'14. Fitch anticipates that fundamentals will remain solid, but continue to decelerate towards the longer term historical average of 2% to 3% SSNOI growth. Fitch expects occupancy to remain in the 95%-96% range as the company continues its focus on utilizing its industry-leading operational platform and technology to optimize NOI.
WEAK WASHINGTON DC EXPECTATIONS
Washington, DC is EQR's largest market at 18.6% of stabilized NOI and may continue to weigh on the overall portfolio performance. SSNOI decreased by 2.8% in 1Q'14 versus 1Q'13. Although Washington, DC was one of the strongest real estate markets during the global financial crisis, the metro has been hurt by an abundance of new supply coupled with tepid job growth and uncertainty surrounding near-term government job growth.
UPTICK IN DEVELOPMENT
EQR acquired several strong development sites through the Archstone transaction, which should provide growth opportunities over the next several years. The unfunded development pipeline as a percentage of gross assets was 4.1% as of March 31, 2014, up from 2.8% at year-end 2013. The development projects are focused in strong markets including New York, Seattle and Los Angeles.
APPROPRIATE CONTINGENT LIQUIDITY
EQR's unencumbered cash NOI stressed at a 7% capitalization rate covered its net unsecured debt by approximately 2.8x as of March 31, 2014, pro forma the June 2014 bond deal. The company has consistently maintained adequate net UA/UD above 2.5x. The quality of the unencumbered portfolio is consistent with the quality of the overall portfolio.
ADEQUATE LIQUIDITY; SUPPORTED BY CAPITAL ACCESS
Fitch calculates that EQR's sources of liquidity (unrestricted cash, availability under its unsecured revolving credit facility, expected retained cash flows from operating activities after dividends and distributions) divided by uses of liquidity (debt maturities, developments and recurring capital expenditures) results in a liquidity coverage ratio of 1.3x for the period April 1, 2014 to Dec. 31, 2015, pro forma for the June 2014 bond offerings. Over the projected period, approximately $1.55 billion of unsecured debt will mature, and Fitch expects nearly $1.4 billion of unfunded developments and recurring capital expenditures will be incurred, which largely offset sources of liquidity.
Assuming EQR refinances 80% of its maturing secured debt liquidity coverage would be 1.4x. Fitch notes EQR's demonstrated access to a variety of capital channels including public unsecured debt, bank facilities, life insurance company mortgage debt, agency-mortgage debt and equity, which mitigates refinance risk.
AFFO PAYOUT RATIO POLICY REVISED
EQR's annual dividend is based on 65% of the midpoint range of normalized funds from operations (FFO) guidance. Prior to 2014, EQR had a policy in place in which the company made three fixed dividend payments during the first three quarters and one variable dividend payment in the fourth quarter. Under the prior policy, the annual payout was also targeted to equal 65% of normalized FFO. Fitch-calculated adjusted funds from operations (AFFO) payout ratio was 70% over the TTM ended March 31, 2014, indicative of strong internally generated capital.
PREFERRED UNIT NOTCHING
The two-notch differential between EQR's IDR and preferred stock rating is consistent with Fitch's criteria for corporate entities with an IDR of 'BBB+'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis, dated Dec. 23, 2013 and available on Fitch's Web site at www.fitchratings.com, these preferred securities are deeply subordinated and have loss absorption elements that would likely result in poor recoveries in the event of a corporate default.
The Stable Outlook reflects Fitch's expectation that multifamily operating fundamentals will continue to revert toward its long-term average. The company's leverage should remain approximately at current levels in the short term, and range between 6.5x and 7.5x over the longer term due to the timing of developments. In addition, EQR has good access to capital, and should be able to refinance maturing obligations due to strong coverage ratios.
The following factors may have a positive impact on EQR's ratings or Outlook:
--Fitch's expectation of leverage sustaining below 7.0x (leverage was 6.8x for the TTM ended March 31, 2014 and Fitch expects leverage to sustain between 6.5x - 7.5x on a longer-term basis);
--Fitch's expectation of fixed charge coverage sustaining above 2.5x (coverage was 2.7x for the TTM ended March 31, 2014 and is projected to improve);
--Unencumbered asset coverage of net unsecured debt sustaining above 2.5x (pro forma coverage as of March 31, 2014 was 2.8x).
The following factors may have a negative impact on EQR's ratings or Outlook:
--Fitch's expectation of leverage sustaining above 8.0x;
--Fitch's expectation of fixed charge coverage sustaining below 2.0x;
--A liquidity coverage ratio sustaining below 1.0x.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'Rating U.S. Equity REITs and REOCs (Sector Credit Factors)' (Feb. 26, 2014);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' (Dec. 23, 2013);
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 19, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Criteria for Rating U.S. Equity REITs and REOCs
Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis
Recovery Ratings and Notching Criteria for Equity REITs