NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned an 'A-' rating to the $450 million 3.375% senior unsecured notes due 2025, and the $300 million 4.500% senior unsecured notes due 2045 issued by Equity Residential's (NYSE: EQR) operating partnership, ERP Operating Limited Partnership (collectively EQR or the company). The 2025 notes were priced at 99.450% of par, or at 3.440%, a 118-basis point (bp) spread to the benchmark treasury, and the 2045 notes were priced at 99.622% of par, or at 4.523%, a 150bs spread to the benchmark treasury. EQR expects to use the net proceeds from the offerings for working capital and general company purposes, including repayment of all or a portion of its commercial paper program ($500 million outstanding as of April 30, 2015) and all or a portion of its revolving credit facility ($431 million outstanding as of April 30, 2015).
Fitch currently rates EQR as follows:
Equity Residential
--Long-term IDR 'A-';
--Unsecured revolving term loan 'A-';
--Preferred stock 'BBB'.
ERP Operating Limited Partnership
--Long-term IDR 'A-';
--Short-term IDR 'F2';
--Unsecured revolving credit facility 'A-';
--Senior unsecured notes 'A-';
--Commercial paper notes 'F2'.
The Rating Outlook is Stable.
KEY RATING DRIVERS
The rating reflects strong qualitative elements in EQR's credit profile. Examples include the above-average quality of EQR's largely unencumbered operating portfolio and its cycle-tested management team that has extensive real estate and capital markets experience. The rating also considers the consistency of balance sheet strategy and improvements in the company's portfolio, EQR's demonstrated commitment to a balanced borrowing strategy, and proven access to multiple sources of debt and equity capital in varied capital markets environments. EQR's size, management quality and ownership of lower-yielding assets in core coastal gateway markets help offset its higher leverage relative to similarly-rated REITs.
The 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. EQR's top market, Washington D.C., has struggled recently due to supply deliveries; however, over the long term the market is consistent with the company's focus on markets that have historically experienced above-average growth through the cycle and should continue to exhibit strong growth in the future.
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 (1Q13), but leverage has subsequently returned to normalized levels via asset sales and same store net operating income (SSNOI) growth. Leverage as of Dec. 31, 2014 was 6.4x, lower than Fitch's expectations pre-Archstone transaction. Fitch expects the company's leverage to sustain in the 6.5x-7.5x range over the longer term, based on management's publicly stated goals. Fitch defines leverage as debt, less readily available cash, divided by recurring operating EBITDA.
EQR's fixed-charge coverage (FCC) for the LTM period ended Dec. 31, 2014 was 2.9x which is strong for the rating and up from 2.7x and 2.4x for 2013 and 2012, respectively. Fitch defines FCC 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 FCC will increase to the low 3.0x's from 2015 through 2017.
Positive Same-Store Results
SSNOI growth remains consistent relative to historical performance. EQR's SSNOI growth was 5.6% for 2014 and 5% in 2013 and Fitch anticipates that fundamentals will remain solid, but decelerate toward the longer-term historical average of 2% to 3% SSNOI growth by 2017. 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 net operating income (NOI).
Weak Washington DC Expectations
Washington, DC is EQR's largest market at 17.8% of stabilized 4Q14 NOI and may continue to weigh on the overall portfolio performance. SSNOI declined by 1.8% during 2014, the only market to post a decline within the company's portfolio. This decline compared with growth of 2.7% for full year 2013. Although Washington, DC was one of the strongest real estate markets during the global financial crisis, the metro district has been hurt by an abundance of new supply (likely in response to the early cycle growth) coupled with tepid job growth and uncertainty surrounding near-term government job growth. Fitch expects this market to continue to lag the remainder of the portfolio for the next several years.
Small Uptick in Development
EQR acquired several attractive 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% at Dec. 31, 2014, up from 2.8% at year-end 2013. Despite this uptick, the company's total development pipeline and unfunded development pipeline as a percentage of gross assets is smaller than many of its closest peers. The development projects are focused in strong markets including Northern California, New York, Seattle and Los Angeles.
Good Contingent Liquidity
EQR's unencumbered cash NOI stressed at a 7.0% capitalization rate covered its net unsecured debt by approximately 3.0x as of Dec. 31, 2014. 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, based on location and age.
Slightly Low Liquidity; Mitigated 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 1.1x, pro forma for the May issuances, for the period Jan. 1, 2015 to Dec. 31, 2016, which is slightly low for the rating. The low liquidity is driven by over $1 billion of expected development expenditures during this projection period. The company has demonstrated strong access to nearly all forms of capital, most recently with $750 million of unsecured bond issuances in May 2015, which mitigates concern regarding the company's sizable obligations and expected uses of 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 'A-'. Based on Fitch Research on 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis, dated Nov. 25, 2014 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.
Stable Outlook
The Stable Outlook reflects Fitch's expectation that multifamily operating fundamentals will continue to revert toward their long-term average. The company's leverage should remain approximately at current levels in the short term, and range between 6.5x and 7.0x over the longer term due to the timing of developments. In addition, EQR has market-leading access to capital, and should be able to refinance maturing obligations and fund growth via internally-generated capital and external markets.
KEY ASSUMPTIONS
Fitch's key assumptions for EQR in Fitch's base case include:
--Same-store revenue growth of 4%, 3.3% and 3% in 2015, 2016 and 2017, respectively. SSNOI expected growth is in the low single digits all three years;
--$500 million of annual acquisitions at 5% capitalization rate and dispositions at 6% capitalization rate (net investment $0), throughout the forecast period;
-- $600 million of development completions in all three years of the forecast period;
--AFFO payout ratio between 69%-77%;
--Secured debt is refinanced dollar for dollar in all three years of the projection period;
--Unsecured debt issuances of $950 million for full year 2015, $1.2 billion in 2016 and $1.8 billion in 2017, a portion of which is expected to refinance maturing bonds and the remainder to fund development.
RATING SENSITIVITIES
The following factors may have a positive impact on EQR's ratings or Outlook:
--Combined with EQR management's commitment, Fitch's expectation of leverage sustaining below 6.5x throughout cycles (Fitch expects leverage to sustain between 6.5x-7.0x on a longer-term basis; leverage was 6.4x as of Dec. 31, 2014);
--Fitch's expectation of FCC sustaining above 3.5x (coverage was 2.9x in 2014 and is projected to improve to the low 3.0x's).
The following factors may have a negative impact on EQR's ratings or Outlook:
--A deviation from EQR's current portfolio, capitalization or financing strategy that may result in a deterioration in the company's market-leading access to capital on an absolute or relative basis;
--Fitch's expectation of leverage sustaining above 7.5x;
--Fitch's expectation of FCC sustaining below 2.5x;
--A liquidity coverage ratio sustaining below 1.0x.
Date of Relevant Rating Committee: April 28, 2015
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Equity Residential Ratings Navigator' (Feb. 26, 2015);
--'U.S. Equity REITs and REOCs Ratings Navigator Companion' (Feb. 5, 2015);
--'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis' Nov. 25, 2014;
--'Recovery Ratings and Notching Criteria for Equity REITs' (Nov. 18, 2014);
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Rating U.S. Equity REITs and REOCs (Sector Credit Factors)
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=737957
Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis - Effective Dec. 13, 2012 to Dec. 23, 2013
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=696670
Recovery Ratings and Notching Criteria for Equity REITs
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=813628
Equity Residential - Ratings Navigator
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=862132
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=984546
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