Is Equity Residential (NYSE:EQR) A Healthy REIT?

Equity Residential is a US$29b large-cap, real estate investment trust (REIT) based in Chicago, United States. REITs own and operate income-generating property and adhere to a different set of regulations. This impacts how EQR’s business operates and also how we should analyse its stock. In this commentary, I’ll take you through some of the things I look at when assessing EQR.

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A common financial term REIT investors should know is Funds from Operations, or FFO for short, which is a REIT’s main source of income from its portfolio of property, such as rent. FFO is a cleaner and more representative figure of how much EQR actually makes from its day-to-day operations, compared to net income, which can be affected by one-off activities or non-cash items such as depreciation. For EQR, its FFO of US$1.4b makes up 80% of its gross profit, which means the majority of its earnings are high-quality and recurring.

NYSE:EQR Historical Debt, May 21st 2019
NYSE:EQR Historical Debt, May 21st 2019

In order to understand whether EQR has a healthy balance sheet, we have to look at a metric called FFO-to-total debt. This tells us how long it will take EQR to pay off its debt using its income from its main business activities, and gives us an insight into EQR’s ability to service its borrowings. With a ratio of 15%, the credit rating agency Standard & Poor would consider this as significantly high risk. This would take EQR 6.51 years to pay off using operating income alone. Given that long-term debt is a multi-year commitment this is not unusual, however, the longer it takes for a company to pay back debt, the higher the risk associated with that company.

Next, interest coverage ratio shows how many times EQR’s earnings can cover its annual interest payments. Usually the ratio is calculated using EBIT, but for REITs, it’s better to use FFO divided by net interest. This is similar to the above concept, but looks at the nearer-term obligations. With an interest coverage ratio of 3.19x, it’s safe to say EQR is generating an appropriate amount of cash from its borrowings.

I also use FFO to look at EQR’s valuation relative to other REITs in United States by using the price-to-FFO metric. This is conceptually the same as the price-to-earnings (PE) ratio, but as previously mentioned, FFO is more suitable. EQR’s price-to-FFO is 21.71x, compared to the long-term industry average of 16.5x, meaning that it is overvalued.

Next Steps:

In this article, I’ve taken a look at Funds from Operations using various metrics, but it is certainly not sufficient to derive an investment decision based on this value alone. Equity Residential can bring about diversification for your portfolio, but before you decide to invest, take a look at the other aspects you must consider before investing:

  1. Future Outlook: What are well-informed industry analysts predicting for EQR’s future growth? Take a look at our free research report of analyst consensus for EQR’s outlook.
  2. Valuation: What is EQR worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether EQR is currently mispriced by the market.
  3. Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.