TEXT-S&P: Equity Residential ratings unaffected by Archstone news

Tue Nov 27, 2012 4:31pm EST

Nov 27 - Standard & Poor's Ratings Services said today that its rating and
outlook for Chicago-based Equity Residential (EQR; BBB+/Stable) are
unchanged following EQR's announcement that it has entered into an agreement to
acquire 60% of Archstone Enterprises L.P. from Lehman Brothers Holdings Inc. for
roughly $9.4 billion (excluding transaction costs). The acquisition will include
the assumption of $5.5 billion of debt (including a noncash component related to
the mark-to-market for certain debt that adds roughly $310 million debt and $355
million of unconsolidated joint-venture debt). The transaction size and debt
assumption will decline further after Archstone sells roughly $750 million of
assets that EQR is under contract to acquire. The acquisition is expected to
yield a low initial return in high 4% area, based on EQR's projected 2013 net
operating income (NOI). The transaction is expected to close in the first
quarter of 2013. 

As proposed, the transaction will result in initially higher leverage and 
weakened coverage measures, and the company is reliant on asset sales proceeds 
to achieve its deleveraging goals. However, in the current, favorable 
environment for multifamily assets, we believe the company will be able to 
execute on its planned equity sale and asset dispositions such that leverage 
and credit metrics will return to pre-transaction levels by the end of 2013. 
We view the transaction as strategically positive for the business because it 
accelerates the company's portfolio-repositioning plan and believe there is 
limited integration risk. However, we could lower the rating if planned asset 
sales are delayed resulting in debt levels being elevated and credit metrics 
being weaker for longer than we expect. 

EQR will acquire 78 communities totaling 23,110 units (about $367,000 per 
unit) located in the company's existing core markets. We believe the 
transaction makes sense from a business and portfolio perspective given that 
the assets the company is acquiring are in existing markets. Pro forma for the 
acquisition, EQR's exposure in Washington, D.C., will rise to 20.1% of NOI 
from 16.1%, exposure to the New York area will rise to 14.8% from 13.8%, 
exposure to the San Francisco Bay area will rise to 10.3% from 7.8%, and 
exposure to Boston will increase to 9.2% from 8.0%. Some of the assets in the 
existing markets, notably in Washington, D.C., which has experienced some 
softness recently, could be disposition candidates and reduce the 
concentration in certain markets. Given EQR's large operating platform and 
strong technology systems, the transaction could provide operating 
efficiencies, particularly as it spreads overhead over a larger asset base. 
This transaction also effectively allows EQR to accelerate the completion of 
its portfolio repositioning through the combination of acquiring its share of 
Archstone's assets and divest of at least $3-$4 billion of assets in noncore 
markets primarily through 1031 exchanges over the next 12 months. EQR plans to 
use proceeds from these sales to repay debt assumed through the proposed 
Archstone acquisition, as well as existing EQR debt. EQR will repay more than 
$400 million of GSE debt at close. Another $1.2 billion and $880 million of 
GSE debt is pre-payable in 2013 and 2014, respectively. We expect EQR to repay 
a meaningful portion of the GSE debt with asset sale proceeds, which is 
essential to reducing debt and returning key credit metrics to pre-transaction 
levels. 

EQR is expected to initially fund the acquisition with 60% debt, including 
assumed debt and revolver borrowings, and 40% with equity and asset sales. EQR 
will issue roughly $3 billion of equity-$1.9 billion directly to Lehman upon 
closing and $1 billion of new equity and expects to dispose of about $1 
billion of assets by the time the transaction closes. The new equity and asset 
sales are expected to fund transaction costs and repay debt. Assuming EQR 
funds the investment as proposed, including the issuance of equity and 
completion of $1 billion of asset sales to reduce debt, we estimate EQR's 
credit metrics will initially weaken from pre-transaction levels (45% debt to 
undepreciated real estate, 6.8x debt-to-EBITDA, and 2.6x fixed-charge 
coverage). We estimate pro forma debt-to-EBITDA will be roughly 8x (pro forma 
for Archstone cash flow) and debt-to-undepreciated real estate will be about 
50%, as a result, EQR will need to successfully execute dispositions to reduce 
debt and strengthen its credit metrics. 

Our rating and outlook assume EQR can successfully execute on its disposition 
strategy, as well as raise $1 billion of new equity to reduce total debt and 
secured debt. Under our base-case scenario assumptions, which include the 
noted equity raise and asset dispositions, as well as 2012 and 2013 same-store 
NOI growth of 5.5% and 4%, respectively, we estimate EQR will repay about $2 
billion-$3 billion of debt by the end of 2013 and end the year with $11 
billion-$12 billion of debt and preferred, and EBITDA will be in the $1.6 
billion area. Based on these assumptions, we estimate key credit metrics will 
end 2013 at levels closer to  current levels, including debt-to-EBITDA around 
7x-7.5x and fixed-charge coverage in the 2.6x-2.7x range. Due to the increase 
in secured debt and sale of unencumbered assets, we estimate that unencumbered 
NOI will decline to the low 50% area in 2013 from over 60%, but we expect 
unencumbered NOI to rebound to about 60% in 2014 due to additional secured 
debt reductions, organic growth, and the stabilization of some development 
properties.

As part of this transaction, EQR has put a $2.5 billion bridge loan in place. 
However, under our base-case scenario, we do not assume the company uses this 
facility. EQR may also increase its revolving credit facility from $1.75 
billion to $2.5 billion and extend the maturity to 2018, and may also 
potentially put a $750 million term loan in place. We assume EQR will use its 
revolver line temporarily to fund the acquisition, but we expect the company 
will repay borrowings with asset sales. We also assume the company would only 
use if the timing of planned asset sales is delayed. Should asset sales prove 
difficult to execute and EQR is unable to repay GSE and other secured debt as 
assumed, or if the company draws on its various bank facilities to repay GSE 
and other secured debt, resulting in elevated debt levels for longer than we 
currently expect, we would likely lower the rating one notch.
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.