United It Stands
[January/February 2006]
United Dominion Realty Trust's five-year plan has it repositioned for the long term.
By Michael Fickes
In the public markets, a company's fortunes can turn on its most recent earnings release. However, long-term strategy and execution still matter, especially in regards to long-term investments like REITs. United Dominion Realty Trust (NYSE: UDR) drew some analyst concern in 2005 but the company remains a popular multifamily pick based on the street's confidence in its long-term strategic plan. United Dominion is finishing a five-year repositioning effort and has outlined a clearly defined strategy for the next five years.
Five years ago, sales of new assets didn't figure prominently in the United Dominion business model. Back then, the company was an aggressive consolidator, led by Chairman Emeritus John McCann (see sidebar).
"That strategy worked very well for many years," according to Thomas W. Toomey, United Dominion president and CEO. "It accumulated a portfolio that at one time stretched up to 85,000 units."
Five years ago, McCann retired and turned the reins over to Toomey and a new executive team, which has since restructured the portfolio and repositioned the company from consolidator to multi-faceted operator.
Toomey and his team paired the portfolio down to 80,000 units. They sold apartment communities worth $1 billion and acquired properties worth about $3 billion. This activity has revamped the balance sheet with more than $2.5 billion of refinancing and debt issuance. Toomey calls it a process of "building back to safety and predictability."
REITs historically produce total returns in the low teens. Two-thirds of a REIT's total return usually comes from the dividend while one-third comes from earnings growth. Toomey says his team has re-built United Dominion to generate these kinds of returns.
The restructured company has moved out of 22 markets and settled into what Toomey believes are an ideal 40 markets. "We were overexposed in some markets, like Texas and the Carolinas, and underexposed in other markets like California," he says. "Over the past five years, we bought about $1.4 billion in California and reduced our exposure to Texas and the Carolinas. Today, no more than 9 percent of our NOI (net operating income) comes from any one metropolitan statistical area."
Well positioned in high growth areas, UDR expects 50 percent of NOI to come from apartment communities in California, Florida, and Washington, D.C. "For the foreseeable future, job growth will be greatest in these three regions," Toomey says. "In addition, the price difference between single-family housing and multifamily housing is very high. This has been our positioning for the past three years."
Toomey's strategy has begun to pay off with results like these:
- Five-year annual shareholder total return of 17.4 percent
- 29 consecutive years of dividend increases
- Total market capitalization of $6.5 billion
- Nine month 2005 rental income of $504 million, up 21 percent from $417 million in the year earlier period
- Nine month 2005 diluted funds from operations of $176 million, up 8.5 percent from $162 million in the year earlier period
- Increased the size of the unencumbered pool of assets to $3.5 billion, valued on a historical cost basis
- Met or exceeded underwritten returns on more than $1.5 billion of acquisitions completed since 2003
UNITED DOMINION REALTY TRUST
1745 Shea Center Drive, Suite 200
Littleton, CO 80129
720-283-6120
www.udrt.com
CHAIRMAN: Robert C. Larson
PRESIDENT & CEO: Thomas W. Toomey
EVP & CFO: Christopher D. Genry
TICKER SYMBOL: UDR (New York Stock Exchange)
• 52-WEEK HIGH: $25.97 (8/3/05)
• 52-WEEK LOW: $20.85 (3/23/05)
CORE MARKETS: The company owns and operates approximately 75,000 apartment homes in more than 220 communities,
encompassing 43 markets dispersed throughout 16 states.
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Quarterly Concern
In the analyst reports following the 2005 third quarter earnings report, two common concerns were raised. First, the company reported $0.39 per share in funds from operations (FFO) for the quarter, $0.02 below the consensus Wall Street estimates. Second, analysts flagged a 6.9 percent jump in expenses.
Toomey prefers placing the company's third quarter performance in a longer-term perspective. "My comment about the third quarter is that you continue to see the evolution of REITs in general," he says. "REITs are becoming complete companies in that they are able to deliver value in different formats. Some of these value deliveries aren't as predictable as just showing up and collecting rent."
Toomey attributes the company's third quarter FFO performance to a timing difference related to a property disposition. The company had built a residential community in Houston for $57,000 per unit. United Dominion then accepted an offer to sell the community for $77,000 per unit. Originally scheduled for the end of the third quarter, the closing was delayed until the fourth quarter due to the aftermath of hurricanes Katrina and Rita.
Despite concerns over the results, Morgan Stanley still rates United Dominion its top pick in the multifamily sector. "At roughly $22 per share, the stock is attractive on both an absolute and relative basis, and we continue to believe that investors under-appreciate the improving portfolio mix (50 percent of net operating income from California, south Florida and D.C.)," according to Robert Stevenson, a Morgan Stanley analyst.
The third-quarter performance concerns were somewhat allayed by the investment community's generally optimistic opinion of United Dominion's long-term prospects.
 Over the next five years, Toomey plans to focus
on what he believes to be three opportunities to add value: upgrading operational expertise, rehabbing aging
stock, and optimizing disposition income through sales
to condominium converters. |
"What the UDR management team has done over the past five years is laudable," says Carey Callaghan, senior REIT analyst with Goldman Sachs. "It has downsized the number of markets it participates in. It has concentrated on better growth markets. At the same time, it has upgraded the quality of its portfolio. We believe these changes have not been fully recognized by the market."
Callaghan notes that United Dominion's 13.3 FFO multiple is the lowest among multifamily REITs and substantially lower than the multifamily FFO multiple average of 16.7.
While Goldman Sachs still places an overall cautious outlook on the multifamily sector, it forecasts United Dominion to outperform its peers, thanks by and large to the quality of the company's strategic plans.
"We're looking forward to next year," Callaghan says. "We have UDR earning $1.65 per share in FFO, compared to $1.60 this year. We don't believe it will be a high growth year, given the higher trajectory for expenses. Some UDR peers will likely grow faster. But even factoring that in, the company still looks compelling to us."
What's Next?
With a restructured portfolio featuring properties in carefully selected markets, Toomey is now turning to a second phase of his strategy for United Dominion. Over the next five years, he plans to focus on what he believes to be three opportunities to add value: upgrading operational expertise, rehabbing aging stock, and optimizing disposition income through sales to condominium converters.
With just 15 percent of the nation's 38 million apartment units held by the top 100 companies, the multifamily industry by and large remains fragmented and unsophisticated. "In an industry where operations are generally not very sophisticated, operations can be your greatest opportunity to add value," Toomey says.
Among other operational innovations, Toomey points to new technologies. Five years ago, for example, the company leased about 2 percent of its apartments over the Internet. Today, Internet leasing has jumped to more than 30 percent. Tenants that sign up over the net reduce United Dominion's cost for acquiring a tenant from $300 to $50. "When you acquire customers for one-sixth the cost, you capture more on the bottom line," Toomey says.
UPSIDE-DOWNSIDE
Samplings of what analysts are saying about
United Dominion Realty Trust
Merrill Lynch
Rating: NEUTRAL (10/24/05)
"Although UDR trades at one of the larger NAV discounts in our apartment universe (7 percent versus 1 percent composite average), we feel the valuation is warranted due to the company's slower than average near-term FFO growth prospects and still meaningful low barrier market property concentration."
Goldman Sachs
Rating: Outperform/Cautious (10/26/05)
"Despite UDR's continued solid execution on its portfolio repositioning efforts, the company still trades at an unwarranted discount, in our view, relative to its peers. … Given UDR's higher expense run rates, we're modestly trimming our 2005, 2006 and 2007 FFO estimates to $1.60, $1.65 and $1.73 from $1.62, $1.70 and $1.80, respectively. Despite our modest downward estimate revisions, UDR's attractive relative valuation keeps it our top pick among the apartments and a constituent of both our Goldman Sachs Recommended and Income Portfolios."
Prudential Equity Group, LLC
Rating: UNDERWEIGHT (11/15/05)
"Demand for apartments appears on the rise, and fundamentals for the sector continue to strengthen. Accordingly, United Dominion and other apartment owners should achieve higher rents over the coming quarters. That said, we believe higher expenses should offset much of these gains. As such, we have lowered our same-store NOI estimates for 2005 and 2006 to 3.3 percent from 4.1 percent and 3.7 percent from 4.4 percent, respectively."
Banc of America Securities
Rating: NEUTRAL (10/25/05)
"Although UDR's stock looks attractively valued at 17.3 times 2006 AFFO (versus 19.4 times AFFO for its peers) and an 8 percent discount to our NAV and DCF, we think its numerous growth hurdles could make it a value trap. We would look, however, to an aggressive stock buyback program in fourth quarter 2005 as a positive for the stock."
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The second most important way to add value is rehabbing, Toomey continues. He estimates that as much as 65 percent of the nation's apartment stock is 20-plus years old and in need of retooling. "Many apartment communities have big, well-constructed floor plans in good locations," he says. "But they don't have today's amenity packages or energy efficiency packages. So we're going in and replacing appliances, flooring, ceilings, and lighting fixtures."
In addition to an aggressive apartment rehab program, United Dominion is developing new properties for its own portfolio. According to Toomey, the development pipeline is moving about $240 million in new apartments through the system. Over the next few years, Toomey hopes to double the company's development activity to $500 million.
"For a number of years, multifamily companies made money by consolidating," Toomey says. "The cost of capital was cheap, and there was a spread between the cost of the capital and what you could buy assets for. Today, however, you are starting to see companies develop much more sophisticated full cycle growth capabilities. They can build, rehab, operate, acquire, and sell. No matter what part of the cycle you are in, you can create value."
That's a good position to be in.
Michael Fickes is a regular contributor to Portfolio.
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