When it came to redefining itself, apartment owner UDR Inc. decided that bigger isn’t necessarily better.
The company recently unloaded more than 25,000 apartment units — about 40 percent of its portfolio — for $1.7 billion. Now, industry watchers want to see whether UDR, formerly known as United Dominion Realty Trust, can transform itself from a national giant renting nondescript, bread-and-butter apartments into a smaller company with a sharper focus on pricier markets and newer apartments.
While analysts like the deal and the company’s shares have risen, it won’t be easy. “This is a nice chunk of their assets,” said Philip Kibel of Moody’s Investors Service. “It could affect their leadership and their brand name.” It will affect the real-estate investment trust’s earnings: Year-over-year funds from operations, a measure of REIT performance, are expected to decline about 10 percent, industry watchers say. The company sold off “a decent portion of that income stream,” said Timothy Pire, managing director of domestic public securities for Heitman LLC, a Chicago real-estate-investment-management firm.
“Will they get back to their previous levels of earnings?” he asked. “Over time.” While it isn’t clear how long that will take — next month’s earnings should provide some early clues — there are other issues: Like all apartment operators, UDR faces increased competition as a foreclosure wave floods the market with bargain-priced supply. And the Highlands Ranch company has ramped up development during the worst housing downturn in decades.
“In one transaction, it changed the entire outlook and growth strategy for the company, certainly, we think, for the better,” UDR President and Chief Executive Thomas Toomey said. It “gives us a certain amount of firepower and liquidity at a time when the market is down.” For now, analysts seem supportive of the deal — which would be harder to get done today, with buyers’ risk appetites changed and debt costs higher, said Haendel St. Juste, who co-manages Green Street Advisors Inc.’s residential research team. The transaction could have taken years if the communities were sold piecemeal.
“You don’t find too often that companies are willing to sell off large blocks of their empire, for lack of a better word,” Mr.
St. Juste said. “Most companies don’t like to shrink their empires.” When UDR officials announced the sale to investment adviser DRA Advisors LLC in a joint venture with real-estate company Steven D.
Bell & Co. earlier this year, they said they would use the windfall to reinvest in targeted markets — the company reportedly lassoed more than 2,000 units in the Dallas and Washington areas — pay down debt, explore a special dividend and buy back shares.
Since then, the share price has climbed — it is up about 25 percent in the past three months — winnowing the discount to net-asset value, essentially the price the portfolio could command if sold. As the share price rises, the incentive to buy back stock falls, leading some analysts to debate whether a buyback remains the best option.
“It’s a pretty slim discount at this point,” said Richard Anderson, who covers the company for BMO Capital Markets Corp.
Green Street puts the share-price discount to NAV at 11 percent, compared with 13 percent for the apartment sector overall.
“I think people have grown a little bit more concerned about the direction of the economy, and this is a name that looks like a safer place to be,” said Stephen Swett of Keefe, Bruyette & Woods Inc.
Or maybe investors just like the deal, which purged older inventory with an average age of a little less than 25 years. Now that average is 15 years, requiring less upkeep, such as paint and new carpet, to stay competitive in the marketplace.
And, more important, the company now has a slightly fatter operating margin, and the monthly rent jumped nearly 20 percent to $1,163, leapfrogging competitors Camden Property Trust and Home Properties Inc., according to company data detailing the sale.
“Clearly, we sold a handpicked portfolio of assets that we would classify below average compared to the remaining portfolio,” Mr. Toomey said on a conference call earlier this year.
UDR also decided to exit some slower-growth markets with lower barriers to entry. The portfolio sale freed the company from states including Arkansas and the Carolinas where land is often plentiful and homeownership more affordable. Many of its roughly 40,000 units are now in California, the Virginia/Washington region and Florida.
But this strategy shrinks its national footprint and puts it more at risk from the stress of individual markets. Much of its net operating income now comes from homes in three regions, and Florida and California are now in a post-housing-bubble period.
Meanwhile, industry watchers debate whether the nation’s foreclosure crisis will hurt or help apartment operators. With millions of foreclosures looming, some say the former homeowners will become renters, benefiting companies such as UDR. Others, however, say former owners are more likely to live with family members or rent a foreclosed home. Another problem is that the condo market — oversupplied in Phoenix and South Florida, for example — is creating additional competition for apartment landlords.
“The glut of vacant homes has competed and will continue to compete directly with multifamily units, resulting in weaker power pricing for apartment owners,” Credit Suisse Group’s Michael Gorman wrote in a recent note on Camden Property Trust.
Mr. Anderson of BMO Capital Markets isn’t as bearish. “I’m not as concerned, really. I don’t think that a foreclosed home is going to compete one-for-one with an apartment building,” he said. “It is bad, but maybe an offsetting positive for multifamily REITs.” UDR has been upgrading itself. It is redeveloping thousands of units and adding new supply. The current pipeline, which stretches from California to Florida, has a budgeted cost topping $2.5 billion.
Wall Street is hesitant to endorse any company adding product into an economy sliding toward recession, so development is raising eyebrows, but company observers aren’t concerned. For now, they are giving the company the benefit of the doubt during this transformation.
But they won’t wait forever.
“What we want to see is just a consistent focus from the company,” said UBS AG’s Alexander Goldfarb.
