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UDR/MetLife JV split reflects differing views on urban apartments

With their deal to buy out each other's stakes in 15 apartment properties, UDR Inc. and Metlife Investment Management LLC hinted at different outlooks on the future performance of urban versus suburban multifamily markets.

In the transaction, which shrinks the firms' multifamily joint venture to 13 assets, UDR plans to acquire full ownership of 10 operating properties, one property under development and four land sites — mostly in suburban locations. MetLife, an affiliate of MetLife Inc., will take full ownership of five urban high-rise apartment buildings.

Analysts said the swap simplifies UDR's business while reflecting the two parties' diverging approaches to the real estate cycle: MetLife, a long-term investor, can afford to stockpile premium buildings, even without much room for rent growth. In contrast, UDR, a publicly traded real estate investment trust tied to the quarterly earnings cycle, is focusing on lower-rent suburban properties where it can generate revenue increases by improving operations in the short term.

The properties MetLife is taking over have an average revenue per occupied home of $3,936, compared to $2,189 in the properties UDR is taking.

Drew Babin, a REIT analyst at Robert W. Baird, said in an interview that same-store net operating income growth in the MetLife joint venture has consistently underperformed UDR's wholly owned portfolio.

Part of the lag has been a result of high levels of new construction in urban areas, which has hurt existing property owners' ability to raise rents, Babin said. Another factor, he added, is that initiating operational changes can be a cumbersome process in jointly owned properties, whereas UDR typically prefers to operate more nimbly in buildings it owns outright.

In the properties UDR is taking over, "I'm sure that occupancy, rate, margins, you're going to see these things improve," Babin said. "Whereas before, they just weren't able to move that quickly."

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The transaction implies initial yields on the properties in the low 5% range for the suburban properties UDR is taking, and in the high 4% range for the urban properties MetLife is taking. Given the high prices and new-supply levels in urban areas, the MetLife properties' yields do not appear likely to rise over time — though MetLife may be comfortable with that, because it can boost its gains by taking on leverage, Babin said.

For UDR, the initial transaction yield may appear more like a starting point, with the potential to boost returns by investing in property upgrades and new operating systems, which include technological initiatives like unguided tours and smart-home devices.

Analysts covering UDR were largely positive on the swap, with Mizuho Securities USA Inc. analyst Haendel St. Juste calling it a "prudent" asset exchange that simplifies the REIT's story and balances its portfolio while potentially boosting earnings for 2020. St. Juste said in a note that the company's separate acquisition of a property in suburban Boston tells a similar story.

The transaction reduces the level of UDR's net operating income wrapped up in joint ventures to 5%, from 10% previously, SMBC Nikko Securities America analyst Richard Anderson said in a note. Anderson characterized UDR as more self-sufficient than it was when it launched the joint venture in 2010, at a time when it was a smaller company with a higher debt ratio and a greater need for private capital.

The two sides were likely able to agree on which joint venture assets to buy and sell because of differences of opinion about the properties involved, and about the outlook for apartment markets, Anderson said.

But while the rest of the venture could also be unwound, he added, "The problem is there may be less disagreement between the two parties about the remaining buildings, making it harder to identify the buyer and seller."

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