Archstone-Smith Trust (ASN)
(7/25/06)

· Summary:
○ ASN is an apartment REIT operating in high value areas (Over 60% in D.C. and SoCal)
○ Ameritron, a wholly owned subsidiary, focuses on developing apartment properties for sale.
○ A significant portion of ASN's earnings come from the sale, or reallocation, of properties. They are selling properties in non-core markets to buy new ones, and disburse some of the proceeds as dividends.

· Key stats:
○ Their occupancy rate is on average 96.4%
○ Market cap: $11.1B
○ Debt-to-Equity ratio of 1:1
○ Dividend Yield: 3.4% ($1.74 per share)
○ P/E: 16.0
○ Average 5-year revenue growth (to 2005) was 8.9%. It was 27.3% in 2005.
○ Average 5-year net-income growth (to 2005) was 19.4%. The only recent year where net income dropped was in 2001 (-1.3%). Net income growth in 2005 was 13.6%.
○ S&P opinion: Hold

· FY 2005 financials:
○ Revenue: $946M
○ Total operating expenses: $812M (
○ Net operating income: $163M (17% net operating margin)
○ Distribution from property sales: $453M
○ Total net income: $616M (65% net margin)
○ Total dividend distribution: $353.6M
○ Balance sheet:
- $11.5B in assets, of which $10.8B is in Real Estate.
□ They generate $946M on $10.8B of RE (8.76% return on assets)
- $6.48B in liabilities
- $4.98B of equity

· Recent financials (Q2 2006):
○ http://www.marketwatch.com/News/Story/Story.aspx?guid=%7B47D4C5A0%2D36E5%2D42BD%2DB162%2D3E6DBEA2EF39%7D&source=blq%2Fyhoo&dist=yhoo&siteid=yhoo
○ Quarterly EPS was 77 cents.
○ Guidance for the year is $2.75-$3.05.
○ REITs must disburse 90% of earnings each year. 90% of $2.75 is $2.47, which is 42% above last years dividend of $1.74 (or it might result in a special dividend).

· From their 2005 10-K (Mar 2006)
· Since 2003, they have been selling "non-core" properties at an increasing rate. In 2005, the distributions from the sale of properties accounted for 73% of the net income.
· Their debt maturity periods are well spaced, with no more than $552M of debt maturing in any of the next 5 years (through 2010). That's no more than 5% of their market cap per year.
· Their dividends are paid quarterly, and have been steadily growing each year.
· They have $5.3 billion in total debt (12/31/2005), of which $2.4 billion was secured by real estate assets and $1.4 billion was subject to variable interest rates, including $394.6 million outstanding on short-term credit facilities.
- Debt is 49% of RE value

· My thoughts:
○ Here's a useful scaled analogy of their operations: ASN's performance is like a business that owns a $100K apartment with a $49K mortgage. They are able to lease it out for $8,760 a year ($730 a month). Total costs (sales + mortgage + taxes, etc.) are $5,874 a year plus $1,396 in depreciation, netting $1,489 of profit each year. This means that their true rental income is (net profit + depreciation) $2,885 a year, also known in REIT parlance as "funds from operations" or FFO (http://www.investorwords.com/1923/FFO.html). Note that this model does not include their income from the sale of properties.
○ Observations from this: A substantial portion of ASN's value is in the property they own (vs. just the rental cashflow its throwing off). The booked real-estate asset value may not be the actual market value of their properties. In the analogy above, it's like saying that an apartment that rents for $730 a month is only worth $100K. Most of their properties are in high-value areas (such as right across from Microsoft). Such an apartment that rents for $730 a month is likely to be worth at least 2-3 times that in today's market. This gives me confidence that the pure asset value of the properties is close to the market cap of ASN.

· SWOT:
○ Strengths:
§ The rental market is expected to increase in the short term as interest rates rise and home sales slow.
§ ASN's occupancy rates are very high, meaning that rental rates are set to go up.
§ Most of their debt was secured at low interest rates (< 6%).
§ They are able to take advantage of currently high property prices by selling existing properties, and through their Ameritron subsidiary, which exclusively builds apartments to sell.
§ A big dividend appears to be coming up, from the earnings numbers.
○ Weaknesses:
§ A lot of ASN's income is from sales (reallocation) of properties. A real-estate crash would drastically affect ASN's property prices and cut earnings.
§ A glut in new properties (the highest inventory in 9 years right now) many of them being converted into apartments, resulting in higher supply.
○ Opportunities:
§ They are reconsolidating their properties into core areas (i.e. selling off non core properties). This means that they could profit from buying cheaper real-estate and converting them into rental properties in core markets.
○ Threats:
§ ASN owns properties concentrated in D.C. and Southern California. Any sudden weaknesses in those markets (e.g. another terrorist attack) can drastically affect ASN.

· Other links:
○ Recent article in WSJ on apartment REITs: Apartment REITs Go to Head of Class, For Now, but Tougher Tests Lie Ahead (http://online.wsj.com/article/SB115379248492616131-email.html)
○ Big list of apartment REITs: http://www.dividenddetective.com/reit_directory_residential.htm

· Other REITs that might be worth looking at:
○ SUI - 8% dividend (!), currently losing money, but may be close to swinging into profitability
○ AVB - similar ratios to ASN, but more focused on luxury properties

· The bottom line:
○ Rental REITs look like a good buy at the moment, despite the fact that most of them have a hold or sell rating in S&P analyst reports. The upcoming dividend potential looks very promising. I am planning to go in looking for a near-term (< 1 year) jump in value. I've already picked up a few shares, and am looking to buy more (perhaps in other REITs). Longer term, a severe real-estate meltdown could hurt them.

○ Verdict: Buy (at $52, sell if above $60).