Fitch Affirms Equity Residential's IDR at 'A-'; Outlook Negative

Equity Residential

-- IDR at 'A-';

-- $200 million preferred stock at 'BBB+';

-- $9 million convertible preferred stock at 'BBB+'.

ERP Operating Limited Partnership

-- IDR at 'A-';

-- $4.4 billion senior unsecured notes at 'A-';

-- $531 million exchangeable senior notes at 'A-'.

The Rating Outlook has been revised to Negative from Stable.

The rating affirmations center on EQR's solid franchise, consistent cash flow coverage metrics and strong liquidity management. Franchise strength is evident in EQR's broad geographic diversification, focus on longer-term high growth markets, demonstrated access to multiple forms of capital, consistent operating strategy and an adequate level of unencumbered assets.

The Negative Outlook reflects that leverage, measured by net debt / recurring operating EBITDA, and fixed charge coverage are likely to worsen given continued weakness in property-level fundamentals over the next 18 months. Absent deleveraging, fixed charge coverage will likely trend below 2.0 times (x) and leverage will likely increase above 8.0x, metrics which are more appropriate for an IDR below 'A-'.

EQR's ratings are indicative of cash flow granularity, as each of EQR's top 10 markets generated net operating income (NOI) between 4.5% and 10.1% of total second quarter 2009 (2Q '09) NOI. Fitch views EQR's operating strategy of focusing on owning assets in supply-constrained, coastal destination markets, particularly given the slowdown in multifamily fundamentals, as a credit positive. These markets tend to exhibit relatively strong and consistent demand, a dearth of buildable land and high construction costs, curtailing substantial supply growth.

For the 12 months ended June 30, 2009, EQR maintained solid and consistent coverage, as reflected by its fixed charge coverage (recurring operating EBITDA less capital improvements divided by interest incurred and preferred distributions) ratio of 2.0x, as compared with 1.9x for the year ended Dec. 31, 2008. Fitch anticipates that this ratio will likely decline below 2.0x by the end of 2009 and into 2010 absent the company deleveraging.

EQR continues to maintain an adequate level of unencumbered assets that provides solid coverage of unsecured debt for the rating category. Per the company's bank covenant calculations, EQR's unencumbered assets covered unsecured debt by 2.4x and 2.2x as of June 30, 2009 and Dec. 31, 2008, respectively, up from 2.1x as of Dec. 31, 2007.

Fitch notes that EQR's net debt to recurring operating EBITDA as of June 30, 2009 was 7.4x, down from 7.7x and 8.0x as of Dec. 31, 2008 and 2007, respectively. Fitch utilizes net debt for EQR's leverage calculations as EQR has a sizeable unrestricted cash balance due to the company entering into a $500 million Freddie Mac secured debt transaction on June 30, 2009 to pre-fund 2009 and 2010 secured debt maturities. In addition, the company's risk-adjusted capitalization ratio remained adequate for the 'A' rating category at 1.2x as of June 30, 2009, relatively unchanged since Dec. 31, 2007.

Fitch calculates that EQR's sources of liquidity (cash, availability under its revolving credit facility, expected retained cash flows from operating activities) exceed uses of liquidity (debt maturities and expected capital expenditures) by over $650 million from July 1, 2009 to Dec. 31, 2011. This liquidity surplus is due in large part to the company proactively addressing any liquidity concerns by entering into secured debt transactions with either Fannie Mae or Freddie Mac over the past 18 months to pre-fund all debt maturities until the end of 2010.

In addition, the financial covenants in the company's unsecured debt agreements do not limit EQR's financial flexibility.

The ratings are balanced by declining property-level fundamentals. EQR's same property NOI declined by 3.4% during 2Q '09 relative to 2Q '08, and Fitch anticipates that it will decline over 5.0% for both full year 2009 and 2010, placing pressure on fixed charge coverage. While the company is focused on owning properties in markets that are supply-constrained and have barriers to entry, Fitch anticipates that demand weakness due to job losses will continue to place pressure on occupancy and rental rates. Absent raising equity, Fitch expects that EQR's coverage and leverage metrics will weaken until employment conditions improve across the markets in the company's portfolio.

The one-notch differential between EQR's IDR and its preferred stock ratings is consistent with Fitch's criteria for corporate entities with an IDR of 'A-'. Based on Fitch's criteria report, 'Equity Credit for Hybrids & Other Capital Securities,' available on Fitch's web site at 'www.fitchratings.com', EQR's preferred stock is 75% equity-like and 25% debt-like, since it is perpetual and has no covenants but has a cumulative deferral option. Net debt plus 25% of preferred stock to recurring operating EBITDA and was 7.4x as of June 30, 2009, down slightly from 7.7x as of Dec. 31, 2009.

The following factors may have a positive impact on Equity Residential's ratings:

-- Fixed charge coverage sustains above 2.0x (for the trailing twelve months ended June 30, 2009, fixed charge coverage was 2.0x);

-- Net debt to recurring operating EBITDA sustains below 7.5x (as of June 30, 2009, net debt to recurring operating EBITDA was 7.4x);

-- Unencumbered asset coverage sustains above 2.8x (as of June 30, 2009, unencumbered asset coverage was 2.4x).

The following factors may have a negative impact on Equity Residential's ratings:

-- Fixed charge coverage sustains below 2.0x;

-- Net debt to recurring operating EBITDA sustains above 7.5x;

-- A decrease in the risk-adjusted capital ratio at an 'A' rating category stress level below 1.0x (as of June 30, 2009 the risk-adjusted capital ratio was 1.2x).

Headquartered in Chicago, Illinois, Equity Residential is a company focused on the acquisition, development and management of high quality apartment properties in top U.S. growth markets. Equity Residential owns or has investments in 512 properties totaling 140,605 units.

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SOURCE: Fitch Ratings

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