Apartment REITs benefit from soaring home prices and mortgage rates

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Soaring house prices and mortgage rates are making it difficult to buy a home. But it’s an opportunity for bargain hunters to invest in apartment REITs, which have been beleaguered this year and are down about 20% despite soaring rents.

“Looking back over the past decade, opportunities to buy blue chip apartment REIT stocks have been rare,” says Brad Thomas, CEO and principal analyst at Wide Moat Research and author of The smart REIT investor. “There is a rare sale going on right now.”

Apartment REITs are currently trading at a 21% discount to the value of their underlying assets, calculates Green Street, a commercial real estate analyst firm. Just a year ago, they were trading at a 3% discount.

It’s no surprise that apartment REITs have fallen along with stocks and bonds this year in a broad market sell-off. Real estate investments are sensitive to interest rates, which increase borrowing costs.

On Wednesday, the Department of Labor announced that consumer prices rose at an annual rate of 9.1% in June, paving the way for another sharp interest rate hike from the Federal Reserve later. this month.

But high rates are actually good news for apartment REITs because they make it harder to buy a home. After a period of record high mortgage rates, the 30-year fixed rate nearly doubled to 5.51%. In May, the median selling price of existing homes topped $400,000 for the first time, further weighing on affordability.

“There are potential buyers who are now being pushed into the tenant pool,” says Handel St. Juste, managing director and REIT analyst at Mizuho Securities. “The dramatic change in the cost of home ownership is a net benefit to the rental side.”

Analysts say the sell-off of apartment REITs seems overdone, given that the companies have healthy balance sheets and the outlook for rental demand looks strong. The latest Consumer Price Index report showed rental prices rose the most since 1986, up 5.8% from the previous year.

John Pawlowski, managing director of Green Street, agrees that apartment REIT prices have fallen too steeply. There are times when rental housing “gets thrown out with the bathwater of a negative housing macro-narrative,” he says. Most of the REITs he covers have only 20 to 25 cents of debt for every dollar of asset value and plenty of cash to pay off the debt.

Admittedly, real estate is strongly correlated to the economy. Just look back to 2020, when millions of Americans lost their jobs during the Covid crisis, and the impact that had on rents and occupancy.

Urban coastal cities, including San Francisco, New York, downtown Los Angeles and Seattle, “saw the biggest drop in apartment rents and declines in occupancy,” says Pawlowski. But in Sunbelt areas, including Atlanta, the Carolinas, Texas, Phoenix and Las Vegas, rents fell slightly while occupancy rates remained robust.

Different apartment REITs allow investors to bet on different parts of the country, St. Juste says.

Camden Estate Trust

(symbol: CPT) and

Central American apartment communities

(MAA) mainly hold stakes in Sunbelt.

Residential Equity

(EQR) and

AvalonBay Communities

(AVB) are strongly bicoastal.

Apartment Income REIT

(AIRC) and

UDR

(UDR) are exposed to both Coastal and Sunbelt markets, while

Essex Land Trust

(ESS) is a West Coast play.

Company / Symbol Recent Price Price change since the beginning of the year Total return 2021 Market value (bil) Price / 2023E FFO* Dividend yield
BICOASTAL
AvalonBay/AVB Communities $191.34 -24.3% 62.1% $26.7 18.2 3.3%
Residential Equity / EQR 71.29 -21.2 57.3 26.8 18.7 3.5
SUN BELT
Camden Property Trust / CPT $132.56 -25.8% 83.1% $14.1 18.6 2.8%
Central American Apartment Communities / MAA 169.60 -26.1 85.8 19.6 19.0 2.9
BALANCED EXPOSURE TO BOTH MARKETS
REIT/AIRC apartment income $41.29 -24.5% 47.7% $6.5 16.6 4.4%
UDR / UDR 44.83 -25.3% 61.1 14.3 17.9 3.4

E=estimate. FFO=operating funds. *Price/FFO is a standard measure of REIT value. The industry average is now 19.2.

Source: Bloomberg

Pawlowski says UDR and Equity Residential have fallen by a similar magnitude to their peers this year, but have had tough 2020s and 2021s. , and now valuations have reset and fundamentals are improving and so UDR and Equity Residential are two particularly cheap REITs right now. He said they are trading at a higher yield on 2022 earnings than their apartment REIT peers, and their expected internal rate of return is in the top half of all real estate sectors.

One of the factors that bodes well for apartment REITs is that housing is a non-discretionary item, so even if people lose their jobs in a recession or take a pay cut, demand for rental housing doesn’t fall. not as fast as the demand for discretionary housing. items, such as travel or luxury goods. “During a recession, rents could go down even further,” says Pawlowski. “But because demand is less discretionary, demand will hold up better than other areas.”

Gina Szymanski, portfolio manager in the REIT Securities Group at AEW Capital Management, says residential REITs are “one of our favorite categories,” given their pricing power and fundamentals. She notes that they “are not immune to a pullback as interest rate headwinds affect all businesses.”

But, she adds, “the residential names’ balance sheets are among the best of any company in our universe. We feel really good that they will bounce back.

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