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Skyrocketing home prices and mortgage rates make this a tough time to buy a house. But it’s an opportunity for bargain hunters to invest in apartment real estate investment trusts, which have been clobbered this year and are down about 20% despite surging rents.
“Looking back over the past decade or so, opportunities to buy shares of blue-chip apartment REIT stocks have been few and far between,” says Brad Thomas, CEO and senior analyst at Wide Moat Research and author of The Intelligent 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 analytics firm. As recently as a year ago, they were trading at a 3% discount.
It isn’t surprising that apartment REITs have tumbled along with stocks and bonds this year in a broad market selloff. Real estate investments are sensitive to interest rates, which raise borrowing costs.
On Wednesday, the Department of Labor reported that consumer prices soared at a 9.1% annual pace in June, paving the way for another steep interest-rate increase from the Federal Reserve later this month.
But high rates are actually good news for apartment REITs, since they make buying a home more difficult. After a period of record-low mortgage rates, the 30-year fixed rate has nearly doubled to 5.51%. In May, the median existing-home sales price topped $400,000 for the first time, further straining affordability.
“There are some would-be buyers who are now pushed into the rentership pool,” says Haendel St. Juste, managing director and REITs analyst at Mizuho Securities. “The dramatic shift in the cost of homeownership is a net benefit for the rental side.”
Analysts say the selloff in apartment REITs appears to be overdone, given that the companies have healthy balance sheets and the outlook for rental demand looks strong. The latest consumer-price-index report showed that rent prices had climbed by the most since 1986—up 5.8% from a year earlier.
John Pawlowski, managing director at Green Street, agrees that apartment REIT prices have dropped too sharply. There are times when rental housing “gets thrown out with the bathwater of a negative macro housing narrative,” he says. Most of the REITs he covers have just 20 cents to 25 cents of debt for each dollar of asset value, and plenty of cash flow to service debt.
To be sure, real estate is highly correlated to the economy. One only has to look back to 2020, when millions of Americans lost their jobs during the Covid downturn, and the impact it had on rents and occupancy.
Urban coastal cities, including San Francisco, New York, downtown Los Angeles, and Seattle, “saw the sharpest decline in apartment rents and declines in occupancy,” says Pawlowski. But in the Sunbelt areas, including Atlanta, the Carolinas, Texas, Phoenix, and Las Vegas, rents fell slightly while occupancy remained robust.
Different apartment REITs allow investors to bet on different parts of the country, St. Juste says.
Camden Property Trust
(ticker: CPT) and
Mid-America Apartment Communities
(MAA) have mainly Sunbelt holdings.
Equity Residential
(EQR) and
AvalonBay Communities
(AVB) are heavily bicoastal.
Apartment Income REIT
(AIRC) and
UDR
(UDR) have exposure to both coastal and Sunbelt markets, while
Essex Property Trust
(ESS) is a West Coast play.
| Company / Ticker | Recent Price | YTD Price Change | 2021 Total Return | Market Value (bil) | Price / 2023E FFO* | Dividend Yield |
|---|---|---|---|---|---|---|
| BICOASTAL | ||||||
| AvalonBay Communities / AVB | $191.34 | -24.3% | 62.1% | $26.7 | 18.2 | 3.3% |
| Equity Residential / EQR | 71.29 | -21.2 | 57.3 | 26.8 | 18.7 | 3.5 |
| SUNBELT | ||||||
| Camden Property Trust / CPT | $132.56 | -25.8% | 83.1% | $14.1 | 18.6 | 2.8% |
| Mid-America Apartment Communities / MAA | 169.60 | -26.1 | 85.8 | 19.6 | 19.0 | 2.9 |
| BALANCED EXPOSURE TO BOTH MARKETS | ||||||
| Apartment Income REIT / AIRC | $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=funds from operations. *Price/funds from operations is a standard measure of value for REITs. The industry average now is 19.2.
Source: Bloomberg
Pawlowski says that UDR and Equity Residential have traded down by a similar magnitude to their peers this year, but had a tough 2020 and 2021. “They’ve already taken a lot of pain and so they were not all that expensive heading into this year, 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 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 nondiscretionary item, so even if people lose their jobs in a recession or get a pay cut, the demand for rental housing doesn’t fall as precipitously as the demand for discretionary items, such as travel or luxury goods. “In a recession, rents could still fall,” says Pawlowski. “But because demand is less discretionary, the demand will hold up better than other areas.”
Gina Szymanski, a 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 because interest-rate headwinds impact all companies.”
But, she adds, “the balance sheets of the residential names are in some of the best shape of all the companies in our universe. We feel really good that they’ll bounce back.”
Write to Lauren Foster at lauren.foster@barrons.com