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When Apartment REITs Go Wrong
For most Americans, finding an apartment may be harder than finding a house - but for investors, this isn't a home-free opportunity. Apartment rents in the United States rose 1% in the first three months of 2008, according to Bloomberg News. The highest increases could be seen in San Francisco and San Jose with increases of 11.1% and 8.9% respectively. It was the 24th consecutive quarter with a rate increase. Americans are clearly apprehensive about home purchases, many choosing to rent until the housing market bottoms.
When will this happen? No one can be sure. Given this uncertainty, you may think apartment REITs would be a good investment. Well, you could be wrong! Analysts point out that the condominium glut that exists due to the housing crisis will force property owners to keep a lid on rents in order to compete with desperate property owners. Let's take a look at why they say to look before you lease.
Are Analysts Right?
The analysts certainly make a compelling argument. According to the National Multi-Housing Council (NMHC), at the end of Sept. 2007 there were six million vacant housing units in the United States. That represents 4.6% of the total housing stock. In 2002, in the corresponding quarter, the number was 3.8%. NMHC Chief Economist Mark Obrinsky calls it "a pretty substantial jump." In addition, he feels the housing downturn isn't over yet and more homes will end up in foreclosure, flooding the rental market further with lower rents and higher vacancy rates.
In the first quarter of 2008, the national vacancy rate was 5.9%, up 0.3% from the previous quarter. The second and third quarters could also suffer as graduating students move back home because of limited job opportunities and increased rent. It doesn't look good. (To read more on this subject, see Why Housing Market Bubbles Pop.)
It's Not So Bad
Year-to-date investment returns for UDR Inc. (NYSE:UDR), one of the country's largest Apartment REITs, is at 25%. Compared to that of the S&P 500, which is down about 8% year-to-date, it seems almost idyllic. Why the big move? In 2007, the Dow Jones REIT index fell 16%. Investors might have chosen to lump anyone connected with residential real estate into the same boat.
The result? According to Green Street Advisor's' analyst Haendel St. Juste, apartment REITs are trading at an estimated 13% to 18% discount to net asset value. Historically, REITs of all stripes trade at a 4% surplus on average. It appears the shellacking received in 2007 was an overreaction to the collapse of the housing market, and 2008 was, in part, a move to make things right in the sector.
Where Do We Go From Here
Despite the estimated unusual surplus of rental housing, poor economic fundamentals, and quickly eroding residential real estate values, I believe that the best time to own apartment REITs is when rental apartments aren't taboo. Home ownership is no longer the panacea that everyone thought it was and renting once again is a perfectly acceptable housing option. The REITs to own are those where the majority of properties are located - in areas with expensive real estate, like San Francisco and New York City.
REITs That Make Sense
Avalon Bay Communities (NYSE:AVB) owns 53,000 apartment units in 10 states and the District of Columbia. Of that 53,000, 55% of the properties are in two areas: the Northeast (Boston, New York, etc.) and the Mid-Atlantic. Generally, they locate new communities in places where the barriers-to-entry are high. Revenues in 2007 were up 12% to $806 million and EBITDA was up 17.6% to $638 million. With occupancy rates of 96.5%, its no wonder the company stated on its website that it is cautiously optimistic about 2008. The stock has a trailing annual dividend yield rate of 3.4% and a debt to equity ratio in their most recent quarter of just over one, which is lower than most. Other names to consider include BRE Properties Inc. (NYSE:BRE) and Seniors Housing Properties Trust (NYSE:SNH).
Bottom Line
A difference of opinion exists between those in the apartment REIT industry today. Some, like the CEO of Avalon Bay, feel the future is very bright. Others feel a crumbling economy will seriously limit the companies' abilities to increase revenues without adding new developments. I believe the truth is somewhere in between.
When will this happen? No one can be sure. Given this uncertainty, you may think apartment REITs would be a good investment. Well, you could be wrong! Analysts point out that the condominium glut that exists due to the housing crisis will force property owners to keep a lid on rents in order to compete with desperate property owners. Let's take a look at why they say to look before you lease.
Are Analysts Right?
The analysts certainly make a compelling argument. According to the National Multi-Housing Council (NMHC), at the end of Sept. 2007 there were six million vacant housing units in the United States. That represents 4.6% of the total housing stock. In 2002, in the corresponding quarter, the number was 3.8%. NMHC Chief Economist Mark Obrinsky calls it "a pretty substantial jump." In addition, he feels the housing downturn isn't over yet and more homes will end up in foreclosure, flooding the rental market further with lower rents and higher vacancy rates.
In the first quarter of 2008, the national vacancy rate was 5.9%, up 0.3% from the previous quarter. The second and third quarters could also suffer as graduating students move back home because of limited job opportunities and increased rent. It doesn't look good. (To read more on this subject, see Why Housing Market Bubbles Pop.)
It's Not So Bad
Year-to-date investment returns for UDR Inc. (NYSE:UDR), one of the country's largest Apartment REITs, is at 25%. Compared to that of the S&P 500, which is down about 8% year-to-date, it seems almost idyllic. Why the big move? In 2007, the Dow Jones REIT index fell 16%. Investors might have chosen to lump anyone connected with residential real estate into the same boat.
Where Do We Go From Here
Despite the estimated unusual surplus of rental housing, poor economic fundamentals, and quickly eroding residential real estate values, I believe that the best time to own apartment REITs is when rental apartments aren't taboo. Home ownership is no longer the panacea that everyone thought it was and renting once again is a perfectly acceptable housing option. The REITs to own are those where the majority of properties are located - in areas with expensive real estate, like San Francisco and New York City.
REITs That Make Sense
Avalon Bay Communities (NYSE:AVB) owns 53,000 apartment units in 10 states and the District of Columbia. Of that 53,000, 55% of the properties are in two areas: the Northeast (Boston, New York, etc.) and the Mid-Atlantic. Generally, they locate new communities in places where the barriers-to-entry are high. Revenues in 2007 were up 12% to $806 million and EBITDA was up 17.6% to $638 million. With occupancy rates of 96.5%, its no wonder the company stated on its website that it is cautiously optimistic about 2008. The stock has a trailing annual dividend yield rate of 3.4% and a debt to equity ratio in their most recent quarter of just over one, which is lower than most. Other names to consider include BRE Properties Inc. (NYSE:BRE) and Seniors Housing Properties Trust (NYSE:SNH).
Bottom Line
A difference of opinion exists between those in the apartment REIT industry today. Some, like the CEO of Avalon Bay, feel the future is very bright. Others feel a crumbling economy will seriously limit the companies' abilities to increase revenues without adding new developments. I believe the truth is somewhere in between.
by
Will Ashworth
Will Ashworth lives and works in Toronto, Canada. He's worked in and around the financial services industry for much of his adult life. He loves investing and is passionate about helping others learn how to put their money to work.
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