Apartment REITs Shine

By Aaron Levitt | January 14, 2011 AAA

The cause of the global credit crisis could be summed up in word: housing. The proliferation and bust of subprime and no-doc mortgages had profound effect on the global economy and sent many asset classes downward. Two years after the debacle, the state of residential housing is still poor and there are concerns over the amount of commercial real estate debt. In spite of this, there are some bright spots in real estate. Funds that follow REITs such as the SPDR Dow Jones REIT (NYSE:RWR) have tacked on more than 20% in 2010, and the odds of a double-dip recession appear to be declining. However, one sector of real estate may offer the best total returns going forward.

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Rising Rents
Fueled by stricter mortgage rules and foreclosure, homeownership is on the decline; falling by more than 69% since 2006. This shift in home buying/ownership is having a positive effect on apartment rentals. According to analysts at Reis Inc., apartment occupancy rates rose to 92.2% in the second quarter of 2010, up from 92.0% in the first quarter. Rents are also seeing an increase. Nationally, rents rose an average of 5% in 2010. In addition, apartments are seeing increases in property values. Moody's REAL Commercial Property Price Index reported that apartment buildings, along with retail, were the only property sub-sectors to show a gain in transaction prices nationwide during the third quarter of 2010. Across the country, apartment prices are up nearly 16% versus a year ago.

The longer term prospects for renting and the apartment sector are also good. Analysts estimate that there will be an additional 4.5 million renters by 2015, an increase of nearly 13%. The lack of new construction bodes well for rent rates. The number of new apartment projects coming online is pretty stagnant until 2012. Finally, there could be a real fundamental shift in the attitudes of people towards housing. According to data from the U.S. Census, from 1940 to 2004, housing prices have only appreciated an average of 2% annually. This appreciation has been less than inflation. The shift from "house as an investment" style thinking is bullish news for those who run apartment complexes.

Signing a Lease
Analysts estimate that apartment REIT sub-sector to gain nearly 12.5% annually over the two years. This on top of the amazing 40% total return apartment stocks saw in 2010. Broad based real estate funds like the iShares Cohen & Steers Realty Majors (NYSE:ICF) do include some top apartment names like Equity Residential (NYSE:EQR). However, it may be in investor's best interests to hone in on the sub-sector.

The iShares FTSE NAREIT Residential plus Capped Index ETF (NYSE:REZ) follows a basket 36 different REITs in the apartment and senior living sectors. The fund is the easiest way to gain access to the apartment sub-sector. The fund should also benefit as many baby boomers begin retiring and downsizing into senior apartments. The ETF yields a treasury beating 3.46% is up nearly 31% over the last year. Expenses run a cheap 0.48%.

With one of the highest dividends in the apartment sector, Associated Estates Realty (NYSE:AEC) manages 13,600 plus units. The company's 2011 estimated adjusted funds from operation (AFFO) is more than enough to cover the 4.6% dividend yield. Similarly, apartment giant UDR (NYSE:UDR) has been buying foreclosed homes to convert into rental units throughout 2010.

As a side play on the increased appeal of apartments, the self storage real estate market is heating up as moving into smaller spaces requires external storage options. Companies like Sovran Self Storage (NYSE:SSS) have recently reported rising net incomes. Sovran yields 4.9%.

Bottom Line
Real estate was one of main causes of the global credit crisis. While the overall sector has bounced back from its lows, demographics are pointing to one of its sub-sectors to be the real star. As renting becomes more popular, REITs that focus on apartments will be winners. Investors may want to focus their attention towards stocks like Avalonbay Communities (NYSE:AVB) or the REZ ETF. (For other reading, also take a look at Introduction To International REITs.)

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