Tickers in this Article: AVB, UDR, EQR, BRE, HME, AIV, REIS
Renting is becoming the de facto housing choice. Recent data suggests apartment REITs, which have dramatically outperformed the S&P 500 over the past three months, are in position to sustain momentum even if the market stalls.

TUTORIAL: Mortgage Basics

Vacancies Down, Rents Up
Apartment vacancy rates are quickly decreasing across the country. Commercial real estate research company REIS, Inc. (Nasdaq:REIS) reported that through the first three months of 2011, the vacancy rate in the 82 major markets it covers fell a record 0.4% from the fourth quarter of 2010 to 6.2%. That's down from 8% in the same quarter last year. Decreasing vacancy rates are even more prevalent in densely populated cities where several major apartment REITs have a significant footprint.

Several factors are driving people to rent. These include:

  • Stricter lending requirements and potential buyers not being able to come up with thousands of dollars for a down payment.
  • Rising interest rates raising the cost of borrowing.
  • Buyer fear due to housing woes (primarily in the single family home segment) and financial uncertainty.
These forces, coupled with the expiration and lack of new federal incentives, are driving people to rent instead of buy. It's a simple case of supply and demand. Increasing demand for rental units translates into higher rents. This fact played out last quarter as effective rents rose in 75 of the 82 markets year that REIS covers.

Living Good with Rental REITs
Apartment REITs are prepared to capitalize on the renting trend. AvalonBay Communities, Inc. (NYSE:AVB) ramped up production in a big way last year, beginning about $800 million in new developments during 2010. Back in March, Denver-based property manager UDR, Inc. (NYSE:UDR) purchased its first rental building in New York City for $260.8 million. Growth drivers are in place.

In addition, REITs offer solid dividend income yield. Most of the big REITs yield right around 3%. Home Properties, Inc. (NYSE:HME) pays a 4.21% dividend yield on the high end and Apartment Investment and Management Co. (NYSE:AIV) yields 1.9% on the low end.

Those yields supplement the driving forces behind the market's desire to take part in REIT growth. As rent rates increased, so has demand for apartment REIT stocks. After a big dip to start 2011, most REITs are handily beating the market. Since January 18, Equity Residential (NYSE:EQR), BRE Properties, Inc. (NYSE:BRE) and Home Properties, Inc. are up about 10% each while the S&P 500 has risen just 1.6%. Avalon Bay is up a smaller 7% over the same period of time, providing more upside room than competitors on a relative strength basis. The Virginia-based apartment REIT also features some of the best current profit and operating margins within the group at an average beta.

The Bottom Line
Valuation may act as a soft ceiling for some overextended apartment operators. Yet stabilizing unemployment and home sales weakness is a great foundation for apartment REITs to keep building on. Add in the sad state of home foreclosures - providing another pool of potential apartment tenants - and the REIT play is nowhere near saturated. (To learn more about REITs, see How To Assess A Real Estate Investment Trust (REIT).)

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