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REITs 101: Apartment REITs
Apartment landlords occupy a unique space within the world of real estate. Unlike real estate investment trusts that operate in other segments, apartment REITs tend to perform relatively well whether in good economic times or bad. Indeed, apartment owners benefit when the economy is expanding, as jobs are created and household formation accelerates. Interest rates typically rise during periods of growth, making it more costly for builders to secure capital and develop new properties. However, higher mortgage rates make single-family homes less affordable, increasing demand for apartments and solidifying the outlook for landlords. Moreover, apartment REITs tend to weather a downturn better than their counterparts, since shelter—as opposed to, say, office or retail space—remains a basic human need.
Equity Residential (EQR) is the prototypical example of a successful apartment REIT. The largest publicly traded owner of multifamily properties in the country, Equity often serves as a bellwether of broader apartment-market trends. Founded in 1969 by real estate maven Sam Zell, the company has gone on to amass nearly 500 properties, comprised of more than 137,000 apartment units, with a book value in excess of $15 billion. To put that in perspective, Equity’s real estate assets have a book value more than double that of its nearest competitor.
As would be expected, Equity’s operating results took a step back during the downturn, a casualty of the elevated jobless rate, stalled housing turnover, and the subsequent drop in demand for apartments. Still, the company’s performance held up better than most of its apartment peers’, and far outpaced those of operators in other real estate segments, a testament to its well-diversified, high-quality asset base. Indeed, instead of putting its eggs in one basket, EQR has cultivated several nests, with no single market accounting for more than 10% of assets. Equity has also been highly selective about which areas to invest in, choosing supply-constrained markets with solid growth prospects, such as Washington, DC (which represents 7% of assets), New York (5%), Boston (5%), and San Francisco (5%).
Cobbled together in 1998 through the merger of Avalon Properties and Bay Apartment Communities, AvalonBay Communities (AVB) has also navigated the downturn relatively well. Like its larger rival, Avalon is concentrated in well-established markets that serve as commercial, cultural, financial, and governmental centers. In fact, the Capital, the Big Apple, the Olde Towne, and the City by the Bay represent 17%, 10%, 14%, and 6%, respectively, of the company’s $7 billion in real estate assets. Unlike Equity Residential, AvalonBay has been more judicious in its use of debt, and tends to focus more on high-end luxury properties.
Although apartment owners, as a group, have performed better than the broader REIT universe over the past few years, a few suffered some bumps and bruises, largely due to their concentration in some of the country’s hardest-hit real estate markets. With the lion’s share of their assets tied up in California, Florida, and Arizona, it’s no small wonder that Apartment Investment & Management Company (AIV), BRE Properties (BRE), and UDR (UDR) have trailed their larger peers. With its operating performance sagging and cash flow on the decline, BRE lowered its dividend 33% from its peak level. UDR also came under pressure and cut its payout 45%, though part of that was attributable to a reduced asset base after divesting a good portion of its real estate portfolio. AIMCO took it a step further, slashing its annual payout from $2.40 a share to $0.40, in an effort to conserve capital at a critical time.
None of the stocks we’ve covered here stand out for year-ahead relative price performance. This should come as no surprise since real estate fundamentals—especially the housing market—often act as a barometer of investor sentiment about the state of the broader economy. We’re optimistic about the segment’s long-term prospects, however, since the elevated jobless rate and tighter credit standards for mortgages are liable to make single-family homes less attainable, driving up demand for apartments. But total-return potential here is limited, and, at the current quotations, dividend yields among the group trail both their historical averages and the mean for the REIT industry as a whole.
At the time of this article’s writing, the author did not have any positions in any of the companies mentioned.