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3 Top Picks From the Booming Residential REIT Industry

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The REIT And Equity Trust - Residential constituents are anticipated to benefit in the upcoming days, as rental housing demand remains robust with young adults forming new households, a better job-market, particularly for the high-paying employment sectors that is triggering demand for luxury units. Rising home prices and limited inventory levels in the for-sale sector are hindering the conversions to homeownership and aiding rental housing demand. Also, the ending of the federal eviction moratorium comes as a relief. While product absorption continues in the Sun Belt and other non-gateway metros, the gateway metros are now showcasing a strong rebound, helping residential REITs like AvalonBay Communities, Inc. (AVB - Free Report) , Equity Residential (EQR - Free Report) and Sun Communities, Inc. (SUI - Free Report) to ride the growth curve, despite elevated deliveries and regulation woes.

About the Industry

The Zacks REIT And Equity Trust - Residential category is engaged in owning, developing and managing a variety of residences. The types of residences include apartment buildings, student housing, manufactured homes and single-family homes. Residential REITs rent spaces in these properties to tenants and earn rental income in return. Markedly, some residential REITs also focus on specific classes of types of residences or a particular geographical region. Moreover, unlike apartment buildings, manufactured homes and single-family homes that are open for leasing to all, the student housing units are leased only to students. Such real estates are, therefore, generally required to be set up within or in places closer to colleges and universities. Furthermore, enrolment growth of educational institutes is a major driver for student housing assets.

What's Shaping the REIT and Equity Trust - Residential Industry's Future?

Robust Rental Demand, Rent and Occupancy Growth: For the U.S. apartment market, the third quarter appeared to be robust this year, with renter demand continuing to surge significantly. The number of occupied apartments was up 255,094 units, per a report depicting preliminary calculations from the real estate technology and analytics firm RealPage. This marked the biggest quarterly product absorption figure observed in the database that go back to the early 1990s. As of third-quarter 2021, the annual demand volume reached a whopping 597,354 units. Increase in occupied apartments over the past year surpassed the prior results. After living with parents during the initial days of the pandemic, young adults are now forming new households. A better job market, particularly for the high-paying employment sectors than in the low-wage positions, is triggering demand for luxury units. Moreover, rising home prices and limited inventory levels in the for-sale sector are hindering the conversions to homeownership and aiding rental housing demand. In terms of markets, product absorption continued in the Sun Belt and other non-gateway metros. What’s grabbing attention is the large product absorption in the gateway metros, reflecting healthy rental demand. The current favorable environment is boosting occupancy levels and in turn, pushing up rents. Rent growth has also been widespread. While leasing activity usually declines in the colder months, the number of apartment leases that will have expiry in the rest of the current year is significant compared to the other years as last year’s leasing activity was back half loaded. In addition, after a lackluster performance in 2020, the student housing market witnessed a strong 2021 leasing season in terms of pricing on the reopening of campuses and in-person classes as well as extracurricular activities.

Technology Adoption: Technological adoption already gathered steam last year amid the social-distancing trend, as the global health crisis needed an almost-overnight shift to virtual operations for the continuation of business operations. Landlords are now emphasizing more on the existing technologies and supplements aimed at driving revenues, trimming costs, improving operating margins, as well as enhancing customer experience. The residential REITs are focusing on virtual leasing assistance, virtual and self-guided tours, and digital move-in process. Other moves include improvement in search and tour booking as well as smart home access. These efforts are aimed at generating incremental net operating income in the years ahead.

Elevated Deliveries of New Units, Rent Control and Eviction: However, the struggle to lure renters is here to stay, as supply volumes might remain elevated in some of the markets. In fact, following the delays in the project timelines, completions bounced back in the last half of 2020. This trend is likely to continue in the rest of the current year as well, with the ongoing construction standing at a high level, suggesting a sizeable number of apartment deliveries in the upcoming period. While the ending of the federal eviction moratorium comes as a relief for the residential landlords, tenants still have some protections and in some cases, the local and state eviction bans remain in place. Also, the rent-control regulations in some of the major markets might curb the growth tempo. As such, the residential REITs with healthier balance sheets and ample liquidity are poised to sail through any negative externalities.

Zacks Industry Rank Indicates Bright Prospects

The REIT And Equity Trust - Residential industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #33, which places it at the top 13% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bright near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s positioning in the top 50% of the Zacks-ranked industries is a result of the positive funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are gaining confidence in this group’s growth potential. Since April 2021, the industry’s FFO per share estimate for 2021 and 2022 has moved 3.7% and 5.9% north, respectively.

Before we present a few stocks that you might want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Outperforms Sector and S&P 500

The REIT And Equity Trust - Residential Industry has outperformed the S&P 500 composite and the broader Finance sector in the year so far.

The industry has gained 33.3% during this period compared with the S&P 500 composite’s rally of 17.2% and the broader Finance sector’s 18.5%.

Year-to-Date Price Performance

Industry's Current Valuation

On the basis of the forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly-used multiple for valuing Residential REITs, we see that the industry is currently trading at 23.67X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 20.90X. The industry is trading above the Finance sector’s forward 12-month P/E of 15.93X. This is shown in the chart below.

Forward 12-Month Price-to-FFO (P/FFO) Ratio

Over the last five years, the industry has traded as high as 25.42X, as low as 15.80X, with a median of 18.65X.

3 Residential REIT Stocks Worth Betting On

AvalonBay Communities, Inc.: This residential REIT primarily focuses on developing, redeveloping, acquiring, and managing apartment communities in the leading metropolitan areas. Its markets include New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, Southeast Florida, Denver, CO; and Northern and Southern California. The company is also tracking opportunities in the new expansion markets of Dallas and Austin, TX; and Charlotte and Raleigh-Durham, NC. AvalonBay is poised to benefit from the high-quality assets in the premium markets, and portfolio diversification among the urban and sub-urban markets.

AvalonBay recently raised its third-quarter total residential rental revenue projection for the same-store communities on lower-than-expected uncollectible lease revenues, and greater-than-projected effective lease rates and occupancy. This residential REIT witnessed higher-than-anticipated delinquent rent payments from the COVID-19 rental assistance programs.

Apart from this, during the third quarter, the company acquired a number of properties. In Flower Mound, TX, it acquired The Nexus Lakeside for around $117 million. In Charlotte, NC, the company acquired Hub South End for nearly $104 million and Three 30 Five for roughly $53 million.

AvalonBay currently carries a Zacks Rank #2 (Buy). The Zacks Consensus Estimate for the ongoing-year FFO per share has been revised marginally upward in the past week. The company’s shares have appreciated 18.6% in the past six months.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Equity Residential: This Chicago, IL-based residential REIT is focused on the acquisition, development and management of residential properties in and around the vibrant cities that lure high-quality long-term renters. It is anticipated to benefit from portfolio diversification in the urban and suburban markets. While the company enjoys an established presence in Boston, New York, Washington, D.C., Seattle, San Francisco and Southern California, it is growing its presence in Denver, Atlanta, Dallas and Austin.

In its operating update, this residential REIT noted that it is concluding a strong leasing season, witnessing healthy demand and pricing for the company’s apartment units. Management, therefore, said that its same-store revenue growth is on track to meet or slightly surpass the company’s projections mentioned in the second-quarter 2021 earnings release.

Particularly, as of Sep 21, 2021, the company saw physical occupancy of 96.9%, up from 96.7% as of the end of August and July, and 96.3% at the end of June. Renewals also improved in September, with 62% of the residents renewing by the month compared with 58% by August, 54% by July and 53% by June. Further, the blended rate has increased to 9.7% for September, up from August’s 8.2%, July’s 5.1% and June’s 0.6%.

Equity Residential presently holds a Zacks Rank of 2. Over the past month, the Zacks Consensus Estimate for 2021 FFO per share has witnessed a 1.4% upward revision to $2.91. The stock has also gained 11.6% over the past six months.

Sun Communities, Inc.: The Southfield, MI-based REIT is engaged in ownership, operation or enjoys stake in manufactured housing communities, recreational vehicle (RV) resorts and marina properties located across 39 states throughout the United States, and Ontario, Canada.

This REIT is poised to benefit from its growth efforts in manufactured housing, RV resorts and marinas. The continued demand for affordable housing is acting as a tailwind, while demand for RV vacations is picking up pace amid the increased pace of vaccination and resumption of normalcy.  

Sun Communities currently carries a Zacks Rank of 2. The Zacks Consensus Estimate for the current-year FFO per share has been revised 5.1% upward in two months’ time. The company’s shares have rallied 21.2% over the past six months.

Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.

In-Depth Zacks Research for the Tickers Above

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AvalonBay Communities, Inc. (AVB) - free report >>

Equity Residential (EQR) - free report >>

Sun Communities, Inc. (SUI) - free report >>