Residential real estate investment trusts (REITs) are engaged in owning, developing and managing a variety of residences. These include apartment buildings, student housing, manufactured homes and single-family homes. Residential REITs rent space in these properties to tenants and earn a rental income in return.
Performance of the residential REIT industry depends on the economy’s strength, as well as the job-market scenario since these determine the capacity of rent that renters can shell out. Also, demographics play a crucial role in determining the demand for rental housing as young adults generally prefer renting to home ownership.
Although rising supply of new units has emerged as a major concern for the U.S. residential REITs in recent years, the prime leasing season this year, i.e. between April and September, was impressive, with demand surging and majority markets reporting solid absorption.
Here are the three major themes in the industry:
Favorable Demographic Growth: Demographic growth continues to be strong in the young-adult age cohort, which has a higher propensity to rent. In fact, a significant change in lifestyle has taken place and life-cycle events are getting delayed. This, again, is leading to an extension of the average age of first-time homeownership.
This age cohort has also witnessed considerable part of net job growth which is helping spur primary renter demand. Moreover, as interest rates are climbing, owning a home is getting costlier. Several millennials have high student debt, which makes it difficult for them to save for the down payment in order to purchase a house. Therefore, as housing affordability will likely become more challenging in the upcoming period, demand for rented apartments is likely to shoot up.
Improving U.S. economy: The healthy U.S. economy and job-market gains are essential catalysts for this industry’s growth. Particularly, corporate profits are up, and corporate tax cuts are encouraging companies to deploy capital and increase wages. As such, consumer confidence is increasing, fueled by job growth and rising wages.
This, in turn, is supporting an increase in household formation which may further accelerate demand for rental housing. In addition, a number of rate hikes, so far this year, and indication of more raises indicate strengthening of the economy. This is anticipated to have positive ripple effects across the industry.
Elevated Deliveries of New Units: Although healthy job growth in recent months signals more household formations and raises expectations of a revival of the U.S. residential real estate market fundamentals, the struggle to lure renters is feared to continue into the near term, when much of new supply is likely to come on course.
This might curb residential landlords' ability to command more rents, and affect occupancy and concession levels. However, construction costs have been flaring up, consequently putting pressure on permits and starts. This might slightly abate the softening of market fundamentals from the rising supply of new units.
These apart, the student housing sector, which is part of the residential REIT industry, has been experiencing a slowdown in leasing velocity and compression in rent growth, of late, amid demand supply imbalances, intensifying competition and uncertainties shrouding international students. Specifically, properties away from campus are feeling the brunt.
Zacks Industry Rank Indicates Bright Prospects
The Zacks REIT And Equity Trust - Residential industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #112, which places it at the top 44% 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 positive funds from operations (FFO) per share outlook for the constituent companies in aggregate.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Leads on Stock Market Performance
The REIT And Equity Trust - Residential Industry has outperformed the broader Zacks Finance Sector, as well as the Zacks S&P 500 composite, year to date.
The industry has rallied 3.2% during this period compared to the S&P 500’s rise of 1.8%. During the same time frame, the broader Finance sector has declined 7.2%.
Year-to-Date Price Performance
Industry’s Current Valuation
On the basis of 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 18.08X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 16.31X. The industry is trading above the Finance sector’s forward 12-month P/E of 13.32X. 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 19.25X, as low as 15.04X, with a median of 17.91X.
In a nutshell, the residential REIT industry is poised for growth amid economic recovery and job-market growth, favorable demographics, lifestyle transformation and creation of households, at present. However, elevated supply in a number of markets in the near- to mid-term may strain rental rates and result in high concessions. Furthermore, with persistent hikes in interest rates, companies are anticipated to witness rise in financing costs as well.
Here we present three stocks from the industry with a Zacks Rank of 2 (Buy) that investors may consider adding to their portfolios.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Bluerock Residential Growth REIT, Inc. (BRG - Free Report) : This New York-based REIT is engaged in developing and acquiring highly amenitized live/work/play apartment communities in demographically attractive growth markets throughout the United States. The company’s Zacks Consensus Estimate for the current-year funds from operations (FFO) per share remained unchanged at 69 cents, over the last 30 days. However, it indicates a projected increase of 23.2% year over year.
Price and Consensus: BRG
NexPoint Residential Trust, Inc. (NXRT - Free Report) : This residential REIT is based in Dallas, TX, and is engaged in acquiring, owning, and operating well-positioned middle-income multifamily properties. It operates mainly in the Southeastern and Southwestern United States. The stock has seen the Zacks Consensus Estimate for 2018 FFO per share being revised 1% upward to $1.94, over the last 30 days. Further, the company is expected to witness 12.9% year-over-year FFO per share growth in 2019.
Price and Consensus: NXRT
UDR Inc. (UDR - Free Report) : The Highlands Ranch, CO -based residential REIT is focused on managing, buying, selling, developing, and redeveloping multifamily real estate in targeted U.S. markets. The company’s 2018 consensus estimate for FFO per share was marginally revised north to $1.95, in seven days’ time. Additionally, its 2019 FFO per share will likely witness year-over-year improvement of 6.1%.
Price and Consensus: UDR
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.
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