Real estate investment trusts (REITs) invest in all types of properties — from offices to malls to hospitals and hotels. The Zacks REIT And Equity Trust - Residential category is the one which 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 space in these properties to tenants and earn a rental income in return.
Some of the prominent players in this industry are AvalonBay Communities, Inc. (AVB - Free Report) , Apartment Investment and Management Company (AIV - Free Report) , Mid-America Apartment Communities, Inc. (MAA - Free Report) and UDR Inc. (UDR - Free Report) .
The latest figures from real estate technology and analytics firm RealPage, Inc. (RP - Free Report) suggest that following a robust prime leasing season in 2019, the U.S. apartment rental market put up a decent show in October and November, despite demand for apartments generally slowing down during colder months as renters usually prefer less to move in the winter. Occupancy remained as high as 95.7% in November, reflecting 40 basis points (bps) higher than one year ago and only 20 bps lower than a month before. This also marks the highest rate in any November on record. Moreover, annual U.S. rent growth remained strong in the month at 2.9%, same as in October.
Here are the three major themes in the industry:
Resilient Economy and Capital Availability: The latest numbers from the Labor Department indicate an upbeat job-market picture, with increase in non-farm payrolls and fall in unemployment rate in November. Also, consumer sentiment remains high and spending continues to be resilient. Household formation remains good, which will likely support the industry’s growth. Moreover, easy availability of capital and comparatively lowers levels of interest rates keep the momentum upbeat.
Favorable Demographic Growth and Technology Embrace: 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. While millennials will continue to move into homeownership, affordability issues are likely to temper the pace. In fact, with high home-ownership costs in several markets hindering transition from renter to homeowner, demand for rental housing units is likely to be decent. Further, residential REITs are embracing new technology, aimed at improving operating margins and customer experiences, which is encouraging. These apart, the student housing sector, which is part of the residential REIT industry, has been witnessing decent demand and pre-leasing velocity despite more newer student beds.
Elevated Deliveries of New Units and Rent Control: However, the struggle to lure renters is feared to continue into the near term, as supply volumes might remain aggressive. According to a CBRE Group (CBRE - Free Report) report discussing 2020 multi-family outlook, permits and starts will likely drop in 2020, but not deliveries. CBRE Group projects multi-family completions to aggregate 280,000 units, nearly same as 2019’s estimated 281,000 units. Although rental-housing demand has been robust in recent times, this high supply volume is a concern because it generally curbs residential landlords' ability to command more rents, and affect occupancy and concession levels. Moreover, new rent-control regulations have been introduced in some of the major markets this year, while a number of other markets are being considered for establishing such regulations in future. This is likely to curb any significant growth in the top line.
Zacks Industry Rank Indicates Better Prospects
The Zacks REIT And Equity Trust - Residential industry is housed within the broader Zacks Finance sector. It carries a Zacks Industry Rank #83, which places it at the top 33% 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. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are gaining confidence in this group’s growth potential. Over the past eight months, the industry’s FFO per share estimate for the current year moved 1.3% north.
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 so far in the year.
The industry has rallied 27% during this period compared with the S&P 500’s rise of 24.4%. During the same time frame, the broader Finance sector has gained 15.9%.
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 20.95X compared to the S&P 500’s forward 12-month price-to-earnings (P/E) of 18.16X. The industry is trading above the Finance sector’s forward 12-month P/E of 14.61X. 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 21.89X, as low as 16.20X, with a median of 18.42X.
In a nutshell, despite elevated supply in a number of markets and rent regulations, the apartment rental market’s fundamentals are likely to remain buoyed by a stable economy, a healthy job market with low unemployment level, and job gains and household formations.
Currently, there is no stock in the industry sporting a Zacks Rank #1 (Strong Buy). However, there is a stock carrying a Zacks Rank of 2 (Buy), which seems a strategic one for addition to the portfolio as well as two other picks for considerations.
Sun Communities, Inc. (SUI - Free Report) : This Southfield, MI-based REIT is engaged in ownership, operation or enjoys stake in manufactured housing and recreational vehicle communities located in 32 states throughout the United States and Ontario, Canada. The stock currently carries a Zacks Rank of 2. The Zacks Consensus Estimate for 2019 FFO per share has been marginally revised upward in two months’ time to $4.89. It also indicates a projected year-over-year increase of 6.8%.
Equity Residential (EQR - Free Report) : The Chicago, IL-based residential REIT is engaged in the acquisition, development and management of rental apartment properties in urban and high-density suburban communities where renters want to live, work and play. The Zacks Consensus Estimate for current-year FFO per share has moved 0.6% north over the past 60 days to $3.47. It also indicates a year-over-year increase of 6.8%. Equity Residential currently carries a Zacks Rank #3 (Hold) and its long-term projected growth rate is 6.2%.
Essex Property Trust, Inc. (ESS - Free Report) : The San Mateo, CA-based residential REIT is focused on acquisition, developing, redeveloping, and managing multi-family residential properties in select West Coast markets. This Zacks Rank #3 company’s consensus estimate for the ongoing year’s FFO per share moved marginally upward to $13.34, in the past 30 days. The figure denotes an estimated rise of 6.1% from the prior-year period.
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.