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. These include apartment buildings, student housing, manufactured homes and single-family homes. Residential REITs rent spaces in these properties to tenants and earn rental income.
Some of the prominent players in this industry are AvalonBay Communities, Inc. (AVB - Free Report) , Apartment Investment and Management Company (AIV - Free Report) , Essex Property Trust, Inc. (ESS - Free Report) , Mid-America Apartment Communities, Inc. (MAA - Free Report) and UDR Inc. (UDR - Free Report) .
Here are the three major themes in the industry:
High retention and rent collection: Given the choppy economic environment amid the coronavirus pandemic and the job loss, there were apprehensions about rent collections for the month of April. However, rent payments for apartments exceeded expectations through the second week in April, which is encouraging. Markets that are more oriented with business services and technology are witnessing better rent payment numbers compared with the hospitality and retail-oriented ones. Nevertheless, the stimulus measures are likely to support renters’ liquidity to some extent. Moreover, amid the pandemic, there is higher residential retention as renters shelve move-out plans, and request lease extensions and residential landlords offer exceptional flexibility to accommodate them. This increased renewal demand will likely mitigate the decline in new-lease demand and help the residential REITs in the short term.
Technology Adoption: The embracing of new technology, aimed at improving operating margins and customer experience, has been underway for quite some time now. However, it has become all the more essential in this social-distancing era, as the virus outbreak needed an almost-overnight shift to virtual operations for the continuity of normal business operations. Right from apartment tours and leasing, to lease renewals, rent payments and service requests through online platforms is the call of the hour, and using analytics to optimize leasing, renewals and operations is essential. Therefore, residential REITs which would quickly adapt to such modernizations are more likely to enjoy a competitive edge over others.
The COVID-19 pandemic and market uncertainty: Nevertheless, there is uncertainty and volatility in the current economic and capital-market environment. Therefore, residential REITs with a better balance-sheet position and ample liquidity are likely to have a smooth sail through the current blues. Moreover, although retention rate is high, growth in rents for renewals is considerably low. In addition, though renewals are taking place, new leasing activity has been significantly affected, which might dent residential REITs’ performance during the peak leasing period. Although rent collections for April have been encouraging, there are concerns for May as unemployment continues to rise. Initial lease-up of new deliveries will likely be challenging in the near-term and rent discounting and use of concessions is likely to be rampant. However, supply-chain disruptions and inability to use full construction staff in the present scenario might cause delays in deliveries to some extent. In case of student housing, there is uncertainty regarding the timing when colleges will be able to resume normal operations. Therefore, there is uncertainty with regard to performance of student-housing assets.
Zacks Industry Rank Indicates Better Prospects
The REIT And Equity Trust - Residential industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #86, which places it at the top 34% 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.
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 Lags the S&P 500
The REIT And Equity Trust - Residential Industry has lagged the S&P 500 composite but outperformed the broader Finance sector in a year’s time.
The industry has depreciated 12.1% during this period compared with the S&P 500’s decline of 3.5%. During the same time frame, the broader Finance sector has plunged 21.4%.
One-Year 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 16.51X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 19.24X. The industry is trading above the Finance sector’s forward 12-month P/E of 13.73X. 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 22.36X, as low as 15.54X, with a median of 18.47X.
In a nutshell, despite the macroeconomic uncertainties due to the coronavirus outbreak, the constituent members of this industry are likely to sail through efficiently with high retention and technology embrace. Also, with the stimulus checks likely to support renters’ liquidity, rent collections in May might benefit.
Currently, there is no stock in the industry sporting a Zacks Rank #1 (Strong Buy). However, there are two stocks carrying a Zacks Rank of 2 (Buy), which seem strategic for addition to the portfolio as well as one other pick for considerations.
Independence Realty Trust, Inc. (IRT - Free Report) : This Philadelphia, PA-based REIT is engaged in ownership and operations of multifamily apartment properties across non-gateway U.S. markets, including Atlanta, Louisville, Memphis, and Raleigh. The company focuses on having properties in sub-markets that offer good school districts, high-quality retail and major employment centers. The stock currently carries a Zacks Rank of 2. The Zacks Consensus Estimate of 79 cents for 2020 FFO per share indicates a year-over-year increase of nearly 4%.
NexPoint Residential Trust, Inc. (NXRT - Free Report) : The Dallas, TX-based residential REIT is focused on the acquisition, asset management, and disposition of multifamily assets, positioned mainly in the Southeast United States and Texas. This Zacks Rank #2 company’s consensus estimate for the ongoing year’s FFO per share moved 1.2% upward to $2.56, in the past 30 days. The figure suggests a rise of 16.4% from the prior-year period.
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. Equity Residential currently carries a Zacks Rank #3 (Hold) and its long-term projected growth rate is 5.5%.
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.