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There's No Place Like (A Multifamily) Home

There's No Place Like (A Multifamily) Home

Apartment REITs benefit from the burst homeownership bubble.

While it may be an exaggeration to say the American Dream of homeownership is dead, it's a fact that more and more Americans are choosing to rent. That shift, combined with a growing population, translates into opportunity for apartment REITs.

“There seems to be a growing consumer preference for renting,” says Mike Salinksy, a vice president with RBC Capital Markets who specializes in apartment REITs. “You have a situation where people are fearful of buying a home because they don't feel confident with valuations. That fear, along with stricter lending standards, is causing a lot of people to wait to buy a home.”

More People, More Renters

Currently, there are 13 publicly-traded apartment REITs that operate in the U.S. They boast a total market capitalization of $63.8 billion, according to SNL Financial. Today, these companies are experiencing strong occupancy rates and above-average rental rate growth. As of July 13, 2011, apartment REITs posted a year-to-date total return of 18.32 percent compared to just 12.51 percent for all equity REITs tracked by SNL Financial. The S&P, in contrast, achieved a total return of just 5.86 percent, while the Dow Jones Industrial recorded a total return of 7.9 percent for the same period.

While those numbers are impressive, the long-term performance for apartment REITs is extraordinary. Last year, apartment REITs achieved a total return of 38.93 percent compared to the S&P's 22.71 percent. Similarly, the five-year total return was 48.33 percent compared to S&P's 17.95 percent.

“By historical norms, the stock prices for apartment REITs are pretty robust, but the fundamentals support that pricing,” says Paula Poskon, a REIT analyst with R.W. Baird & Co. “Do the valuations price in a lot of growth? Yes, they do. Are we likely to see that growth actually occur? Yes, definitely.”

Apartment REITs, unlike other categories in the REIT sector, have demographics on their side, Poskon says. “We've got the Echo Boomers coming out of college, and there are 80 million people in that demographic group — a group that typically rents,” she points out. “That wave of demand is starting now and is predicted to sustain for the next several years against a picture of very little new supply.”

Today, rental housing serves a large and diverse population of nearly 39 million households. Among householders under age 25, some 78 percent are renters, while more than 65 percent of 25- to 30-year-olds also rent, according to Harvard University's Joint Center for Housing Studies (JCHS).

The center's most recent report indicates that demographic trends favor continued growth in the number of renter households for at least the next decade. Conservatively assuming that homeownership rates by age, race, and household type stabilize at 2010 levels and that immigration is only half the current Census Bureau baseline projection, population growth alone should lift the number of renter households by more than 3.6 million by 2020.

This projection reflects the net formation of 11.3 million new households among the huge Echo-Boom generation (those under age 35 in 2020) and the loss of 7.7 million households among renters in all older age groups. Meanwhile, the sheer size of the Baby Boom generation will push up the number of renters over age 65 by nearly 2 million.

Changing Attitudes

From 1965 to 2005, homeownership rates grew steadily. In 2005, however, homeownership rates not only stopped growing, they reversed, according to JCHS.

Had homeownership rates by age remained at 2005 levels, net renter household growth from 2005 to 2010 would have been just under 370,000. Instead, renter household growth surged by nearly 4 million over this period, and the net dissolution of renter households over age 30 was just 1.8 million — fully 3 million less than expected.

Housing experts say that now, more than ever, Americans are less interested in owning a home. They're worried about paying too much and then suffering negative equity. And, those worries are compounded by a lack of confidence about their own financial position and lingering high unemployment rates.

Moreover, stricter lending standards now require heftier down payments, and for the past several years, Americans have spent rather than saved. As a result, they don't have the funds to make a down payment, so they rent.

A survey commissioned by the National Apartment Association conducted in May 2010 found that 76 percent of consumers prefer renting to ownership, a 5 percent increase from 2008.

“Very few households are exiting the apartment sector to make first-time home purchases,” says Greg Willett, vice president of MPF Research, a national firm that tracks apartment performance.

Strong Industry Fundamentals

Historically, apartment demand has been driven by job growth. Yet the decline in revenue experienced by apartment owners during the “Great Recession” of 2007 to 2009 was no more severe than the 2001 to 2003 recession, despite the country losing three times as many jobs.

And, even though job growth has been relatively unimpressive as the U.S. has emerged from the recession, Willett points out that young adults, who tend to be renters rather than home buyers, are capturing a disproportionately large share of the job additions.

At the end of the second quarter, the average occupancy for U.S. apartments reached 94.3 percent, up from a low of 91.8 percent recorded at the bottom of the recent cycle in late 2009, but still below the 95.6 percent occupancy achieved prior to the recession, according to MPF Research.

During that same period, the sector turned in near-record revenue growth performance of 2.5 percent. Salinksy acknowledges that while it's surprising to see such strong rent growth with high unemployment, apartment REITs are seeing even greater rent increases, primarily because they own higher quality product in major metro markets. “On the high side, we're seeing them get 8 percent rent increases, and 5 percent increases on the low side,” he says. “We've already seen most apartment REITs raise their guidance for 2011 because of the rent increases.”

That level of rental growth is well above historic norms, Salinsky notes. “That's very aggressive, and it has to slow down,” he says. “But we've still got two very good years of growth.”

That's why Salinsky says investors need to have some exposure to multifamily REITs. “While valuations are not all that attractive because we're reflecting a lot of upside over the next two years, I don't want to say the stocks are overvalued, they're just not in a bargain position right now,” he explains. “The fundamentals for apartments are particularly compelling and compared to other sectors, apartments look a lot better, so in many ways, the valuations are justified.”

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