Apartment REITs have significantly slowed down their acquisition and development activity, especially compared to earlier in this cycle. But when REITs do buy new buildings or start construction, they are showing a surprising focus on garden apartment properties.
Leading REITs were net sellers in 2017
Equity Residential, one of the leading apartment REITs in the U.S., sold more properties than it bought in 2017. The REIT sold five apartment communities, totaling 1,194 units, for a total of $355 million. It bought four, totaling 947 units, for $468 million.
AvalonBay Communities, another leading REIT, sold six apartment communities totaling 1,624 apartments and $476 million. By any measure, that’s more than the three properties AvalonBay bought in 2017, totaling 1,062 apartments and $366 million.
A lot of multifamily investors bought fewer properties in 2017 compared to 2016 and 2015. Investors bought $12.5 billion in apartment properties in 2017 (as of November) in the U.S., according to Real Capital Analytics (RCA), a New York City-based research firm. That’s down 7 percent from the same period in 2016.
Multifamily REIT acquisitions are making up a smaller piece of that shrinking pie. “REITs posted a declining share of overall volume for the year,” according to the latest report from RCA. Their purchases represented only 4 percent of the total dollar volume of apartment sales completed in 2017.
That’s a huge falling off from the pace of REIT acquisitions earlier in the cycle, when their stock prices were growing quickly. For example, in 2013, REITs accounted for 21 percent of apartment sales.
When multifamily REITs do make acquisitions, the kinds of properties they buy are changing. After years of concentrating on mid-rise and high-rise apartment buildings, REITs are beginning to show interest in garden apartment communities. Their pace of acquisition of garden apartment complexes was up 1 percent last year compared to 2016, but their acquisition of mid-rise and high-rise buildings fell 36 percent during the same period.
Development slackens, changes focus
Top REITs are still building new apartment projects, but also not quite at the pace they used to. AvalonBay, for example, is no longer appearing on the list of the busiest multifamily builders for 2017. Its construction pipeline shrank in the fourth quarter of 2017, as it started construction on four properties totaling 1,477 apartments, but finished construction on six communities totaling 1,821 apartments.
REITs were behind just 5.4 percent of all the apartment units that started construction in the third quarter of 2017. In earlier quarters, REITs were regularly responsible for more than 8 percent of all apartment construction starts, according to RCA.
Garden-style apartment development is becoming a significant part of their current activity. In the third quarter, REITs were responsible for 3.1 percent of all construction starts for garden apartments, according to RCA. That’s up from 0.6 percent two years before.
Occupancy rates for less expensive, Class-B apartments, including many garden apartment properties, have been rising steadily. These communities are difficult to build. The large sites needed to create them have been increasingly difficult to find.
REIT still continue to build mid-rise and high-rise properties, but to a lesser extent. The REIT share of construction starts for these properties has fallen to 6.2 percent from 8.2 percent two years ago. REITs have lessened their focus on these properties as overbuilding has sapped the vitality of many urban mid-rise and high-rise markets.
Capital availability
Multifamily REITs continue to have an advantage when investing in new apartment properties, but that advantage is shrinking. REITs can raise money from the stock market. Early in the recovery the prices investors paid for REIT stocks rose quickly, jumping by 27 percent in 2014, for example, according to the FTSE Nareit All REITs index.
REITs have gotten much less of advantage from the stock market over the last few years. The index rose by just 2 percent in 2015 and by just over 9 percent in both 2016 and 2017. That’s significantly more than the rate of inflation, less than the increase in value in the wider stock market over the same period. The Dow Jones Industrial Average grew by 12 percent in 2016 and 22 percent in 2017.
The stock markets have been battered by volatility in early 2018, but by the end of February, the Dow Jones Industrial Average was still up 4 percent since the beginning of the year. REIT stocks were down more than 7 percent over the same period.
Strong demand for housing helps make up for overbuilding
REITs continue to invest in apartments because despite short-term challenges like weaker stock prices and overbuilding, the outlook for apartment demand looks strong for the next few years.
Developers have built more apartments than they can easily fill with residents in many top markets. “Our markets will experience another year of elevated supply, reduced pricing power and slowing revenue growth [in 2018],” says David Neithercut, president and CEO of Equity Residential.
But demand for apartment rentals continues to grow, and the supply of new apartments hitting the market has begun to taper off. “The outlook in our coastal markets with high cost of home ownership will soon improve significantly as new apartment supply reduces while favorable demographics, low unemployment and rising incomes continue to produce extraordinarily strong demand,” says Neithercut.
