The Real Estate Investment Trusts sector (REITs), is fragmented and includes many sub-industries. Each sub-industry has its own set features and factors that can impact its performance. REITs usually give out 90% of their earnings in dividends, making them attractive investments for those looking for regular income streams.
Let’s look deeper into one such promising industry- Residential REITs. They are poised for rapid growth in 2022. Due to rising interest rates, mortgage rates have reached all-time highs at 4%. This makes it more expensive to buy a home. People prefer to live on rent, which is driving the Residential REITs sector.
Notably, Residential REITs have seen rising occupancy and rising rent rates through 2021. This trend is expected to continue into 2022. The sub-industry can further be broken down by the market location, such as suburban, coastal, central business district (CBD), etc. as well as the property type (e.g. apartment, multifamily and student housing).
Derek Johnston, Deutsche Bank analyst, has fascinating insights into the sector. Johnston recently returned to the industry of Residential REITs. Based on the current economic environment, Johnston has increased the cap rates (yield on investment) and lowered the premiums applied to the company’s net asset value (NAVs). A result of these changes, Johnston has also adjusted earnings projections and lowered stock price targets.
Johnston remains bullish on the sector, despite the lower-than market value due to the valuation and cloudy micro-environment. For apartment REITs and single family residences (SFR), the analyst predicts a growth in funds from operations (FFO), of 18.8% and 15.2%, respectively, for 2022 and 2023.
Johnston pointed out the forces that are driving his optimism about the sector. The analyst noted that millennials are starting families and roommates are largely separated after the pandemic. Home valuation spikes could lead to a downsize cycle while affordability for first-time buyers is limited.
The analyst also believes that the industry will see a decrease in expense comp benefits year-over-year as technological investments from the past begin to bear fruit, lowering employee cost. The COVID-19-related expenses are also decreasing, further reducing margin pressure. Based on the above, the analyst projects that the sector will experience a significant increase in earnings growth by 2022.
Let’s take a closer look and see what the analyst thinks of three top Residential REITs companies.
AvalonBay Communities (AVB)
AvalonBay is involved in the development, redevelopment, acquisition, and management of multifamily communities. It focuses primarily on high-barrier urban areas in New England, New York/New Jersey, the Mid-Atlantic and Northern California.
The company’s investments have seen superior returns due to their exposure to top-rated metropolitan areas. These areas offer favorable characteristics like growing employment in high-wage sectors, lower housing affordability, and a diverse and vibrant quality life.
AVBs portfolio contained 297 apartment communities, which hosted 87,992 homes in 12 states, as of December 31, 2021.
Analyst Johnston believes that AVBs portfolio is best placed to benefit from coastal market revival and ongoing suburbanization as shown in its February month update on rents, occupancy and revenue. Further digitalization will lead to 15% labor cost savings, according to Johnston.
Based on strong rent growth, development completion, stabilization tailwinds and AVBs FFO per shares, the analyst has raised AVBs FFO by share estimates to $9.59 in 2022 and $10.68 in 2023.
The analyst reiterated a Buy rating for AVB stock, but lowered the price target to $272 (from $255). This implies an 8.8% upside potential to current levels. AvalonBay’s dividend yield is 2.57%.
Other Wall Street analysts give the stock a Moderate Buy consensus rating with five Buys, and eight Holds. AvalonBay’s average price forecast of $270.31 suggests 8.1% upside potential from current levels. Its shares have lost slightly over 1% in the past year, while it has seen a 37.4% increase over the same period.
Camden Property Trust (CPT)
Camden has a portfolio of apartment homes in the sunbelt area of the U.S. Camden specializes in the leasing, management, marketing, and maintenance of apartment homes.
CPTs portfolio consisted of 171 properties housing 58.300 apartments homes as of January 31, 2022.
CPT experienced very little impact compared to its peers who had seen a negative impact on their bottom line from the pandemic over two years. The company saw positive rent growth in January and February 2022 and is expected to continue this upward trend.
According to analyst Johnston, for CPT This lack of an earnings ‘hole to fill’ (in regards to rental rates and occupancy) paves the way for additional acquisition/development investments like the recently announced $1.6B TRS acquisition.
CPT operates in markets where there is limited inventory supply for 2022, which creates a favorable sticky occupancy trend of around 97%. CPT is expected to grow FFO by 19.6% in 2022. This will translate to a higher FFO per share forecast of $6.45 (including TRS purchase) from $6.22.
FFO per share has increased to $7.11, from $6.76 in 2023. The key drivers of the increase in FFO growth are increased tenant demand and solid lease spreads.
The analyst reiterated a Buy rating for CPT stock and lowered the price target to $190 (from 200), which implies 12.5% upside potential from current levels. Camden Property has a dividend yield in excess of 2.08%.
Overall, Wall Street is cautiously optimistic about the stock. The Moderate Buy consensus rating is based upon nine Buys and four holds. Camden Property’s average price forecast of $184.69 suggests 9.4% upside potential from current levels. CPT stock has seen a 4.3% decline in value over the past year, compared to a 55.4% increase.
Equity Residential (EQR)
Equity Residential specializes in the acquisition, construction, and management rental properties in high-density suburban gateway markets, including Boston, New York, Washington, D.C., Washington, D.C., Southern California, San Francisco, Seattle, San Francisco, and San Francisco. EQR is also expanding its presence in Denver and Atlanta, Dallas/Ft. Worth and Austin.
EQRs portfolio contained 310 properties that house 80,407 apartments as of December 31, 2021.
Analyst Johnston says that EQR has a blue-chip portfolio within the coastal market. The company plans to increase its presence on growth markets by funding with dispositions in its California and New York markets.
Commenting on the same, the analyst said, While the Toll Brother’s partnership should ease this transition, we expect some dilution near term as EQR builds scale to match efficiencies enjoyed in long-standing markets such as New York City and Southern California.
The February year-to date metrics for EQR also showed continued momentum in rental rate growth. However, occupancy is now at 96.4% after losing some ground (-20bps YTD).
Management anticipates that there will be savings of between $25 million-$30 million through enhanced artificial intelligence-driven prospect communication and self-guided tour.
Based on these assumptions, analyst Johnston increased FFO per share estimates EQR at $3.45 (from 3.991) for 2021 and to $3.83 (from 3.991) for 2023.
The analyst reiterated a Hold rating for the EQR stock and lowered the price target to $93 from $94, which implies a 3.2% upside potential to current levels. Equity Residential has a dividend yield at 2.73%.
Other Street analysts are also cautiously optimistic about the stock. They give it a Moderate Buy consensus rating, based on five Buys, and 10 Holds. The Equity Residential average price forecast of $98.33 suggests 9.2% upside potential from current levels. Its shares are almost flat for the year, compared with a 28.3% gain during the past year.
Points to Ponder
REITs are a great investment option due to their exposure to many different segments of the real estate industry. Investors may also find the mandatory dividend payments a motivating factor. They provide regular income streams and a return of investment.
The residential REITs are expected be successful in 2022. This makes it an attractive investment option, with so many options. FFO expectations have been consistently outperformed by most companies in the sub-industry in 2021. Many have raised their full year 2022 outlook on the strength of underlying demand and favorable rental growth.
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