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Rising Interest Rate Environment: Residential REITs Gain Attention
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Rising Interest Rate Environment: Residential REITs Gain Attention

Rising Interest Rate Environment Shifts Focus on Residential REITs

TThe Real Estate Investment Trusts, (REITs), sector is highly fragmented and includes many sub-industries. Each sub-industry has its own set features and factors that can affect its performance. REITs generally give out 90% or more of their earnings as dividends. This makes them an attractive investment option for those who are looking for regular income.

Let’s look deeper into one promising sub-industry: Residential REITs. They are poised for rapid growth in 2022. Mortgage rates are rising at a record 4%, making home ownership expensive. People are choosing to live on rent and this is driving the Residential REITs segment.

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Notably, Residential Reit Investment Trusts have seen an increase in occupancy and higher rent rates since 2021. This trend is expected continue well into 2022. The sub-industry can further be broken down by the market location, namely coastal or suburban, central business district, CBD, etc., and also by the property type (e.g. apartment, multifamily, student accommodation, etc.).

Deutsche Bank analyst Derek JohnstonJohnston recently returned to the Residential REITs sector and has some compelling insights. Johnston has increased cap rates (yield-on-investment) and lowered premiums to the company’s net assets value (NAVs) based on current economic conditions. 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 noted the forces driving his optimism regarding the sector. Johnston noted that as millennials age, they start families, their roommates are often de-coupled after the pandemic. He also suggested that home valuation spikes and a downsizing cycle may be a possibility, while first-time buyers might have a harder time getting affordable housing.

Analysts believe the industry will experience lower year-over–year expense comp benefits due to technological investments that have been made in the past. This will result in lower employee costs. The COVID-19-related expenses are also decreasing, further reducing margin pressure. Based on the above points, the analyst predicts a large sector-wide earnings growth of over 20% in 2022.

Let’s take a closer look at three of the most prominent Residential REITs companies, and what the analyst thinks.

AvalonBay Communities (AVB)

AvalonBay specializes in the development, rehabilitation, acquisition, and management multifamily communities. This is primarily in high-barrier urban market areas such as New England, New York/New Jersey and the Mid-Atlantic, Pacific Northwest, Northern and Southern 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 consisted of 297 apartment communities that housed 87,992 apartments 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. The analyst also sees 15% labor cost savings in the future with further digitalization.

Based on robust 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 manages a portfolio that includes apartment communities in the sunbelt 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 apartment homes as of January 31, 2022.

CPT had a much smaller impact than its peers, who experienced a negative effect on their bottom lines due to the pandemic over ten years. CPT saw favorable rent growth in January 2022 and February 2022. This upward trend is expected to continue.

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 for 2023 has increased to $7.11 from $6.76. The factors driving the increased FFO growth include improved tenant demand and solid lease spreads.

The analyst reiterated the Buy rating on CPT stock, while lowering the price target from $200 to $190. This implies 12.5% upside potential to current levels. Camden Property’s dividend yield is 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, development, management, and maintenance of rental apartments in urban and suburban gateway markets, including Boston, New York, Washington, D.C., Washington, D.C., Southern California, San Francisco, Seattle, and Washington, D.C. EQR has a growing presence in Denver, Atlanta and 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.

The analyst commented on the same. He said that while the Toll Brother’s partnership should ease the transition, we expect some dilution near-term as EQR scales up to match the efficiency enjoyed in long-standing markets like New York City or Southern California.

EQR’s February year-todate metrics also showed continued momentum for rental rates. However, occupancy has fallen by -20 bps YTD and now stands at 96.4%.

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 the above assumptions analyst Johnston raised the FFO per share estimates of EQR to $3.45 (from 3.31 for 2021) and further to $3.83 for 2023 (from 3.61 for 2023).

The analyst reiterated a hold rating for EQR stock, while reducing price target to $93 (from $94). This implies a 3.2% upside potential from 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 price forecast at $98.33 indicates 9.2% upside potential compared to 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 might also find that mandatory dividend payments provide regular income streams as well as a return on their investment, which can be a motivating aspect.

It is expected that residential REITs will do well in 2022. With so many players to choose, it makes it a compelling option for investors. FFO expectations have been consistently outperformed by most companies in the sub-industry in 2021. Many have raised their full year 2022 outlook due in part to strong underlying demand and favorable rental growth.

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These views and opinions are solely the author’s and do not necessarily reflect the views of Nasdaq, Inc.

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