Outlook Gloomy for Residential REITs Amid Coronavirus Crisis

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. The types of residences include apartment buildings, student housing, manufactured homes and single-family homes. Residential REITs rent spaces in these properties to tenants and earn a rental income in return.

Some of the prominent players in this industry are AvalonBay Communities, Inc. (AVB), Apartment Investment and Management Company (AIV), Essex Property Trust, Inc. (ESS), Mid-America Apartment Communities, Inc. (MAA) and UDR Inc. (UDR).

Remarkably, the prime leasing season for the U.S. apartment market did not have a favorable start this time. This is because the coronavirus crisis has hurt the economy, while the massive job cuts in the beginning of the April-June period affected leasing activity. However, the latest figures from real estate technology and analytics firm RealPage (RP) suggest that apartment leasing pace was “brisk” in July, aiding occupancy rates to remain steady and keeping rents flat. Total new lease signing volumes climbed 5.7%, year on year. Retention rates were also high, in turn resulting in a steady occupancy level.  

Here are the three major themes in the industry:

The COVID-19 Pandemic and Soft Rental Demand: The pandemic has been wreaking havoc, and resulting in macroeconomic uncertainties and a choppy job-market environment, in turn, causing household contraction and consolidation. Apart from these, a number of factors have been affecting rental demand, including the coronavirus outbreak and the work-from-home trend, resulting in a shift of some renter demand away from higher cost and urban/infill markets. In addition, record-low mortgage rates and the desire for space are spurring homes sales and adversely impacting rental demand. Moreover, there is a decline in demand from two categories of renters — corporate and students — since most temporary corporate assignments have been canceled, while higher education is now adopting remote learning models and limiting on-campus activities for the near term. Thus, there is a reduced demand in many urban submarkets, though a number of suburban ones are benefiting from this.

Technology Adoption: The adoption of new technology, aimed at improving operating margins and customer experience, has been underway for quite some time now. Nevertheless, 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 are 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.

Rent Collection Woes: The pandemic is also affecting the rent-paying capabilities of residential tenants. Though the extended unemployment benefits from the CARES Act provided support earlier, of late concerns have been rising over the reduced unemployment payments. Furthermore, use of concessions is likely to be rampant amid a slowdown in demand. In addition, waiving of various fees for residents, including late payments, has dampened residential REITs’ top-line growth. Given the magnitude of uncertainty in the economy and its reopening, any turnaround is unlikely in the near term. Therefore, residential REITs with a better balance-sheet position and ample liquidity are likely to have a smooth sail through the current crisis.

Zacks Industry Rank Indicates Bleak Prospects

The REIT And Equity Trust - Residential industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #189, which places it at the bottom 25% 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 bleak 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 bottom 50% of the Zacks-ranked industries is a result of the negative 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 losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2020 and 2021 moved 9% and 8.3% south, respectively.

Before we present a few stocks that you might 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 as well as the broader Finance sector in a year’s time.

The industry has depreciated 20.3% during this period compared with the S&P 500’s decline of 18.3%. During the same time frame, the broader Finance sector has lost 7.1%.

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 17.76X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 22.85X. The industry is trading above the Finance sector’s forward 12-month P/E of 16.40X. 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.

Bottom Line

In a nutshell, despite the technology embrace, any significant turnaround in rental demand is unlikely in the near term given the magnitude of uncertainty in the economy and about reopening amid the still-high infection rates. Nonetheless, the shift in rental demand from urban/infill markets to suburban markets might open up opportunities for some regions, while any stimulus check to support renters’ liquidity will support rent payments.

Currently, there is no stock in the industry sporting a Zacks Rank #1 (Strong Buy). However, there are two stocks with a Zacks Rank of 2 (Buy) and another carrying a Zacks Rank #3, which seem prudent choices for the portfolio.

You can see the complete list of today’s Zacks #1 Rank stocks here.

American Homes 4 Rent (AMH): This Agoura Hills, CA-based REIT is focused on acquiring, developing, renovating, leasing and operating attractive, single-family homes as rental properties. The company owns single-family properties in select submarkets across 22 states. The stock currently carries a Zacks Rank of 2. The stock’s current cash-flow growth of 9.2% compares favorably with the industry’s 7.2%. The Zacks Consensus Estimate of $1.19 for 2021 FFO per share indicates a year-over-year increase of 8%.

Preferred Apartment Communities, Inc. (APTS): The Atlanta, GA-based REIT is mainly engaged in the ownership and operation of Class A multi-family properties, with select investments in grocery-anchored shopping centers, Class A office buildings, and student housing properties. This Zacks Rank #2 company’s consensus estimate for the ongoing year’s FFO per share moved nearly 1% upward to $1.05, in the past 30 days.

Equity Residential (EQR): 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). The ZacksConsensus Estimate for the current-year FFO per share moved 1% north to $3.35, in the past 60 days.

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.

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United Dominion Realty Trust, Inc. (UDR): Free Stock Analysis Report

RealPage, Inc. (RP): Free Stock Analysis Report

MidAmerica Apartment Communities, Inc. (MAA): Free Stock Analysis Report

Essex Property Trust, Inc. (ESS): Free Stock Analysis Report

Equity Residential (EQR): Free Stock Analysis Report

AvalonBay Communities, Inc. (AVB): Free Stock Analysis Report

Preferred Apartment Communities, Inc. (APTS): Free Stock Analysis Report

American Homes 4 Rent (AMH): Free Stock Analysis Report

Apartment Investment and Management Company (AIV): Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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