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Rental Market Shakeup: Good or Bad for These 3 REITs?

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The housing market has been somewhat fickle over the past year or two, sputtering and stalling until finally getting into gear over the past few months. Not surprisingly, many real estate investment trusts have been affected by all aspects of the housing market lows and nascent recovery -- particularly those involved in renting property, and, in a new twist, those buying the foreclosures littering the landscape of the housing bust.

But it's not just a residential issue. The downturn in housing caused another casualty, particularly in New York City: office rentals. As Wall Street firms contracted in the wake of the mortgage meltdown, vacancies went unfilled -- a real problem for business property REITs.

Both the residential and business rental markets are changing, affecting three REITs that operate in different areas of property investment: apartment complex REIT AvalonBay Communities (NYSE: AVB  ) , office property manager Brookfield Properties (UNKNOWN: BPO.DL  ) , and newcomer Silver Bay Realty Trust (NYSE: SBY  ) , which invests in single-family foreclosures.

AvalonBay: feeling the pinch as housing improves
Big apartment REIT AvalonBay has had a busy year, the effects of which recently showed up on its fourth-quarter earnings report. Superstorm Sandy expenses weighed on the company's balance sheet, as did acquisition costs for its recent purchase, with partner Equity Residential, of former Lehman Brothers property portfolio Archstone.

It was more than these one-time charges that caught investors' attention, though, causing the stock to fall a little each day since AvalonBay reported earnings on Jan. 31. In a conference call following the earnings release, CEO Timothy Naughton indicated that rising single-family home sales and home prices may prompt more tenants to become homeowners, curbing the advantage that apartment owners have had over the past few years, when many chose to rent rather than buy. In addition, new units in AvalonBay's market, particularly along the coast, will be available this year -- a bit ahead of schedule, putting unexpected pressure on the REIT.

Brookfield Properties gets its groove back
On the subject of rentals, things are looking up for office space in the Big Apple. Just a few short months ago, office REITs like Brookfield were concerned about the lack of growth in their sector. Lately, though, things have been looking up. Brookfield's stock has risen precipitously ever since management announced that it is in the latter stages of signing tenants for approximately half of the 3 million square feet that's expected to become available by the end of this year.

The huge office rental company expects two tenants to take over 1.5 million square feet at its Brookfield Place location in Manhattan, formerly known as the World Financial Center. The space is currently being rented by Bank of America, which acquired the leases along with its takeover of Merrill Lynch in 2009.

Silver Bay: A newcomer with potential
Spun off from Two Harbors Investment (NYSE: TWO  ) , Silver Bay specializes in buying up foreclosed single-family homes, renovating them, and renting them. Though newly settled in on the big board, the success of the model can be seen through the frenzied acquisitions of the Blackstone Group (NYSE: BX  ) , which can't seem to get enough of these types of homes.

Will a recovering housing market be kind to companies like Silver Bay? Time will tell, but it is interesting to note that one of the first Wall Street firms to jump on this trend was Och-Ziff Capital Management (NYSE: OZM  ) , which accumulated about 300 houses in northern California before announcing last fall that it would like to sell its portfolio, according to Reuters.

Overall, a sunny forecast for REITs
Does this bode well or ill for the nascent single-family rental industry? While the article notes that the private-equity firm may have been disappointed with the returns, the company sources also commented that Och-Ziff wants to make money on the healthy rise in home prices in that section of the country. Even though this player is exiting the business, selling some of the renovated houses in their portfolios certainly sounds like it should eventually be part of the plan for Blackstone and Silver Bay as well.

Though the predictions from AvalonBay sound a bit dire, there was plenty of good news, too. A recent report from Reis, a real-estate research firm, noted that the rate of apartment vacancies dropped from 5.2% in the fourth quarter of 2011 to 4.5% in the last quarter of 2012. Even the fact that new apartments will be entering the market throughout the year doesn't shake Reis' belief that vacancies will stay low.

Despite the CEO's concerns, AvalonBay's own predictions for the coming year are rather upbeat as well. The company expects its current properties to produce revenue increases of 3.5% to 5%, while operating expenses are estimated to increase only by 3% to 4%. Net operating income is projected to rise by 4% to 5.5%. Reis also believes that rents will increase throughout this year but notes that wealthy clients of high-end rentals -- such as Archstone -- may decide to jump into the housing market now that the rebound seems permanent.

As for Brookfield, Reis reported last October that office vacancies were at their lowest point in nearly three years, particularly in large cities such as Manhattan. The research firm noted that tech and energy firms were snapping up office space in large cities, and, as a bonus, rents were rising, too. As the mortgage market picks up in response to a housing rebound, more financial-sector businesses should begin trickling into the lower Manhattan office-rental market as well.

The rental trade is a profitable one and should only become more so, as the economy improves -- even AvalonBay expects 2014 and 2015 to be better than this year. And that's good news for investors of every stripe.

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