Being small isn't bad, but it means you miss out on some big opportunities. That's why Essex Property Trust (NYSE:ESS) merged with BRE Properties and why Mid-America Apartment Communities (NYSE:MAA) bought Colonial Properties Trust. Operating on a bigger stage, these two apartment real estate investment trusts (REITs) have new tools at their disposal.
A commodity product means scale
Apartments are increasingly a commodity item. That isn't to suggest that every apartment or every apartment market is the same, but customer expectations are increasingly similar. If you want to be in the top markets, you need to offer good product. So, there's little value in being a niche player unless you are working in lesser markets or dealing with fixer uppers.
Essex and Mid-America aren't in either of those spaces. Essex, which completed its $16 billion merger with BRE in April, operates on the West Coast, with 50% of its portfolio is Southern California (Los Angeles, for example), 33% in Northern California (San Francisco), and the rest largely in Seattle. Those are desirable markets with high standards.
But living up to high standards requires people on the ground to keep apartments looking nice. And, on that front, Essex gained material scale. After the merger it has more apartments on the West Coast than any other apartment REIT. That spells economies of scale for a REIT that's still something of a niche player.
Such synergies were also behind Mid-America's late 2013 purchase of Colonial for around $8 billion. Although Mid-America's portfolio is far more diverse than Essex', spanning more than a dozen states and 50 markets, the company expects to save over $0.30 a share now that it's bulked up.
It's more than just spending less
But these deals were about more than just getting bigger in a hurry. They were also about laying a foundation for continued growth. That includes greater access to capital. Essex, for example, specifically highlighted these benefits: "Larger scale enhances capital market opportunities," "Improved liquidity in both equity and debt markets," and "Lower cost of capital over long term." Essentially, now that its "big," more investors will notice it and with a larger asset base it will have more clout.
Eric Bolton, the CEO of Mid-America Apartments, noted in his company's 2013 annual report that, "The larger scale of our operating and financing platform creates advantages which will support higher operating margins and lower cost of capital..." The annual report's tag line was, "20 Prosperous Years & Just Getting Started." The ability to access cheaper capital can only help Mid-America live up to that.
Now is a good time to get big
And now is the right time for Mid-America and Essex to refocus around growth plans. The REIT industry is large, but the biggest players often get the best opportunities. That's especially true in prime markets. So leapfrogging up the scale is a win/win for the REITs and their investors. Particularly with home ownership in steady decline.
After peaking around 69% in 2006, home ownership has fallen steadily to about 65% today. Some industry watchers, like legendary landlord Sam Zell, think it could fall another 10 percentage points. In other words, there's increased demand for apartments already and the potential for even more demand down the line.
And, so far, according to Calvin Schnure, industry trade group NAREIT's vice president of research and industry information, apartment demand continues to climb. For example, first quarter vacancies reached a, "new low for the cycle." And that was despite new supply coming on. In fact, Schnure believes that there is material pent up demand, "from individuals who are currently sharing accommodations or living at home..."
Essex and Mid-America are clearly gearing up to meet that current and future demand. And while being big isn't everything, it is important in the apartment markets this pair serve. Both REITs are worth a deeper dive now that they've bulked up. Warren Buffett just bought nearly 9 million shares of this company
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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.