This year has been particularly difficult for most asset classes. Stocks are down over 20% from their highs, and the fixed income market has suffered as well. About the only asset class that has performed well has been residential real estate, which is testament to years of underbuilding.
The trick for equity investors is to find a stock that gives exposure to this asset class. Single-family rental REITs have been in the doghouse as starter homes become more and more expensive. That said, there is a way to gain exposure to residential real estate without the baggage.
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Equity Residential's wheelhouse
Equity Residential (EQR 1.62%) is a real estate investment trust (REIT) that focuses on apartments for young, affluent professionals in urban markets. One of the few assets that has worked this year has been residential real estate, with real estate indices like the FHFA House Price Index reporting that house prices are up 18.8% on a year-over-year basis. Rising house prices, along with increased mortgage rates, have impacted housing affordability, especially for the first-time homebuyer. The typical high-income, first-time homebuyer who has been priced out of the starter home market is pretty much the ideal type of tenant for Equity Residential.
Equity Residential is unique in that it focuses on the top-tier markets and tenants. The company focuses on southern California, San Francisco, New York City, Boston, and other affluent urban areas. It is expanding into Denver and Austin. These locations are characterized by strong knowledge-based job growth, particularly in high-tech industries. These areas usually have tight residential real estate markets, where the typical single-family starter home is expensive relative to incomes. The ideal tenant is a high earner who is not yet rich. These tenants typically want to live close to where they work, which means an urban environment with easy access to public transportation.
The company's recovery from the COVID-19 pandemic is largely complete
Equity Residential suffered a bit during the COVID-19 pandemic because it chose to "buy occupancy," which means it often gave concessions such as a month's free rent or free amenities in order to keep tenants in their apartments. The end result is that the company had a couple of years when leases were below market. The company is at the tail end of that and rents are resetting to market levels. Funds from operations (FFO, which is the preferred measure of profitability for a REIT) fell in 2020 and 2021 due to pandemic-related issues, but first-quarter 2022 FFO rose nearly 15%.Equity Residential's 2021 FFO was 13% lower than pre-pandemic, however the sub-market leases the company signed in 2020 still affected 2021 numbers. As these leases reset to market, Equity Residential has a lot of catch-up potential going forward.
The housing shortage is a tailwind for Equity Residential
Ultimately, Equity Residential is benefiting from the fact that the U.S. has a housing shortage, which is the result of a decade of underbuilding. This is driving up home prices in its key markets, which allows the company to raise rents accordingly. This thesis should remain intact for the foreseeable future as labor and materials costs make new home construction expensive. Equity Residential pays a quarterly dividend of $0.625 per share, which gives the company a dividend yield of 3.4%. The stock gives income investors liquid exposure to the residential real estate market, which is one of the few asset classes that is "working" right now. This makes it a good investment for an income investor.
