According to an analysis of census data from the National Association of Homebuilders, the number of for-rent multifamily housing units started in the second quarter of 2022 surged to 142,000. This is the highest figure since 1986. Overall multifamily for-rent units have been at multidecade highs for the past year.
Are we looking at a glut of apartment units, and will that negatively affect Equity Residential (EQR 1.85%), an operator of luxury apartments?
Equity Residential focuses on the best markets for landlords
Equity Residential focuses on markets that attract affluent long-term renters. Its properties are located in areas that have strong knowledge industry job growth, significant apartment demand, and expensive single-family housing. Unsurprisingly, Equity Residential's primary markets are San Diego, Los Angeles, San Francisco, Seattle, Boston, New York City, and Washington, D.C. Home prices in most of these areas have been rising at a double-digit percentage clip for years, and these locations have some of the most expensive real estate in the U.S.
Many of Equity Residential's markets have a shortage of housing
According to the National Association of Realtors, there is a housing shortage in many of Equity Residential's Markets, including Los Angeles, Boston, San Diego, New York City, and San Francisco. These areas are seeing strong home-price appreciation, which supports higher rents going forward.
In the grand scheme of things, 142,000 units in a quarter (or about 568,000 a year) is a drop in the bucket compared to the need. The National Association of Realtors estimates that there is between a 5.5 million and 6.8 million unit gap between supply and demand in the United States. It will take years to bridge that gap.
Equity Residential apartments will remain home for many erstwhile first-time homebuyers
Between rising home prices and increasing mortgage rates, affordability has taken a hit, particularly for first-time homebuyers. The ideal tenant for Equity Residential is young and affluent and may struggle to find an affordable single-family property in places where starter homes can cost $1 million. Many of these renters will choose to wait until the market turns or their wages increase to the point they can afford a property.
Rents are rising rapidly
Equity Residential reported second-quarter earnings that showed the company was seeing a 19% year-over-year increase in rent for new leases and an 11% rise in lease renewals for a blended rate of nearly 15%. Occupancy improved 10 basis points to 96.4% as well. These figures certainly don't indicate that a glut of apartments is about to suddenly emerge. Despite the numbers out of the National Association of Homebuilders, landlords have the upper hand.
The company also raised its full-year funds from operations (FFO) per share estimate. Funds from operations is how real estate investment trusts (REITs) generally report earnings. This is because generally accepted accounting principles (GAAP) require businesses to deduct depreciation and amortization from revenue. For real estate companies, this non-cash charge is quite large and therefore net income under GAAP tends to understate the earnings power of the business.
Equity Residential stock is trading at 21 times the company's guidance for 2022 normalized FFO per share. It also pays a quarterly dividend of $0.625 a share, which works out to a 3.3% dividend yield. For the foreseeable future, Equity Residential's dividend looks safe and well covered by funds from operations.