The pandemic and record-low interest rates combined to spark a housing market rally that drove home prices and apartment rental rates to unprecedented heights. Now, rising interest rates and recession fears have turned that tide.
The stock market feeds on growth, of course, and the sudden lack of it has caused a lot of investors to bail out, driving down the price of some real estate investment trusts (REITs) that now deserve serious consideration.
That group includes Essex Property Trust (ESS 1.13%), which owns a portfolio of about 62,000 units in 253 apartment communities in and around San Francisco, Southern California, and Seattle, Washington. These are areas that have been among the nation's highest-priced housing markets for years and, while sales prices and rent growth rates have cooled off a bit in them, properties in those markets are still in high demand.
Sustaining some rent growth in strong local markets
Management is guiding for rent growth of only 2% in 2023 but notes that unemployment in its local markets remains lower than the national average. It also noted that job growth in these markets continues to outperform as well. For instance, despite layoffs by some major tech companies, Essex points out that Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) has begun work on a new San Jose campus -- located near a number of Essex communities -- that is projected to provide 25,000 new jobs in the next 10 years.
And it's still more than twice as expensive to buy than it is to rent in Essex Property Trust's core markets, meaning the height of the hurdle one must jump to move from renting to homeownership should help sustain demand for its apartments. While one might expect that would have helped support Essex's share price, the opposite has happened. The stock is down by more than a third from last year and to me, it seems oversold.
Founded in 1971, Essex has raised its dividend every year since going public in 1994. Indeed, the value of resilience through economic cycles should be baked into a provider of one of those basics of life -- shelter -- and Essex has done that well, edging out the S&P 500 and crushing the sector benchmark Vanguard Real Estate ETF in total returns since the dawn of the Great Recession some 15 years ago.
Data by YCharts.
Keeping in mind that Essex Property Trust, as a REIT, is a passive income play as much as a growth stock, it's worth noting here that it also yields about 4%, a bit more than the 3.6% of that Vanguard ETF -- which typically holds about 160 REITs -- and more than twice the 1.7% or so yield of the S&P 500.
As this chart shows, over the same 15 years, Essex not only more than doubled its dividend but grew its funds from operations (FFO) per share by a similar amount. FFO is viewed as the most valid measure of the cash flow that a REIT generates, and speaks to its ability to cover its payouts -- and even better, keep raising them.
Data by YCharts.
A strong longtime performer now on sale
FFO also is one half of another key metric when considering a REIT: the share-price-to-FFO ratio. For Essex, that ratio currently is about 15.6. That's right in line with its peers. The largest publicly owned apartment REIT, Mid America Apartment Communities, trades at a 16.2 share-price-to-FFO ratio.
I own shares of Mid America and was considering adding to that position since the stock is off by about 25% in the past year, but I'm now leaning toward opening a position in Essex instead. With its beaten-down share price, its slow but steady dividend growth, and a strong presence in markets where demand remains strong among people who can pay its high rents, this apartment REIT is the top multifamily stock to buy in January.
