The employment rate has steadily improved during the past several years, which means that more people in the younger generations can finally afford to leave the nest. And the majority of younger people -- between 60% and 70% -- are becoming renters, not owners.
A great way to play this trend is with real estate investment trusts (REITs) that own and operate apartment communities, such as Equity Residential (NYSE:EQR), AvalonBay Communities (NYSE:AVB), and American Campus Communities (NYSE:ACC).
Strength in diversity
One of the largest apartment-focused REITs, Equity Residential, buys high-quality apartment properties in the top U.S. growth markets such as New York, Washington D.C., and San Francisco. The trust owns nearly 400 properties consisting of more than 111,000 rental units, and most are concentrated in the company's "core" markets. These are markets with higher rent than the U.S. average, as well as higher rent growth rates.
In addition, Equity's core markets have lower apartment vacancy rates and higher median home prices, which means that the company's properties tend to be in cities that encourage renting. Even though Equity Residential's portfolio is concentrated in a "core" basket of markets, none of them represent more than 15% of the portfolio. With the geographical strength and diversity, as well as the sheer number of properties owned, you just can't beat this kind of diversification.
As an investment, the trust has produced an average annual total return of about 14% during the past two decades. It definitely has the possibility to create serious wealth in your portfolio over the long run.
High barriers to entry
AvalonBay Communities focuses on developing, acquiring, and managing apartment communities in "high barrier-to-entry" markets, which are actually quite similar to Equity Residential's "core" markets. What AvalonBay means by high barrier-to-entry markets is areas with a low supply of land on which to build more apartments, as well as a lengthy and difficult development process. The trust has identified 18 such markets, and all but five of the company's 274 properties are located in these markets, which include Boston, New York, Northern Virginia, and Los Angeles.
The company likes to diversify the types of apartments it offers, with a healthy mix of garden/townhome, mid-rise, and high-rise properties. In total, AvalonBay owns more than 82,000 apartment homes, which produced about $1.5 billion in revenue last year.
The company's strategy seems to be a winning one; during the past 20 years, AvalonBay has performed fantastically, with average total returns of nearly 17%.
Everyone wants to get out of the dorms
American Campus Communities is a more specialized play on rental housing. The company invests in off-campus student housing communities. Since going public in 2004, it has grown tremendously. These days, American Campus Communities is the largest REIT specializing in student housing, and has 168 properties with a total of nearly 103,000 beds in 78 different university markets.
The company is still growing strong, producing a 2.8% annual rental revenue growth, and is expecting the same in 2015. During the next year, new supply of student housing is expected to slow down, which should further increase American Campus Communities' pricing power.
Basically, this is a play on the fact that students want to live on (or near) campus, but not in the dorms. Not only is there the potential for higher income thanks to rental-rate growth, but there is also a lot of potential to expand, as the idea of a private off-campus housing community is still a relatively young one.
The list goes on
This is by no means an exhaustive list, and there are several other REITs that focus on apartments and other rental housing properties. The main point here is that owning a REIT like one of these is a much better play on real estate for most investors than simply buying an investment property. If all goes perfectly, you could probably earn a higher rate of return by buying a house and renting it out -- but that's a big if.
REITs like these eliminate the hassle and guesswork of owning rental properties, and allow you to spread your money over a basket of properties, thus minimizing risk. If your rental house sits vacant for a month, you make no money. On the other hand, if one of AvalonBay's units sits vacant, you won't even notice.
Investing in one of these (or another) apartment REITs is a great way to play the strong trend in rental housing while still allowing you to sleep at night.
Matthew Frankel 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.