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Last year was a challenging one for residential REITs, or real estate investment trusts, as the average one produced a negative 10.7% total return. Some performed even worse because the pandemic had an outsized impact on apartment markets in high-cost urban locations. That's because companies allowed their employees to telecommute, which caused an exodus to lower-cost suburban areas.
However, that trend could reverse in 2021 as vaccines roll out, enabling companies to welcome their employees back to urban offices. That could provide a big shot in the arm to REITs focused on those urban cores like AvalonBay Communities (NYSE: AVB), Essex Property Trust (NYSE: ESS), and Equity Residential (NYSE: EQR). This bounce-back potential makes this trio of high-quality apartment REITs look like compelling buys this January.
Betting big on itself
Shares of AvalonBay Communities slumped 23.5% last year. The culprit was the impact of the pandemic on its operations. For example, the REIT's core FFO per share declined 12% during the third quarter, driven by a 6.1% year-over-year drop in same-store rental revenue because of lower occupancy and rental rates, as well as some uncollectable rent. The biggest trouble spots were high-cost cities like New York City and San Francisco.
On the one hand, those headwinds will likely remain in place for the next few months. CEO Tim Naughton stated on the third-quarter earnings conference call that "a meaningful recovery in our business will not occur until employers believe that they could safely bring their workers back to the workplace."
However, that should begin to happen this year as vaccines get rolled out, which could help put the pandemic in the rearview mirror. In the meantime, the REIT is betting on itself by repurchasing its beaten-down stock and pays a well-supported 4%-yielding dividend.
Well-positioned for the West Coast recovery
Shares of Essex Property Trust declined by 21% last year because of many of the same issues facing AvalonBay. The REIT, which focuses entirely on high-cost West Coast markets, experienced a 6% decline in its core FFO during the third quarter, due in large part to concessions it made to entice tenants to sign leases.
While the company will likely continue to experience some headwinds during the first part of 2021 until the virus is under control, its results should bounce back as companies return to the office, forcing employees to move back closer to their work. In the meantime, the REIT has a top-notch balance sheet and a conservative payout ratio on its 3.6%-yielding dividend, putting that income stream on rock-solid ground.
The flexibility to pounce when the right opportunity emerges
Equity Residential's stock finished 2020 down 26.7%. That's mostly due to its focus on owning apartments in high-cost urban core areas, which were hit hard by the pandemic. That was evident in the third quarter as its normalized FFO tumbled 15.4%. The culprit was that the "approximately 23% of our portfolio located in the urban cores of New York, San Francisco, and Boston continues to struggle with pandemic-related reductions in economic activity, which have led to declines in occupancy, lower resident renewal levels, and a related drop in rental rates," according to comments by CEO Mark Parrell in the third-quarter press release.
On the one hand, the REIT "anticipate[s] that our financial results will weaken over subsequent quarters as the full effect of the pandemic is felt on our business." However, Parrell stated that "looking longer term, we expect that positive developments relating to the pandemic will eventually reenergize the urban centers which have persevered and thrived through many decades and in similarly challenging circumstances."
That should happen as vaccines roll out, enabling people to return to their urban offices and enjoy the benefits of living close to all the action. In the meantime, the REIT has a top-notch balance sheet, which it recently bolstered by selling a property in San Diego for $312.5 million that will help pay off its only significant 2021 debt maturity. Because of that, it has lots of financial flexibility to capture opportunities that might arise this year. Meanwhile, it offers an attractive 4.2%-yielding dividend to complement its upside potential as its stock recovers.
High-quality apartment REITs on sale
AvalonBay, Essex Property, and Equity Residential are currently facing strong headwinds because of the pandemic. While these might not fade for a few months, they could eventually become significant tailwinds as people flock back to urban areas to be close to their jobs and cultural and entertainment attractions. That reversal seems likely in 2021 as vaccines put the pandemic in the past, making these apartment REITs great buys this month in anticipation of an eventual rebound.
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