Residential has been one of the more resilient forms of commercial real estate during the 2020 pandemic. Apartment real estate investment trusts, or REITs, reported collecting nearly 95% of their typical rent during both April and May, better than both office and healthcare REITs. And keep in mind that this is just the sector average -- the best-quality retail REITs held up even better.
In addition, there are some compelling demographic trends that should keep demand and rent for apartment properties growing for years to come. The millennial generation is just starting to enter its peak earning years, and this is a group that's more likely to rent than to own residential property than previous generations, to name just one.
With that in mind, here's what you should know before investing in your next apartment REIT, as well as three examples of apartment REITs that could be excellent additions to your portfolio this month.
What is an apartment REIT?
First, a real estate investment trust, or REIT, is a special type of company whose primary business activity involves owning, operating, developing, and/or managing real estate assets. Among other requirements, a REIT must distribute at least 90% of their taxable income to shareholders as a dividend.
Most REITs specialize in a certain type of properties. Residential REITs are one of the subsectors, and while some residential REITs buy single-family rental properties, most own apartment buildings. Some own large, urban high-rise apartments, some own suburban garden apartments, and others own student housing communities, just to name a few examples. And some own a combination of different styles of apartment buildings.
Are apartment REITs risky?
It depends on what you mean by risky. As long as the particular REIT you decide on is well managed and financially sound, apartment real estate tends to be a rather predictable type of investment. Apartments aren't particularly cyclical, meaning that they tend to be in demand no matter what the economy is doing, and paying rent tends to be a financial priority for tenants. The rent collection numbers for the COVID-19 pandemic that I discussed in the introduction help illustrate this point.
On the other hand, no type of stock is completely risk-free, and apartment REITs are no exception. For example, an apartment REIT can face oversupply issues if there are more apartment units in a market than there are potential tenants. Rising interest rates tend to be a negative catalyst for REITs of all types. And if the homeownership rate starts to rise significantly, it could hurt the rental market.
The point is that there are certainly risk factors, but when compared to most other types of stocks, apartment REITs are designed to produce steady and rising income with a relatively low level of risk.
3 Apartment REITs to buy in August
Several apartment REIT stocks look like attractive buys this month in light of their recent sell-offs. Topping the list are AvalonBay Communities (NYSE: AVB), Equity Residential (NYSE: EQR), and Mid-America Apartment Communities (NYSE: MAA).
Investing in itself
Shares of AvalonBay have lost more than 25% of their value this year. Weighing on the stock is the impact COVID-19 has had on rent collections. During the second quarter, the company's total residential rental revenue declined by about 2%, which caused its FFO to slip 1.8%.
That downward trend will likely continue in the coming quarters because more renters who can work from home due to the pandemic are moving to cheaper areas than urban city centers. While that's not the direction investors would like to see those numbers heading, it hardly seems to justify a more than 25% valuation haircut.
Because of that, AvalonBay's board of directors recently authorized a $500 million share repurchase program. That will enable the company to take advantage of the current discount between its stock price and the underlying value of its real estate assets. Add that buyback to the company's compelling 4.2%-yielding dividend and its upside when the economy improves, and the stock has the potential of generating market-beating total returns in the coming years.
A massive war chest to go apartment shopping
Equity Residential's stock price has lost a third of its value this year. Again, the main issue is the impact COVID-19 is having on its tenants. In particular, the market is worried that the current work-from-home trend will cause people to move out of big cities like San Francisco, Boston, and New York, which would impact demand for apartments in those areas. That would have an outsized effect on Equity Residential since it concentrates on urban markets. It's already starting to see this effect. CEO Mark Parrell stated, "We see good demand for our apartments, both urban and suburban, but with increased customer price sensitivity, especially in the urban cores of New York, San Francisco, and Boston."
On a more positive note, the REIT has one of the strongest balance sheets in the sector, including A-rated credit and $2.4 billion of liquidity. It bolstered its financial profile during the second quarter by selling two properties for $384.2 million and closing a low-cost term loan for $495 million. Because of that, it has lots of flexibility to make acquisitions in the current environment.
Those deals should help boost its FFO, giving it the funds to continue growing its dividend, which currently yields 4.5% after this year's sell-off. That rock-solid financial profile and payout make it a great low-risk apartment REIT to buy this month.
Strength amid the storm
Shares of Mid-America Apartment Communities are down about 11% this year. The stock hasn't fallen as much because the REIT isn't as concentrated around the big cities as its rivals but instead focuses on slightly smaller markets in the Sunbelt region.
That enabled Mid-America Apartment Communities to report solid second-quarter results. Core FFO per share increased from $1.53 to $1.59 while average effective rent grew 3.4% year over year. The company also benefited from some recently completed development projects, which are still in their initial lease-up stage.
While market conditions remain uncertain, the apartment REIT has a strong balance sheet to weather the storm. It's also in the process of wrapping up its remaining development projects, which should help grow its FFO over the coming quarters. Those factors put its 3.4%-yielding dividend on solid ground.
High-quality apartment REITs on sale
The COVID-19 outbreak, which caused the deepest recession on record, has real estate investors spooked. They're worried that tenants won't be able to pay their rent, which will impact rates and occupancy levels. While we've seen some impact, it hasn't been anywhere near as bad as the market feared. Because of that, high-quality apartment REITs like AvalonBay, Equity Residential, and Mid-America look attractive this month since they trade at lower prices and higher dividend yields. Given the overall strength of their portfolios and balance sheets, these REITs seem like long-term winners as the economy rebounds.
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