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Are Residential REITs Safe Right Now?

Aug 06, 2020 by Liz Brumer

2020 has been an interesting year for real estate investment trusts (REITs). Certain sectors of real estate have been hit hard by the coronavirus pandemic while others have flourished. Rental real estate is an asset class that historically has been resilient, offering investors financial refuge during economic downturns.

But today's challenges are not the same as those of the past. With millions of tenants unemployed and unable to pay rent, eviction moratoriums prohibiting landlords from evicting delinquent tenants, universities closing the school year early, new cleaning protocols in shared spaces, and social distance requirements have brought a new set of challenges to the rental industry, leaving investors curious as to whether residential REITs are a safe investment right now.

Let's take a look at where the residential REIT industry stands and whether it's a safe investment in the current climate.

What is a residential REIT?

Residential REITs are a type of equity REIT that owns, manages, and leases residential rental real estate. Student housing, single-family rentals, affordable housing communities, urban high rises, and mobile home parks are all examples of residential REITs, making this a diverse category with a variety of different asset classes under one umbrella.

Its strengths

Even during tough economic times, rent payments are one of the last expenses to get cut by tenants. This is reason collection rates for apartment REITs have remained relatively high, with 95.7% of rents collected in July 2020, according to the National Association of Real Estate Investment Trusts (NAREIT).

Outside of the current pandemic, demand for rental housing is strong. The current shortage of housing has resulted in high rental rates and low occupancy, a wonderful combination for residential REITs. People will always need a place to live.

Its vulnerabilities

The biggest vulnerability facing the residential REIT industry right now is the uncertainty around government policies that may or may not be enacted in the second coronavirus stimulus package. There is heavy debate as to whether additional unemployment benefits will continue to be provided, which is likely a large contributing factor to higher rent collection rates by residential REITs over the past few months. Additionally, there is debate over whether a national eviction moratorium will be put in place restricting landlords from evicting past due tenants.

These policies will directly impact the ability of certain tenants to pay and the ability for landlords to fill uncollectible units with paying tenants. While the unemployment rate saw a decline from March and April highs, with a total of 11.1% of Americans unemployed in June of 2020 according to the Bureau of Labor and Statistics -- the unemployment rate is still staggeringly high. Millions of people are out of a job, which places huge pressure on landlords across the nation.

Are residential REITs a safe investment right now?

The current pandemic is affecting each asset class in different ways, meaning certain sectors have been affected more than others or have heightened vulnerabilities. AvalonBay (NYSE: AVB), one of the largest apartment REITs in the nation with 86,380 rental units, had a collection rate of 93.3% as of July 28, 2020. A relatively strong collection rate, although continuously declining since March of 2020.

Invitation Homes (NYSE: INVH), which focuses on leasing high-end single-family rental homes in top-tier markets throughout the U.S., has seen an increase in rental occupancy over the summer at 97.8% occupancy and 92% rental collections for July 2020. Again, a decline, but still a strong collection rate given the current climate.

American Campus Communities (NYSE: ACC), which specializes in developing and remodeling student housing projects on and off campuses across the country, reported a 90.1% pre-lease rate and an 89.2% rent collection rate in June of 2020, a 2% decrease when compared to the same month last year.

Sun Communities (NYSE: SUI) invests in mobile home communities and RV parks, selling or leasing over 142,000 units in 33 states across the U.S. and Canada. Unlike other residential REITs, Sun Communities has seen little impact from COVID-19, achieving a 97.3% occupancy rate, up 0.7% from the second quarter of 2019, and a 97% and 98% collection rate for RV and mobile home rentals, respectively, for Q2 2020, on par with the same quarter of the previous year.

At first glance it appears that the companies above are being impacted in roughly the same way, with some faring better than others. However, there are additional vulnerabilities to consider for each.

For example, AvalonBay also owns retail space which only achieved a collection rate of 56.5% in Q2 2020, resulting in a larger loss of income than that experienced by other apartment REITs that have portfolios solely focused on residential leasing.

And while American Campus Communities has a strong balance sheet, big projects underway, and a relatively stable collection rate, its profitability for Q3 and Q4 of 2020 and beyond largely depends on universities opening in the fall and remaining open, which can change at any moment in the current climate.

The bottom line

As a whole, residential REITs are showing positive signs of resiliency right now and are proving to be a safe investment even during turbulent times. While they are undoubtedly facing a unique set of challenges, it's a short-term fluctuation that is unlikely to cause long-term impacts. But it's important to note that an individual REIT's financial health, liquidity, debt to earnings and income, development, and risk exposure will ultimately determine whether it's a safe investment at the present moment.

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Liz Brumer-Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends American Campus Communities. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.