As war roils markets, apartment REITs gain favor

Job growth and rising rents bode well for share prices

From left: Piper Sandler's Alexander Goldfarb; Mizuho Securities' Haendel St. Juste (Mizuho Services, Piper Sandler) Haendel St. Juste; Alexander Goldfarb, managing director and equity researcher at Piper Sandler
From left: Piper Sandler's Alexander Goldfarb; Mizuho Securities' Haendel St. Juste (Mizuho Services, Piper Sandler) Haendel St. Juste; Alexander Goldfarb, managing director and equity researcher at Piper Sandler

Stocks have had a rocky 2022. Inflation and the Fed’s efforts to curb it by raising interest rates, along with weak economic forecasts  and the invasion of Ukraine have dragged the S&P 500 down more than 10 percent this year. In early March, the index suffered its sharpest one-day drop since 2020, and iInvestors now expect a bear market in 2022.

But analysts say one sector is poised for growth: real estate investment trusts focused on multifamily properties.

For one thing, after a rough first year of the pandemic, their fundamentals now look good.

REITs’ recovery has varied by geography. Firms with portfolios concentrated in big coastal cities, such as Essex Property Trust, which exclusively owns West Coast assets, or bi-coastal Equity Residential and AvalonBay Communities, didn’t recoup pandemic losses until renters returned to urban life last summer.

Sun Belt REITs, such as Mid-America Apartment Communities, recovered more quickly. Shares rose to pre-pandemic levels by May 2021, boosted by fewer Covid restrictions and the influx of renters to more spacious southern suburbs.

“Across the South, a lot of the markets remained open, more government-friendly,” said Haendel St. Juste, a senior REITs analyst at Mizuho Securities. “So the rent collections were better.”

In the months that followed, strong fundamentals for the sector have fueled a steady comeback story for shares. Nationally, rents are up 17 percent from before the pandemic, according to Zillow. And demand for multifamily living has reached its highest level ever, the National Apartment Association reported, with the majority of that stemming from the Sun Belt and parts of the Southwest.

Those REITs reported year-over-year earnings growth throughout 2021. Mid-America Apartment Communities’ fourth-quarter earnings per share surged 122 percent from a year earlier. Equity Residential’s doubled.

Shares have risen in tandem. The stocks of the four firms mentioned above have all outpaced the S&P, led by Mid-America Apartment Communities’ 44 percent gain since March 2021.

Do they still have room to grow? Analysts say yes.

Many leases signed last spring included multi-month concessions. Those discounts have disappeared in the hot market, ensuring rent gains for owners.

“If you remove that one-to-two months’ free rent, that’s 16 percent more rent for any given year,” St. Juste said. “You get a pretty big hike, and I think we’ll continue to see that for the next few months.”

The analyst did warn that year-over-year comparisons this summer could be less impressive, given that rents had rebounded and concessions had begun to dwindle by June.

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But record demand for apartments coupled with the construction delays stalling new development means those REITs still have “pricing power and the ability to generate rent growth,” he said.

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The ability to raise rents has allowed REITs to outrun inflation. As of February, the consumer price index had risen 7.9 percent in the past year versus 12.3 percent for the national median rent for a one-bedroom. “The economic fundamentals driving rent higher are not going away any time soon,” wrote Zumper data scientist Jeff Andrews.

Apart from high demand and low inventory, a key factor pushing apartment REITs’ performance is employment, Piper Sandler analyst Alexander Goldfarb said.

“As long as you have job growth, apartments will be fine,” he reasoned.

Though labor shortages, a byproduct of the so-called Great Resignation, still hamper hiring, recent employment data tell a tale of growth.

In February, the unemployment rate dropped to 3.8 percent, the lowest since February 2020, when it had reached a more than 50-year low. And the economy created 92,000 more jobs than estimated in December or January, Reuters reported.

Essex and other West Coast REITs are uniquely positioned to benefit from employment growth. Across Northern California, rents are still down 10 percent from pre-pandemic levels, said Goldfarb, as tech workers have been slow to return to cities. In San Francisco, Zumper reported rents 16 percent below March 2020 levels.

But with big tech demanding that workers be back in their offices next month, apartment owners are expecting an influx of employees that will bolster rent growth.

“That’s a huge upside for investors who are looking for late plays,” said Goldfarb.

Granted, apartment REITs are not a perfect hedge against a down market. Share prices of Mid-America, Essex, Equity and AvalonBay have waxed and waned since Russia invaded Ukraine three weeks ago. But while the S&P 500 has fallen 4 percent in that span, all four REITs have gained, including Essex by 6 percent.

St. Juste said even if oil costs rise and inflation weighs on household budgets, “housing at its core is a necessity.”

“Yes, the global economy, global issues, all of that has an impact on markets,” he said, “but ultimately, from an investor looking at [apartment REITs], the job growth is critical.”

For investors, the anticipated performance of REITs should mean larger dividends for a sector that already distributes hefty payouts to shareholders. And full-year forecasts for all four firms are for growth in 2022.