Are Residential REITs Undervalued?

Real estate investment trusts focused on high density prime metro area apartment ownership and management are historically a stable asset class offering attractive dividends. These REITs have benefited from stable rent growth and low interest rates.

  • 5yr Beta: 0.5 to 0.85
  • Dividend yields: 2.5% – 4.5%

From February 2020 pre-COVID highs:

  • Equity Residential (ticker: EQR) is down 38%
  • AvalonBay Communities (ticker: AVB) is down 32%
  • Essex Property Trust (ticker: ESS) is down 35%

According to Nareit’s Residential REITs tracker, the sector is down just over 20% as of the date this article was published.

Why are residential REITs so beaten down?

  1. Urban exodus spurred by COVID. With the unprecedented shift to work from home (wfh), people understandable want more space. People also want to avoid common areas and high population density for fear of catching the virus.
  2. Record low mortgage rates are luring apartment renters into home ownership.

Data from the National Multifamily Housing Council suggests the percentage of rent payments made is holding up. Coupled with occupancy rates holding fairly steady, this should protect the balance sheet and dividend through the remainder of the sector downturn.

Here’s what we believe:

  • the above listed apartment REITs are well-managed and equipped to weather the industry downturn
  • demand for urban living will pick up once COVID-19 is under control
  • occupancy rates will remain weakened but stable (EQR is at 95% for Q2 2020 vs. 96.5% for Q2 2019)
  • renters will continue to honor their rent obligations
  • low interest rates will drive class A real estate valuations higher

While the S&P 500 is up 4% from February 2020 pre-COVID highs fueled by perhaps an irrational exuberance for technology stocks, residential REITs make for an attractive contrarian value investment for long-term investors looking for dividend income.

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