Last month we published a note (Fear, Greed and Residential REITs) in which we highlighted our belief that “current valuations are reflective of an overly dour outlook for the group as most signs are leaning towards a re-acceleration in demand and firming occupancy levels as we head into the critical spring/summer leasing season”. We closed out this missive by making the case that the apartment REITs were attractively valued and calling out “that many of our constituents currently provide a dividend yield of approximately 4% and these dividends are well covered by operating cash flow. We would also point to earnings growth (funds from operations) expectations for the group that are in the 6-7% range for 2023. The sub-sector is also trading at an approximate –20% discount to net asset value (NAV) today and it has historically traded at a modest premium to NAV.”
With the first quarter 2023 earnings season now in full bloom, most apartment companies have reported results that were in-line, or modestly better than company guidance and investor expectation. More important, the outlooks for the balance of the summer leasing season were encouraging, with a few operators (AVB, CPT, MAA) having the confidence to raise full year 2023 guidance even with a backdrop of a slowing national economy and sizeable deliveries of still to come in many sunbelt markets. The combination of low expectations for the group coupled with discounted valuations has resulted in a meaningful uptick in performance for apartment REITs on both an absolute and relative basis. Over the past six weeks several of our constituent names have rallied upwards of 10-15%. [1] For the month of April, apartment REITs have achieved a total return of +4.55% and single-family rental REITs have returned +6.48%. This compares to a return on the FTSE Nareit Equity REITs Index of +0.83% over the same one-month period. [2] On a one-year basis, apartment REITs continue to have considerable ground to make up and have lagged the broader FTSE NAREIT Equity REITs by 600bps.
Looking at the apartment industry from a national perspective, a recent CoStar analysis highlighted the drop-off in multifamily absorption which began in the second part of 2022 and accelerated through the end of the year. Net absorption has started to improve of late, but the looming overhang of supply is being felt in many sunbelt markets as rent growth is now considerably stronger in Northeast and Midwest geographies. By way of example, cities and submarkets around Indianapolis, Cincinnati and Northern New Jersey saw 1Q23 rent growth in the 4.5-6.5% range, while Las Vegas and Phoenix witnessed a –1.9% decrease over the period. Vacancies at the national level are up 200bps over the historic low level of 4.7% which was achieved in early 2022 and Costar is forecasting that the national vacancy rate ends 2023 at approximately 7%. The big story in the multifamily segment for 2023 will be supply and Costar is forecasting that around 520,000 units will be delivered over the course of the year, the highest level since the mid-1980’s. Of the top 20 markets projected to hit record deliveries this year, 12 of those markets are in sunbelt metros. [3]
While it is helpful to get the view from a national perspective, conditions on the ground vary greatly from region to region and amongst sub-markets and price point, or asset quality. The first quarter reports from the apartment REITs were decisively more positive than what we glean from the national data. Fundamentals across coastal and sunbelt markets showed signs of sequential improvement with both rents and occupancy levels accelerating over the first several months of 2023 and encouraging data was also noted in April highlights and from lease renewal notices going out for the May/June/July periods.
With the condition of the economy overall, and the consumer in particular causing concern amongst investors, REIT management teams were quick to point out the solid profile of their resident base with unemployment remaining low and rent/income levels that are below historic norms. Inflation weighed quite heavily on the consumer in 2022, even though the economy was strong and unemployment rates low. With inflation now starting to moderate, consumer sentiment rose in the first quarter and could become a greater tailwind for apartment REITs as the year progresses.
Many coastal operators have the benefit of not being faced with supply overhangs in coming quarters and noted that bad debt expense (primary from California) was better in 1Q23 and the positive momentum is expected to persist through the balance of the year. Demand in sunbelt markets was reported to have improved even with a normalization in migration patterns which accelerated following the onset of the pandemic.
Focusing on a few of the big names in the group, AvalonBay Communities (AVB) had a strong start to the year as they beat their forecasted results for the period and raised their full year expectation for earnings. Operating metrics remain impressive as the company reported same-store results for revenue, operating expense and net operating income (NOI) of 8.5%, 4.7% and 10.3%, respectively. Rent growth has accelerated through April, driven by regions including the east coast and southeast Florida. Occupancy ended the period at 96%. The company is also noting a potential pick-up in development activity as construction costs have come down modestly along with land costs as some smaller developers no longer have access to construction financing. The development business could be the primary source of external investment in coming quarters as the acquisition market across multifamily and beyond remains very quiet with a sizeable divide between buyers and sellers. [4]
Equity Residential (EQR) had a good first quarter to start the year. They raised the dividend by 6% and their coastal markets are benefiting from a rebound in demand and manageable levels of supply. The same store results were solid with 9.2% revenue growth, a 7.2% increase in operating expenses, and NOI growth of 10.2%. Operating expenses were inflated in the quarter due to cleanup costs associated with the torrential rains that plagued many parts of California earlier in the year. Revenue numbers were aided by better results for delinquencies in Southern California where non-payers are now either catching up on their past due rent or moving out. The portfolio’s college educated resident base is financially stable with rent/income levels on new leases coming in at 20%. EQR’s New York and Washington DC portfolios are exceeding expectations thus far in the year and S. California is finally starting to improve. San Francisco is performing in line with expectation and the Seattle portfolio is behind forecast with the market seeing higher concessions due to pockets of excess supply. [5]
Mid-America Apartments (MAA) reported best-in-class results for 1Q23 with same store metrics for revenue, expenses and NOI of 11.0%, 8.3% and 12.5%, respectively. Results were ahead of expectation and the company made a slight upward revision to full year guidance. Even with MAA’s exposure to sunbelt markets, their portfolio achieved positive net absorption and occupancy that is consistent with the levels recorded early last year. April trends were also solid and while supply is expected to put some pressure on rents this year, the overall outlook is encouraging. The company expects a slowdown in new multi-family starts by the second half of the year and believes starts will remain muted through 2024, thus making the case for peak supply in 2023. [6]
Definitions:
FTSE NAREIT Equity REITs Index – A comprehensive benchmark that contains all tax-qualified REITs with more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property that also meet minimum size and liquidity criteria
Basis points (bps) – one hundredth of one percent
Footnotes:
[1] YahooFinance: AvalonBay Communities, Equity Residential Apartments, Mid-America Apartments
[2] Nareit: Daily U.S. Return Worksheet: April 28, 2023
[3] Costar Group 2023: United States Multi-Family Overview – April 27, 2023
[4] AvalonBay Communities: 1Q23 Financial Results
[5] Equity Residential: 1Q23 Financial Results
[6] Mid-America Apartments (MAA) – 1Q23 Financial Results
