Chris B

Fundamentals Weaken for U.S. Apartment Building REITs

"...we could see record numbers of renters looking for apartments in a relatively supply-constrained environment. Of course, until then, fewer jobs mean fewer rent checks."
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That's an interesting observation that merits some questioning. Is there a decline in apartment occupancy due to:
1) a massive increase in homelessness,
2) a massive increase in home ownership,
3) or an increase in roommate / adult-kids-with-parents arrangements?

Or are there just more evictions, unpaid rents, and so on? The answer to these questions is key to predicting recovery. In any case, I agree with the unemployment / rent revenue correlation implied here.

REITs: Risk Perception and Prospects

Interesting. I've been studying HCP, looking for the catch...

Current ratio: 2.58 check!
Leverage: Acceptable for an REIT
Rapidly declining debt levels... check!
Does declining debt explain declining cash flow?... yes, check!
Stable revenues...fairly stable, check!
Customers:
- Hospitals... stable, economically insensitive
- Senior housing... stable, economically insensitive
- Medical office buildings... stable, economically insensitive
Positive earnings... check!
Excessive executive compensation?... no, check!
Valuation:
-Selling @ book value
-P/E of 10, earnings growth expected
-expected yield ~ 9%, fairly safe
Increasing dividends?... check!

The bottom line question that a potential investor has to answer is this: Will healthcare property leases generate less income in the future as a result of this recession? Or are hospitals and senior housing somewhat immune?

Avalon Bay: A Look at Apartment REITs

"However I believe that the 70 to 90% decline in apartment REIT prices already reflects this reality. Moreover consider the fact that many properties in the portfolios of these REITs have existed for a decade or two and hence I am more worried about the effect on occupancy from unemployment than from new investors coming in as competitors."
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Even if the value of the equity portion of these properties has dropped 70-90%, the value of the debt underlying them has not. If an apartment complex could be sold on the market today for $1M, and has a $1.2M mortgage on it, owner's equity is less than zero, not 10-20% of what it used to be. Note that declines in market prices for real estate are not reflected in book value, only historical cost and perhaps wear and tear.

How long the physical buildings have existed is irrelevant. What's relevant is when they were last mortgaged and for how much. Just a couple years ago, holding equity in your buildings was considered wasteful, and many REIT managers bought into this thinking, taking out more loans on paid-for buildings to parlay into other properties. That's how you end up underwater on 30 year old apartments.

Likewise, competitors enter the market not by building new apartments, but by purchasing bankrupt operations on the cheap. From the perspective of your REIT, the competing property is still there, as always, but now they have lower costs and rents. This process is also occurring for previously owner-occupied housing, increasing the supply of rentals, especially at the high end of the market where most REITs operate. Rents are going down. Check the government stats of you don't believe it.

It is this deflation of rental rates that is problematic, because the mortgage payments on these properties will never decline. Per Yahoo, AVB's 4Q2008 ROE is under 4% reflecting a 19% decline in revenue and a 98% decline in earnings. How much room have they left themselves for declines in rents or increasing vacancies if they don't reduce rents? Obviously, just a couple of years ago, an environment where rents ever went down was unthinkable for management.

They'll eventually survive by issuing more stock or reducing that dividend to reflect reduced earnings, if earnings can even remain positive. There are no other options. That said, a dividend reduction is the cheapest financing any company can get, so it's the right thing to do here.

I'm actually considering financially strong REITs in the self-storage area such as EXR and PSA and the healthcare/senior care sector such as HCP, HCN, HR, and VTR.

The rationale for self-storage is that demand will be sustained by churn and foreclosures in the real estate market and the trend towards formerly independent households consolidating with roommates. The rationale for the healthcare / senior care REITs is demographic inevitability.

Overall this is an excellent discussion, and I thank all participants.

Avalon Bay: A Look at Apartment REITs

I have one problem with REITs at this point:

New investors are purchasing foreclosure properties all around these apartment complexes (and maybe purchasing entire competing apartment complexes too!) for 30-40% less than what the REIT paid a couple years ago. That means their payments will be lower, which allows them to undercut the local REIT on rents. Wouldn't purchasing an REIT at this point be the equivalent of assuming the mortgage for an underwater landlord?

Stocks in REITs Climb High Despite Broader Real Estate Worries

Aalan,
That's because the real economy keeps chugging on, even as a dozen or so investment banks lose money and dominate the headlines. Look at non-investment bank earnings. Look at retail bank earnings. They're doing OK.

More specifically the author does explain EQR.