As we continue our series on our favorite REITs within each sector we cover, we now turn to the Apartment REITs. This sub-sector has been on a bit of a hot streak for a while now, along with the REIT sector as a whole. Year-to-date, the Vanguard Real Estate ETF (VNQ) is up 12.5% meanwhile the S&P 500 is up 9.7%. We cover six of the largest apartment REITs around, which account for roughly $105 billion in market cap value. Many of these names do not present screaming values at this time, but we will give you an overview of our top three favorite to keep on your watchlist.
Apartment REIT Sector
The Apartment REIT sector, as we mentioned in our opening, has been on a tear for 2019, and much of the past year. As much of the nation's housing has become less and less affordable over the past few years due to the recent housing predicament, it has left many with no choice but to rent apartments. In housing over the last few years, the nation has been bogged down with a housing shortage of new builds, and low inventory coming on the market from existing homes, which in turn have led homeowners to outbid one another, thus increasing pricing.
We cover six of the largest apartment REITs traded today, and they comprise of most of the apartment REIT market cap totaling $106 billion: AvalonBay Communities (AVB), Equity Residential (EQR), Essex Property Trust (ESS), Mid-America Apartment Communities (MAA), UDR, Inc. (UDR), and Camden Property Trust (CPT).
Source: DGE REIT Trading Platform
The sector has outperformed the S&P 500 YTD and for much of the past few years. Here is a look at performance for the apartment REITs we follow compared to the S&P 500:
Source: DGE REIT Trading Platform
As you can see, these apartment REITs have vastly outperformed the S&P 500 at every stage over the course of the last two years, which is largely due to the lack of affordability in housing and the appeal new-age apartments have with the millennial generation, which is not yet inclined to get involved with purchasing a home.
There is a lot to like within the apartment sector, as the strong economy has equated to record low unemployment, which is a headwind to the apartment sector. Low unemployment leads to stronger job creation numbers as well as opportunities for wage growth, as employers must pay for the best, which both bode well for apartment REITs. Wage growth in 2018 for non-managerial workers increased from 2.4% to 3.3%. The lack of interest from millennials to purchase a new home has been largely due to pricing increases, which have increased 50% in the past few years, as have mortgage rates (though still near record lows) of late, combined with rising debt levels. This generation is attracted to many of the perks put in place by the apartment owners that have attracted this new generation. The prime renting age is between 25 and 34.
Another angle homeowners look at is where we stand in the housing cycle. For those that believe we are at the tail end of the latest run, they believe it would be more beneficial to rent at a lower rate and reinvest the savings, and it would outperform owning and building equity in terms of wealth creation, according to a study performed by Florida Atlantic University late last year.
With that said, let's discuss our three favorite apartment REITs: AvalonBay Communities, Equity Residential, and UDR, Inc.
Apartment REIT #1: AvalonBay Communities
In terms of market cap, AvalonBay Communities and Equity Residential are the two largest apartment REITs within the sector, both hovering around $27 billion. AvalonBay is an apartment REIT with a long-term track record of developing, redeveloping, acquiring and managing distinctive apartment homes in some of the best U.S. markets. The company focuses on coastal markets within the Northeast, Mid-Atlantic, Pacific Northwest, and Northern and Southern California regions of the country.
As of December 31, 2018, the company owned or held a direct or indirect ownership interest in 291 apartment communities containing 85,158 apartment homes in 12 states and the District of Columbia, of which 21 communities are under development and nine communities are under redevelopment.
The company grew FFO by 5.3% in 2017 and 4.3% in 2018. Revenues grew by 5.8% during 2018, which primarily was attributable to the stabilization of operating and development communities. The company acquired four communities during the year, three of which came in Q4, so this goes to show that the majority of the revenue growth was organic. Rental revenue increased 2.5% for established communities with occupancy remaining consistent at 96.1% for these properties.
Here is a look at the company's F.A.S.T. Graph:
As you can see, the company has traded around a 22x P/FFO multiple over the course of the last five years. Currently, the stock holds a P/FFO multiple of 22x, so trading right in line with recent history. In terms of dividend yield, the company has increased its dividend an average of 6.6% over the same time period. The board just approved an increase of 3.4% for the first quarter, marking the eighth straight annual increase since exiting the Great Recession. Over the course of the last five years, the company has traded with a dividend yield of 3.02%, which is EXACTLY where it is trading at today, again suggesting the stock is trading in line with recent history.
Overall, by purchasing this stock today, you are not getting a bargain by any means, but management continues to steer the ship in the right direction. The company has reported quality results again this year, so if you are looking for a quality income play within the Apartment REIT sector, we like AVB.
Apartment REIT #2: Equity Residential
Equity Residential is an S&P 500 company focused on the acquisition, development and management of rental apartment properties located in urban and high-density suburban markets. Like AVB, we like the fact that the company is located primarily on the coastal regions of the US. The company has communities within seven markets in the United States: Seattle, San Francisco, Southern California, Boston, New York, Washington D.C., and Denver. As you can see, all but the Denver location is a coastal market. These markets appeal to us and the company due to their strong job growth.
Here is a quick snapshot from the company's most recent investor update regarding its portfolio:
Source: Investor Update
The company recently reported its Q4 and full-year 2018 earnings, which saw same-store revenues grow 2.3% for the full year with occupancy of 96.2%. The renewal rate for the year grew 4.9%, helping produce the highest residential retention rate in the company's history. Normalized FFO grew 3.8% on the year, which was primarily attributable to increased same-store NOI.
Let's look at the company's F.A.S.T. Graph:
As you can see in the chart above, the company is trading above its five-year P/FFO average, which has hovered around 21x. Currently, the stock trades at a P/FFO of 23x, thus indicating it is overvalued in terms of its recent history. Regarding dividends, the company currently sports an annual dividend yield of 2.96%, which is below its five-year average of 3.09%. The company has been all over the map in recent years with its dividend, but it did raise the dividend 7% in 2018 after no raises for a few years.
Overall, the company has a quality portfolio along the coastal markets, which is our preference when investing in apartment REITs. It is trading a little high at current levels, so I would suggest waiting for a pullback before investing.
Apartment REIT #3: UDR, Inc.
UDR, Inc. is an S&P 500 company that focuses on successfully managing, buying, selling, developing and redeveloping attractive real estate properties in top-tier U.S. markets. As of December 31, 2018, UDR owned or had an ownership position in 48,860 apartment homes including 817 homes under development or in its Developer Capital Program - West Coast Development Joint Venture.
From the November investor presentation, the company sported the portfolio snapshot below. As you can see in the snapshot, almost 50% of NOI comes from the west coast markets.
The company prides itself on providing luxury apartments with upscale amenities to attract the millennial generation. It puts a modern twist on rental living, which was once viewed as a launching pad to homeownership; however, millennials have been less interested in homeownership thus far, so companies like UDR are taking advantage.
The company recently reported Q4 and full-year 2018 results. During the year, the company increased FFO 5.5%, same-store revenue 3.5%, and NOI 3.4%. Another interesting note for the year was the fact the company repurchased approximately 593,000 shares at an average price of $33.69. Same-store occupancy increased 20 basis points on the year to 96.9%, which is among the highest in the industry.
Let's take a look at the company's F.A.S.T. Graph:
As you can see in the chart above, the company is trading above its five-year P/FFO average, which has hovered around 20.4x. Currently, the stock trades at a P/FFO of 22.7x, thus indicating it is overvalued in terms of recent history. In regard to dividends, the company currently sports an annual dividend yield of 2.90%, which is well below its five-year average of 3.22%. It has raised its dividend an average of 6.60% over the course of the last five years. Also, the company has raised the dividend for eight straight years now after fully exiting the Great Recession.
Overall, like the other apartment REITs, we believe the company has a well-focused portfolio filled with high-quality coastal properties. The company is well-focused on the millennial generation and is taking full advantage of it. Like other apartment REITs we like, UDR too seems to be overpriced as investors have preferred the apartment REIT sector due to housing shortages and recent price increases. Currently, we rate the stock a Hold and suggest waiting for a pullback.
Note: We hope you all enjoyed the article and found it informative. As always, we look forward to reading and responding to your comments below and feel free to leave any feedback. Happy Investing!
Author's Disclaimer: This article is intended to provide information to interested parties. We have no knowledge of your individual goals as an investor, and we ask that you complete your own due diligence before purchasing any stocks mentioned or recommended.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.