New Highs For Apartment REIT Stocks Show Investor Confidence

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Includes: AIV, CPT, EQR, ESS, MAA, UDR
by: Anne Anderson, CFA
Summary

Apartment REIT stocks are hitting new highs, up 19% on average for 2019.

Supply of new apartments appears delayed from the previously announced schedule.

Essex Property Trust to see most competition from new projects due to west coast market exposure.

Equity Residential sees easing competition in previously overbuilt East Coast markets.

Camden Property Trust CPT expects faster growth following years of divestitures.

Apartment REIT stocks are all trading at new highs, up 19% on average year to date for 2019 compared to the S&P 500 Index, up 15%. This outstanding relative performance of Apartment REITs demonstrates investor confidence that growth of new apartment supply will moderate during 2019, after heightened awareness of the incremental supply issue during 2018. Review of available data from HUD and apartment industry commentators supports this optimistic view of apartment supply.

Also, it appears that, unlike other REIT sectors, investors have firm confidence in FFO growth projections for Apartment REITs, based on high occupancy (95-97%) and rental rate increases of more than 3%. These important factors support consistent performance and dividend growth for Apartment REITs to a greater level of confidence than for Office REITs and Retail REITs, making Apartment REITs a conservative choice, despite current high stock prices.

This chart shows year to date performance for the largest Apartment REIT stocks. Note that the average is up 19%, with UDR Inc. (NYSE:UDR) and Apartment Investment (NYSE:AIV) up the least (up 16% for UDR and up 17% for Apartment Investment). Best performance is shown by Essex Property Trust (NYSE:ESS) and Mid-America Apartment Communities (NYSE:MAA), both up 22%.

Apartment REITs at new Highs

This outstanding stock price performance should concern new investors only if there is a risk to underlying assumptions about growth drivers. Occupancy is so tight that the risk of negative surprise is low. Most important to FFO growth for Apartment REITs is rental rate increases, building "embedded growth" as apartment leases are renewed. Allowing for variance in metropolitan markets, rental rate increases of more than 3% are easily obtainable nationwide.

Greatest uncertainty for Apartment REITs, both for FFO growth and for stock price performance, comes from the outlook for new apartment supply, always presenting a competitive challenge for new move-ins and a source of expensive concessions (free rent for a month or more). Accordingly, a look at expectations for new apartment supply and actual 2019 completions are a way to get comfortable with these record prices for Apartment REITs.

At the beginning of 2019, the outlook for new apartment supply indicated significant new competition in key urban areas. However, it now appears that delays in new construction, whether caused by challenging weather or concern over the economy, will keep new apartment supply at about the same level as in 2018, with significant relief for previously overbuilt East Coast markets such as New York City and the DC metropolitan area.

Analysis of new supply trends is discussed on this article in National Real Estate Investor, quoting Greg Willett, chief economist for RealPage, as well as other real estate industry consultants on the topic of 2019 delivery delays.

Quotes from National Real Estate Investor

Please note that RealPage is citing the number of new apartment units opened, based on their in-depth analysis of local markets throughout the US. Number of apartments opened is not the same as number of apartments permitted nor the number of apartments completed. There is a time lag between completion and opening of new apartment communities, a duration often referred to as "lease-up". In fact, it sometimes happens to unfortunate developers that unforeseen circumstances, whether financial, regulatory, or competitive, may prevent a completed apartment development from opening for many months.

Also from RealPage is this additional analysis of which urban markets are likely to see the largest increase in apartment supply, based on announced development plans as of January 2019. Concern is no longer on East Coast urban markets; now the risk of overbuilding is focused on the West Coast. According to the article from RealPage, "among the top 10 largest increases expected in major markets, 5 are in California."

Apartment Construction in Key Urban Markets

What do we see new apartment supply as we move towards the summer months of 2019? Can we confirm that delayed construction is holding incremental apartment supply during 2019 close to the same level as 2018? Although official US data is available only through April 2019, we can now see that delayed construction actually is a significant factor. This latest report on US Residential Construction from US Census Bureau HUD, dated May 16, 2019, confirms the probability of construction delays offsetting scheduled pace of new apartment construction.

This table below summarizes pertinent data from the latest report on US Residential Construction from Census Bureau HUD. It shows that building permits issued for more than 5 units of multifamily apartment development increased more than 9% year to date through April 2019. However, the number of "authorized not yet started" developments increased 38% from the previous year as of April 2019 and increased 10% from the level of "authorized not yet started" units as of December 2018 (which was the highest month during 2018).

Summary of apartment building permits and construction

The table above also shows actual multi-family construction starts of more than 5 units increased only 1.4% from the previous year as of April 2019, for a current seasonally adjusted pace of 359,000, just barely down 0.4% from the actual construction starts of 360,300 during 2018. Also, the number of seasonally adjusted annual apartment completions is down more than 14% as of April 2019. This data appears to confirm that 2019 is on track for about the same amount of new apartment supply as 2018.

New investors should feel reassured by this data that Apartment REIT stocks are looking at a stable supply environment for 2019. Now examination of the valuation and outlook for the different Apartment REITs should help to focus investor selection on those stocks most likely to deliver incremental gains, even from these high levels.

The table below shows current yields, market caps, and FFO guidance for 7 of the largest Apartment REIT stocks. Yields are lower than in 2018 when these stocks were depressed by concern over incremental apartment supply. Still, with an average yield at 2.97%, assuming stable occupancy and average rental rate increases of more than 3%, dividends should increase at least in line with FFO growth. Long experience with Apartment REITs confirms that management guidance is conservative, in light of these significant growth drivers.

Apartment REITS yields, market caps, FFO guidance

The most conservative investors may choose the largest Apartment REIT stock, Equity Residential (NYSE:EQR), with a current yield of 2.92% supported by a market cap of $30 billion. Although Equity Residential's stock has increased 18% during 2019 to a current price of $78, it has yet to surpass its high price of $82 per share achieved during December 2015. Management guidance for FFO growth of 1-6% for 2019 may deliver an improvement over 4% FFO growth achieved for 2018. Management certainly sounds confident in their latest investor presentations, indicating that East Coast markets have fully absorbed the impact of new upscale apartment supply in New York City and in DC, both markets that were problematic in 2018.

In contrast, Essex Property Trust faces a challenge from the rapid build of new apartments in key West Coast markets. While the West Coast always earns a premium for superior employment growth, particularly in the technology sector, additional pressure comes from constant discussion of rent control initiatives. Essex Property Trust stock is up 22% during 2019, now at an all-time high of almost $300 per share, representing a $20 billion market cap. Yield for Essex Property Trust is the lowest of these 7 Apartment REITs at 2.61%. Although I have no doubt that Essex Property Trust will deliver promised FFO growth in the range of 3-5% for 2019 and will continue on its consistent growth track for the foreseeable future, I see more immediate upside for Equity Residential stock than for Essex Property Trust.

For those investors interested in considering the mid-cap range of Apartment REITs, available yields are higher and current guidance appears achievable. I highlight both Camden Property Trust (NYSE:CPT) with market cap of $10 billion and MAA with market cap of $14 billion. Both these mid-cap Apartment REIT stocks are trading at their all-time high prices. Both yield more than 3.00%, with Camden Property Trust yielding 3.04% and MAA delivering an attractive yield of 3.28%. Current upside for Camden Property Trust appears greater among these 2 Apartment REITs, based on guidance of 5-8% FFO growth for 2019, while MAA demonstrates greater caution, with guidance for FFO growth of 1-5% for 2019.

My current Buy recommendations are on Equity Residential, Camden Property Trust, and MAA. While I see long-term outlook for Essex Property Trust is still attractive, my current rank for the next 12 months is HOLD, due to the greater exposure to more challenging West Coast markets.

About REITMonitor Index:

REITMonitor Index tracks 88 REITs with total market cap of $885 billion.

Performance is analyzed by REIT sectors, noting standout performers and underperformers triggering investor response.

Disclosure: I am/we are long CPT. 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.