Apartment Rents Are Surging. Here Are 3 Surprising Beneficiaries

Summary

• Rents are rising the fastest in over 30 years at the moment.
• You can profit from this by buying undervalued apartment REITs.
• We highlight 3 of them that are overlooked by most investors.
• Looking for a portfolio of ideas like this one? Members of High Yield Landlord get exclusive access to our model portfolio. Learn More »

Art Wager/E+ via Getty Images

Not Enough Housing

Census Bureau data from the 2020 Decennial Census shows that in the decade from 2010 to 2020, 12.3 million new households were formed. In the same time period, only 7 million new homes were completed.

In other words, the number of new households in need of housing outpaced the delivery of new housing supply by a little over 75%.

What happens when growth in demand exceeds the growth of supply? Prices rise. In fact, that is what we've seen with both home prices and rent rates.

Now, it does not really matter in a macroeconomic sense whether one rents or owns their home. What matters is one's total housing expenses. After all, though many assume that homeownership is the better financial decision and that renting is simply "throwing money away," the truth is that it is often more economical to rent than to buy. That is, the recurring expenses of homeownership, such as mortgage interest, insurance, property taxes, and maintenance, are often higher than the total recurring costs of renting.

In either case, rent rates tend to follow the movements of home prices over time. When home prices rise, rent rates follow, with a 6-12 month lag. That is largely because the average residential lease term is about a year. Leases have to expire before rents can catch up to rises in home prices.

Thus, when home prices rise, we should expect to see apartment and single-family rent rates rise in their wake.

That is exactly what we are experiencing right now.

A sudden drop in mortgage rates at the onset of COVID-19, combined with pent-up demand for homeownership from late-blooming Millennials, has resulted in a massive surge in home prices in the past year and a half.

Data by YCharts

And now, in the Summer and Fall of 2021, we are witnessing rent rates explode higher as well.

Investors wondering how to benefit from this might be dismayed by the massive rally in multifamily real estate investment trusts ("REITs") (VNQ) that has driven them to high valuations. But in what follows, after looking at the trend of rising rents, we'll discuss three surprising — and reasonably valued — beneficiaries of the surge in rent rates.

Rents Are Soaring

According to CNBC, rents are expected to be higher in 2021 than if the COVID-19 pandemic had never occurred.

Federal Reserve Bank of Dallas recently chimed in with their own analysis, stating that rent inflation will likely be "stickier" than most other forms of consumer inflation. In fact, the central bank says that elevated rent inflation rates are set to continue for years down the road:

The bank forecasts rent inflation to rise from 1.9% in June 2021 to 3.0% at year-end 2022 and to 6.9% at year-end 2023.

Source: Dallas Fed

If true, this would mark the highest rent growth in over 30 years.

The Dallas Fed also noted that this high rent growth could lead to higher CPI growth rates. After all, rent makes up 7.6% of CPI, and owners' equivalent rent (which tends to follow rent rates more so than home prices) accounts for 23.6% of the CPI. Historically, home prices are a leading indicator for CPI rates by a few quarters to a few years.

Source: Dallas Fed

However, we are in the midst of a very unique inflationary period.

As pointed out recently by the excellent macroeconomic analyst and Seeking Alpha contributor, Eric Basmajian, higher rent inflation will not necessarily translate into higher CPI rates. This is because prices for other CPI components such as commodities and durables have already peaked and seem to be on the decline.

In an article titled "Are You Worried About Rent Inflation," Basmajian notes:

"If the year-over-year rate of durables inflation falls from 15% to 0%, at an 11% relative weighting, the overall CPI would be dragged lower by 1.65%, totally offsetting the rise in rent inflation."

So high rent inflation will not necessarily translate into high overall inflation.

But rent growth can't be ignored, especially for landlords and real estate investors. As of August 2021, the areas of the country experiencing the fastest rent growth are:

·Boise, Idaho

·Central California

·Phoenix, Arizona

·Southern and Central Florida

·Las Vegas, Nevada

·Raleigh and Fayetteville, North Carolina

·Spokane, Washington

·Norfolk, Virginia

Source: Apartment List

Only in a handful of cities do rent rates remain below pre-pandemic levels. These cities include San Francisco, Oakland, San Jose, Fremont, Minneapolis, Seattle, Jersey City, and Washington DC. The hardest hit by the pandemic was San Francisco, where rents are not expected to return to 2019 levels until 2027.

Indeed, as reported by Globe Street, apartment rents increased 2.1% sequentially from July to August, a slight dip from the growth rate of 2.5% from June to July.

Rent rates are now up 13.8% year-to-date, more than double the headline CPI.

Compare that the average annual increase in rents from 2017 to 2019 of 3.6%. It is useful to look at the following chart of rent growth across America's 100 largest cities from 2018 to 2021.

Source: Apartment List

Notice that the very top bar, representing New York City, turned dark blue for most of 2020 but has rebounded to deep red for most of 2021.

Moreover, in keeping with the theme of a housing shortage in the US, we find that rent rates have soared in an inverse correlation to vacancies, which have been dropping steadily since a month after COVID-19 was declared a pandemic.

Source: Apartment List

With the inventory of homes for sale extremely low and rent rates for new leases rising three times faster than for lease renewals, it was recently reported that apartments' resident retention has surged back to near lockdown-era highs. What's more, apartment occupancy hit an all-time high of 97.1% in August.

No wonder, then, that apartments have been the favorite asset class among real estate investors this year.

Globe Street noted in a September 2nd article that apartments have accounted for 35% of all commercial real estate sales this year. What's more, mirroring apartment rent rate growth of 13.8%, apartment sale prices have risen by 13.5% year-over-year.

In other words, the asset class of apartments is enjoying both price appreciation and income growth. Unfortunately, though, the investment world seems to know this and has pushed multifamily REIT share prices (AVB; CPT; MAA; EQR) up accordingly:

Data by YCharts

As such, it's difficult today to find any multifamily REIT that offers a dividend yield higher than 3%.

However, there are a few hidden opportunities in the public REIT space that investors seem to have overlooked. The following three REITs provide exposure to the hot apartment asset class while also offering dividend yields well over 3%.

Armada Hoffler Properties (AHH)

·Dividend Yield: 4.73%

AHH is a diversified REIT that owns 59 mixed-use, office, retail, and multifamily properties across the Mid-Atlantic and Southeast regions of the US. What makes AHH unique is that it is also a developer, and many of the properties it owns were also developed in-house.

Notably, 30% of AHH's net operating income is already derived from apartments, and the REIT expects that percentage to climb to 32% in the near future.

Source: AHH September Presentation

AHH currently owns and operates 2,344 apartments that are 96.6% occupied as well as 1,183 student housing units that are 97.4% occupied. Its multifamily segment enjoyed a 7% increase in rent rates in the second quarter.

Additionally, AHH has several more multifamily projects in development, which will add 826 apartment units to the portfolio. In other words, the multifamily units currently in development amount to about one-quarter of AHH's existing multifamily portfolio.

Despite being an almost one-third multifamily REIT, AHH still trades at a mere 13x the midpoint of 2021 AFFO, in part because many people associate the REIT with its office and retail exposure. And the company's dividend payout ratio is a mere 61.5%, leaving plenty of room for growth.

American Campus Communities (ACC)

·Dividend Yield: 3.75%

ACC is a REIT that develops and owns on-campus apartments and dormitories at universities across the country.

You might be surprised to see a college housing REIT in the list of apartment rent growth beneficiaries. Especially after COVID-19.

Last year, the pandemic caused a substantial drop in university enrollment, and even many of the students that did enroll had no need for on-campus housing as most of their classes were online. Occupancy at on-campus housing sunk to 67% in the Fall of 2020.

But this year, the situation is completely different. College students, of all age groups, crave in-person interaction, and enrollment for in-person classes has surged for the 2021 academic year — so much so that universities are facing their own housing crisis.

This as the supply of new off-campus housing, which competes with on-campus housing to some degree, is set to fall to its lowest level since 2011 in 2022.

Source: ACC July Presentation

This situation, if it persists (and it likely will), should be a huge boon for ACC, which partners with universities to develop and manage on-campus housing. Even if it didn't lead to additional development projects or acquisitions, though, it would surely boost rent rates at ACC's existing properties.

Management has guided for rental revenue growth between 5.1% and 7.6% and occupancy between 92% and 94% for the 2021 academic year (Fall 2021 through Summer 2022). But this is with COVID still lingering. The REIT expects to see a full recovery in occupancy in the Fall of 2022.

BSR REIT (OTCPK:BSRTF)

·Dividend Yield: 3.25%

BSR flies under most investors' radar due to its diminutive size of about $470 million in market cap and the fact that it trades primarily on the Toronto Stock Exchange, but it is one of the best positioned multifamily REITs available on the market today.

That is because nearly 90% of its portfolio as of the second quarter of this year is located in the fast-growing state of Texas.

Source: BSR August Presentation

Recently, the Wall Street Journal reported that the city of Austin is currently the hottest housing market in the country, with more houses selling at over $100k above asking price than anywhere else in the nation. Moreover, Austin has the highest projected five-year population growth in the nation, with an estimated CAGR of 2.61% from 2020 to 2025.

Houston and Dallas, BSR's other two primary markets, are also in the top ten cities for projected five-year population growth.

It's no wonder, then, that in the second quarter, BSR's net asset value rose 22%, while its AFFO soared 27% YoY. We should expect to see BSR's rents continue to climb at a rapid pace for years to come. What's more, since the end of Q2, BSR acquired another, brand new apartment community in Round Rock, Texas — a suburb of Austin — that brings the REIT's total exposure to the Austin market to 22% of its portfolio.

Closing Note

Not all REITs are created equal.

Some are overleveraged. Others are overpriced. And some are even poorly managed.

To beat the market, you need to be selective and that's what we have done at High Yield Landlord

(Source: Interactive Brokers. See disclosure at the end of this article)

Today, we own a total of 7 residential REITs, representing over 20% of our Portfolio.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of AVB; CPT; BSRTF; ACC either through stock ownership, options, or other derivatives. 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.

Relevant disclosure to presented performance: past performance is no indication of future results. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated, includes international REITs, and may at times invest in companies that are not typically included in REIT indexes. The performance of our portfolio is underrepresented because it is affected by withholding taxes on all dividends. This is not the only account that I own, but it is the first account that I created for the sole purpose of building track record and it is now over 3 years old, which is probably just enough to assess results. The performance is money-weighted.

Comments

[Vandooman]

Keep in mind that huge inflation of rents often lead to rent controls.

[TooEasy]

They caused massive legal and illegal immigration for 30 years, put horrendous costs on developers and builders, restricted building and now with massive inflation on the poor and middle class these gouging scum in the banks and on Wall Street are going burn when the revolution they want so bad comes- deservedly so.

[Jussi Askola]

@TooEasy I don't quite get your comment. Also, note that legal immigration is very positive for the country.

[rbrown8016]

When you increase taxes...people with options are incentivized to move to a lower tax areas...and warm weather doesn't hurt. This isn't complicated. Why are democrats unwilling (or unable?) to incorporate basic human motivation into the calculation?
I'm personally not a republican, but can't figure out why basic human motivation is constantly ignored by one party. It's...weird.

[Jussi Askola]

@rbrown8016 Yes, I don't expect this migration trend to end anytime soon.

[Jandei]

@Jussi Askola How come you don't have a position in AHH?

[Jussi Askola]

@Jandei It is high on our watchlist. We favor other names at this time. Feel free to join us for a 2-week free trial to access all our Top Picks: seekingalpha.com/...

[bbob68]

Your headline is certainly on point. BSRTF looks interesting but it surely has been surging these past 6 months or so. Would you jump in here or look for a pull back

[Jussi Askola]

@bbob68 Thank you for your question. Foruntealty, we invested in BSRTF at a lot lower level, but even then, I think that it remains reasonably attractive at the current price. We prefer a few other options though. Feel free to join us for a 2-week free trial to access all our Top Picks: seekingalpha.com/...

Have a great day!

[bbob68]

@Jussi Askola Nice move.

[Raven27936]

Any thoughts on Tricon Residential filing for US exchange and switching to US denominated dividend?

[Jussi Askola]

@Raven27936 I don't have a strong opinion on it at this time.

[PGY]

Along with storage apts. are my preferred asset class in the REIT space. Have owned MAA forever. Bought in when I moved overseas and needed a corporate apt. in the city where my firm was located. So well run I took the money from selling my rental properties and put there. Have not looked back. One look at your graph and you know I am happy.

[Jussi Askola]

@PGY Thank you for sharing! MAA is very well managed, but near fair value I would say.

[StrattonOakmont]

You forgot to mention me as a beneficiary ;)

[Jussi Askola]

@StrattonOakmont Haha right

[Redframes]

How can one tell when a REIT is over leveraged? AHH has over $1 billion in debt and just $162 million in FCF. What other metric should one consider when evaluating leverage for REITS?

[johanvdwerf]

@Redframes Loan To Value (LTV) is a key metric, basically comparable to the value of your mortgage to the value of your house. Unfortunately the Value (NAV) for REITs is often not publicly available, yet various REIT services offer it. Debt/EV is a substitute, yet only works if the valuation is near NAV

[team4325]

@johanvdwerf agree. Also debt/ebitda - which I think most investors have migrated to after the GFC when the “v” dropped overnight and it was all about coverage.

[Lemonsack]

@team4325 Another easy metric you could back into is a rough version of debt yield. EBITDA/Total debt outstanding. I haven't looked, but would guess their debt yield is north of 15% which would suggest an LTV somewhere under 50% given the constitution of their portfolio.

[Darp Research]

When read this:

As of August 2021, the areas of the country experiencing the fastest rent growth are:

·Boise, Idaho
·Central California
·Phoenix, Arizona
·Southern and Central Florida
·Las Vegas, Nevada
·Raleigh and Fayetteville, North Carolina
·Spokane, Washington
·Norfolk, Virginia

It backed up what have observed and talked about, although may be taboo to point out, as is a "the emperor has no clothes" thing. It is political, everyone of those cities is in high demand because of politics. Everyone I know that has moved in the last 2 years has moved for political reasons.

They are fleeing Democrat areas even if they are Democrats, but both sides are fleeing Democrat controlled areas. Sister, Bay Area to CA Central Valley, 2 generations of long term CA residents moved to Idaho, Topanga (Malibu) to Portugal, another Topangan looking to move to NV or Idaho, a Super Democrat moved from CA Bay Area to Raleigh after visiting she said people politics here are fouled up but they are so much nicer people and things are so much better run here (hmm), and on and on. Florida is being flooded with political refuges, not from other failed countries, from failed USA states.

Some of these people realize and say it is politics, others have not figured it out, but that is it.

My hometown of San Francisco has biggest drop in rents so says this article. I left that area 15 years ago because of politics. The people left over there tell me how horrible it has become in last the 5 years and most want to leave and many have. In a poll 50% of people in CA say they would leave if they could.

NYC is depopulating due to politics, it was growing and robust just years ago before the political climate changed.

And teh opposite side of rental demand spectrum is the opposite side of politics:

Only in a handful of cities do rent rates remain below pre-pandemic levels. These cities include San Francisco, Oakland, San Jose, Fremont, Minneapolis, Seattle, Jersey City, and Washington DC. 100% of those are heavily Crat. Just a coincidence?

To understand migration patterns and rental demand in an unbiased and objective manner as an investor you need to pay attention to one of the biggest factors if not the biggest factor, people fleeing failed cities and States that failed due to politics.

One if not the most non-Crat cities in America is Coeur d’Alene ID, I looked for commercial property there last week and was shocked at the prices. Called a friend there and he said prices have gone up 100% in the last year there! (he got in 1 year ago). He says it is politics, people from CA and west coast WA fleeing to CDE because they hate how politicians are destroying their home towns. He said it takes a year to get crew to even start work on a new building.

This should be talked more about. And if you are a real estate investor you have to pay attention to this.

Cheers

[ccking3]

@Darp Research I’d say they are fleeing because of economics caused by the stupid and harmful policies of the democrats. But the result is the same. Unfortunately many of those who flee bring their democrat political views with them. So they vote for the same policies which ultimately caused them to flee the blue states. This has happened for example in New Hampshire with ex Massachusetts voters and is now happening in places like Austin Texas, which is becoming as liberal as San Francisco.

Unfortunately no one teaches economics in high school anymore.

[Darp Research]

@ccking3 Yes you are right. It is huge concern in Idaho and has been for years, they fear that a lot. When NYers fled NY for CA they brought their politics with them and Idaho fears same thing. Right now think Florida is not in danger as people there are so happy compared to in NY the State might be changing minds of people, instead of opposite.

I left that out as in near term will not change the rental demand patterns.

Cheers

[Can't touch this]

@Darp Research simply absurd, your premise is baseless not to mention biased....stick to facts brother and don't fall for the con job of us vs them...dem vs reps, we are all citizens and move for a myriad of reasons. Get a grip!