- The Equity Residential, as the name implies, invests in single and multi-family housing, mainly on both US coasts.
- The article gives a brief overview of the US housing market as that drives construction costs and potential for increasing income from existing properties.
- That is followed up by a review of EQR itself. Despite the recent slowdown in the residential market, owning real estate is a good portfolio diversification asset.
- While EQR is expanding away from the coasts, there are other REITs already focused there that have outperformed EQR. At best, EQR is a hold hoping for better results going forward.
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(This article was co-produced with Hoya Capital Real Estate
While my portfolio owns several REIT ETFs, I have only one specialized REIT, the Alexandria Real Estate Equities (ARE) which specializes in Life Science tenants. With all the talk about a housing shortage in the US, it made sense to start exploring REITs that focused on residential housing, which can also be divided into subclasses like single or multi-family, medical, manufactured homes, or senior facilities. My search started with Equity Residential (NYSE:EQR), which this article reviews. While EQR is expanding away from the coasts, there are other REITs already focused there that have outperformed EQR. At best, EQR is a hold hoping for better results going forward.
Why residential housing now?
There are the Econ 101 reasons: supply & demand factors as the next charts illustrate. Construction of houses and apartments in the US has been below trend lines since the 2008-09 GFC. A sub-issue is that the construction in entry-level homes (<1400sqft) continues to fall, increasing demand from renters as higher down payments and/or monthly mortgage payments leave more potential buyers looking for housing they can afford.
That construction imbalance is also reflected in the declining vacancy rates. This shrinking supply is pushing up home prices and rents! Another issue is what homes are available for first-time buyers.
For investors wanting to expand their REIT exposure, other factors come into play. Crime and continuing “work from home” rules add uncertainty to the future profitability of Office Space REITs. Potential changes to Medicare and Medicaid reimbursement rates would negatively affect income Medical Property REITs receive. Industrial/Warehouse REITs have benefited by more online shopping, which is easing, which could result in leases not being renewed. Consolidation and 5G technology could affect the REITs focused on cell towers.
While there are also negatives for Residential REITs, they might be best positioned of the various REITs after their recent pullback.
Equity Residential review
Seeking Alpha describes this REIT as:
Equity Residential is committed to creating communities where people thrive. The Company, a member of the S&P 500, is focused on the acquisition, development and management of residential properties located in and around dynamic cities that attract high quality long-term renters. Equity Residential owns or has investments in 305 properties consisting of 78,568 apartment units, located in Boston, New York, Washington, D.C., Seattle, San Francisco, Southern California and Denver.
Source: seekingalpha.com EQR
EQR is mainly focused on both coasts of the US, with a growing footprint in Texas, as shown in the following map.
They outline their strategy for success with these four focal points.
- Buy/Sell properties as the market dictates.
- Quality assets in high-cost markets.
- Maintain strong financials, lowering borrowing costs.
- Strong internal controls for managing the assets.
Cost of housing directly affects demand for apartments, thus rents and property values. EQR core holdings are in the high-cost cities, but that is changing!
Where EQR is expanding (the orange dots above) have two things in common:
- Much lower Price/Income ratios than the other areas EQR was in.
- Represent areas with growing populations.
Both factors should increase rents in these areas faster and see more property-value increases than the other areas where EQR owns real estate.
EQR distribution review
Dividend growth has been near or below 4% over the past decade and shorter periods, earning EQR the following grades.
Risk and return review
As EQR might replace some allocation to stocks, I added the SPDR S&P 500 Trust ETF (SPY) to this part of the review.
Since EQR founding in 1993, it has produced a 10.63% CAGR, 99bps annually better than the SPY ETF. The risk data shows mixed picture. While EQR's Sharpe and Sortino ratios are inferior to SPY's, its Beta is much lower (.71 vs .96). As for Alpha generation, it was no contest: 5.31% for EQR; only .42% for SPY. Despite the ratios, it does appear EQR delivered for investors.
Location, location, location
Using a familiar response to what are the three most important considerations in real estate, here are my thoughts on why EQR has trailed other Residential REITs in CAGR that readers will see later. Most will continue to be headwinds going forward.
- California Proposition #13: Dating back to 1978, this caps property tax increases to 2% until the property is sold, thus the tax burden is shifted to new construction, in this case to landlords like EQR who have expanded their California portfolio of holdings.
- Rent Control: While inflation and other real estate costs were increasing slowly, this was less of an issue but still critical; more so on the East coast where they have existed longer. While limiting rent increases benefits the tenants, landlords earn less and thus less willingness to build more units, which makes for calls to expand rent controls even more.
- High cost of living: The prior issue helps cause this occurrence, as does the high income tax rates in many of the West and upper East coast states and cities. A new Washington state tax on "income" already has one major Investment firm saying they are leaving the state. Silicon Valley and the Bay Area are experiencing the same exodus. It also means more folks need to share a home/apartment to survive, all of which cuts into demand.
- Population shifts: Both California and New York lost enough population that they both lost a US House seat after the 2020 census. Colorado and Texas, EQR's growth markets, picked up a combined three seats. This is being driven by three factors: the high living costs already mentioned, rising crime rates, and the ability to work remotely, which seems to be more "sticky" than the experts thought.
While ETFs like SPY hold some REITs themselves, the allocation is usually very small: only 2.6% for SPY. Add a REIT like EQR helps balance out the rest of the portfolio. Another benefit is assets like EQR have is their small correlation factor to the US stock market, which should help dampen the bad times.
There are ETFs that focus on housing, one I recently found and it just over a year old, is the Residential REIT Income ETF (HAUS), which holds 25 assets like EQR, its #2 holding. I mentioned that only show there are lots of REITs covering the housing market; some widely, others more specialized. Using the Peers figure to Seeking Alpha, it shows five other housing-focused REITs.
The next chart helps explain the title and rating.
EQR comes in 5th place since 1998; shorter timeframes looked the same. While EQR's apparent strategy of moving away from both coasts might increase performance, there are better performing REITs available already focused on those more promising markets.
While EQR is expanding away from the coasts, there are other REITs already focused there that have outperformed EQR. At best, EQR is a hold hoping for better results going forward. Knowing why to skip a REIT is as important as knowing which ones to own.
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This article was written by
Retired Investor has been investing since the 1980s and has a background in data analysis and pension fund management. He writes articles to help others prepare for retirement by investing in CEFs, ETFs, BDCs, and REITs. He is a long only investor and shares strategies for trading options with a focus on cash-secured-puts.He is a contributing author to the investing group Hoya Capital Income Builder. Hoya specializes in the portfolio management of publicly traded real estate securities and dividend ETFs. Learn more.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.