1 Office REIT To Buy, 1 Residential REIT To Short

Includes: BXP, EQR
by: Bidness Etc

While U.S. office markets are showings signs of improvement, the U.S. multifamily housing markets are deteriorating, as the single family housing starts to rebound. In this scenario, we believe investors should go long Boston Properties (NYSE:BXP) and short Equity Residential (NYSE:EQR), both operating in the U.S. office REITs and U.S. multifamily REITs sector, respectively.

U.S. Office Markets:

U.S. office markets have shown an improvement despite the sluggish pace of the country's general economy. Countrywide office rentals are increasing, while vacancy rates have touched their lowest levels in three years. We believe the lack of construction of new office facilities has led to the improvement in the U.S. office space markets. Nationwide vacant office space came down from 17.2% in the second quarter to 17.1% in the third quarter of the current year. Nationwide asking rent climbed 21 basis points to $28.23 per square foot from the second quarter to the third quarter of the current year. Energy and technology companies, with a large presence in San Francisco, California, New York and Boston, are said to be driving much of the improvement in the U.S. office space.

Compared to the historic average of 6.5 million square feet per year, office leasing in the San Francisco region totaled 4.5 million square feet during the first half of the current year. Office leasing has never been over 4 million since 2004. Office rents in the region have climbed 10.1% to $42.63 per square feet over the first half of the current year. Colliers International expects the rents to climb another 10% in 2013. Therefore, we believe the office REITs with exclusive or large presence in the region will benefit. We have identified Boston Properties to be one of the beneficiaries.

Boston Properties:

Boston Properties owns and operates office facilities largely in Boston, New York and the San Francisco regions. All three regions led the surge in office rents and decline in office vacancy rates. At the end of the second quarter, the company generated almost 37% of revenues from properties in Boston, followed by 26% and 11.6% from New York and the San Francisco regions, respectively.

BXP's stock has seen around 10% price appreciation since the beginning of the year, and trades at an FFO yield of 5.55%. We believe the company is well positioned to benefit from the improving U.S. office markets.

U.S. Multifamily Housing Markets:

The situation in the U.S. apartment or multifamily REITs markets is quite the opposite. As U.S. housing markets witness a rebound, the U.S. multifamily housing has witnessed a decline. Single family housing construction jumped 5.5% in the month of September 2012, which is the fasted since April 2010. Single family housing permits also increased 0.2%, the highest since March 2010. This has an inverse relation with multifamily housing.

Equity Residential :

Within the residential REITs sector of the U.S., Equity Residential operates as a large cap REIT with ownership development and management of high quality apartment properties. The company was also recently downgraded from neutral to sell by Goldman Sachs on lower return potential. Analysts at Goldman Sachs are of the view that the company has limited opportunity to advance its bottom line given the fundamentals in the U.S. multifamily housing markets. The stock that has seen over a 1% decline in its price since the beginning of the year, and is trading at an FFO yield of 4.5%. Therefore, we recommend our investors to short the stock on its poor earnings growth potential.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Qineqt's Financials Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.