Traditional apartment dwellers are discovering the joys of home ownership. That’s bad news for apartment REITs.
By Charles Keenan
November 2002
Institutional Investor Magazine
Who wants to pay rent when mortgage rates are at a 40-year low? Not enough people to soak up all of the available space, which is the main reason apartment REITs lost 15 percent of their value through early October, according to the National Association of Real Estate Investment Trusts. The losses are especially glaring because other kinds of REITs have provided a measure of comfort to equity investors in this year’s dismal stock market. Mall REITs, for instance, gained 14 percent in the same period, and health care REITs were up 6.6 percent.
Low interest rates that encourage renters to buy their first homes are the primary cause of apartment owners’ suffering, and a softening employment market has only compounded their pain. Also, the pace of new apartment construction hasn’t slowed, especially in the Sun Belt. The result: rental price wars among building owners and declining earnings.
Net operating income for 16 apartment REITs dropped 4.4 percent in the second quarter against the same period a year ago, according to Green Street Advisers, a Newport Beach, California, research firm. That compares with a first-quarter drop of 1.8 percent, year over year.
Says Thomas Sargeant, chief financial officer at AvalonBay Communities, an Alexandria, Virginiabased apartment REIT, “We don’t think we’ll see meaningful revenue growth sequentially until mid-2003 or later.” Andrew Rosivach of Piper Jaffray in New York notes, “Even if we had zero new supply in the U.S. for the next year, the apartment market would still be pretty rocky.”
REITs concentrated in Southern and Western cities have been especially hard hit, because those areas have experienced among the biggest job cuts in the country and have added the most housing supply. In these regions, where land is still cheap, developers have found it relatively easy to enter the market. Low interest rates also mean construction financing costs drop, providing a further incentive to build.
Atlanta is a case in point. The city, hit hard by the falloff in the telecommunications and travel industries, lost 63,400 jobs in the 12 months ended August 31, according to the Bureau of Labor Statistics. Yet building permits for single-family and multifamily units as a percentage of the overall housing stock was a robust 4 percent at the end of June, almost even with August 2001, according to Piper Jaffray.
Post Properties, which has heavy exposure in its home market of Atlanta as well as in Phoenix, reported a 28 percent year-over-year drop, to 65 cents a share, in the second quarter in funds from operations, the main yardstick of REIT performance.
AvalonBay hasn’t been as hard hit because the bulk of its portfolio is outside the South and West. But in early October the REIT revised its third-quarter estimate for funds from operations to 86 cents to 88 cents a share, versus consensus estimates of 95 cents a share. AvalonBay said the weak economy and brisk home sales were behind the shortfall.
To be sure, apartment REITs continue to offer investors a substantial yield, 8.51 percent in early October. That compares with 8.15 for REITs overall and represents an almost 500-basis-point advantage over ten-year Treasuries.
By law REITs are required to pay out 90 percent of taxable income as a dividend; often they pay 100 percent. At Chicago-based Equity Residential, the amount is 90 percent of taxable income but only 50 percent to 60 percent of funds from operations, or free cash flow. The abundant cash gives plenty of cushion to protect the dividend. In today’s market that’s no small comfort.
