By Susan Persin,
managing director, Trepp
Apartment REIT performance has begun to slip this year despite strong market fundamentals and earnings growth.
The apartment sector’s 9.59% year-to-date return as of August 22 is well below the 16.57% all equity REIT average. Market fundamentals are strong, but many REITs appear to be fully priced so that growth prospects, along with some industry challenges, are already incorporated into REIT valuations.
Fueled by economic and demographic trends that favor young population cohorts that are most likely to rent, demand for apartments has remained strong, even as employment growth has slowed.
Uncertainty in the for-sale housing market, including the difficulty many borrowers experience in obtaining financing in spite of low interest rates, also contributes to demand for apartments.
The national apartment vacancy rate dropped to 4.7% at mid-year 2012 from 5.4% at year-end 2011, according to Marcus and Millichap, making it one of the strongest real estate sectors. The real estate firm also reported effective monthly rent growth of 3.5% between the second quarters of 2011 and 2012. Market fundamentals and earnings growth are strong for the large apartment REITs.
The five largest apartment REITs are Equity Residential (EQR), AvalonBay Communities (AVB), UDR (UDR), Camden Property Trust (CPT), and Essex Property Trust (ESS). All five REITs reported strong revenue growth exceeding 5% for the first half of 2012. Occupancy for most of the five companies is above 95%.
With limited room for increasing occupancy, recent revenue growth is based more on rent growth than occupancy improvement. These REITs also posted actual and expected NOI growth of 7% to 8% for 2012.
New apartment deliveries have been limited, but the pipeline of future supply for delivery in 2013 and beyond is significant.
The number of multifamily permits issued surged in 2011 and has maintained its upward trajectory in 2012. The number of multifamily permits issued year-to-date through July was almost 60% ahead of 2011. The supply pipeline is greatest in Washington, D.C., Seattle and San Jose.
Apartment REITs are taking advantage of their favorable capital structureand are stepping up their construction pipelines.
EQR did not start any new construction during the first half of 2012, but expects to begin six projects costing $525 million and totaling 1,040 units during the second half of 2012.
AVB completed four communities costing $246 million and totaling 887 units in Seattle, Massachusetts, and New York during the second quarter of 2012.
The Company has 20 communities under development and anticipates starting $1.0 to $1.2 billion of new development during 2012.
Construction for four communities totaling 1,226 units and costing $310 million began during the second quarter in Massachusetts, Connecticut, Seattle, and Dublin, CA. AVB also anticipates starting construction on four recently-acquired land parcels in 2012 and 2013.
UDR has four projects totaling 1,079 units in its development pipeline, including the 260-unit Signal Hill in the D.C. area that will be completed in the third quarter and the 347-unit Savoye in Dallas that is scheduled for completion in late 2013.
Camden completed four projects totaling 903 units in the first half of 2012. At mid-year, five wholly-owned projects with almost 1,700 units, as well as two joint ventures with 520 units, were under construction.
Eight projects totaling almost 2,500 units are in CPT’s development pipeline.
ESS started four new projects in California totaling 971 units during the first half of 2012. Its development pipeline includes a 55% joint venture interest in a two-tower, 463-unit project in San Francisco that will open by mid-2014, as well as a 197-unit JV project in San Mateo that will open by mid-2014.
A number of REITs are raising money to strengthen their balance sheets and fund development and acquisitions. Apartment REITs have raised $2.7 billion in secondary equity offerings during 2012, about one-third of which was raised in the student housing sector. Apartment REITs count for about 10% of the total raised by REITs year-to-date through July.
Of the six REIT IPOs during 2012, none have been apartment REITs. Lehman filed with the SEC last week to take Colorado-based Archstone (ASN) public. Archstone owned or had an ownership interest in 181 communities in the U.S. with 59,419 units that were operating or under construction as of March 31. The company’s $10 billion in debt could affect the IPO.
Apartment market fundamentals will continue to improve during the second half of 2012. Demand will be driven by demographic trends, although lackluster employment growth will keep the rate of improvement slower than that of 2011. The industry faces longer term headwinds in the form of wage growth concerns and potential oversupply. Limited wage growth will affect the ability of tenants to absorb rent increases.
Additionally, some market softening could occur in 2013 when supply becomes affected by the ramp up in new apartment deliveries.
The current outlook is for 2012 apartment REIT returns that are solid, but lower than recent years.