The weakness in rental housing demand in higher cost and urban/infill markets amid the flexible working environment, low mortgage rates, along with elevated deliveries will continue to affect cash flows of REIT And Equity Trust – Residential constituents in the upcoming days. Nevertheless, solid demand for single-family rentals, affordable housing and recreational vehicle (RV) resorts, as well as healthy demand in the Sunbelt markets and sub-urban locations, have been the saving grace for a number of residential REITs, including Sun Communities, Inc. (SUI – Free Report) , Mid-America Apartment Communities (MAA – Free Report) and American Homes 4 Rent (AMH – Free Report) .
About the Industry
The Zacks REIT And Equity Trust – Residential category is the one which is engaged in owning, developing and managing a variety of residences. The types of residences include apartment buildings, student housing, manufactured homes and single-family homes. Residential REITs rent spaces in these properties to tenants and earn rental income in return. Markedly, some REITs also focus on specific classes of types of residences and/or a particular geographical region. Moreover, unlike apartment buildings, manufactured homes and single-family homes that are open for leasing to all, student housing units are leased only to students. Such real estates are, therefore, generally required to be set up within or in places closer to colleges and universities. Furthermore, enrolment growth of educational institutes is a major driver for student housing assets.
What’s Shaping the REIT and Equity Trust – Residential Industry’s Future?
Rental Demand Rebounds but Varies across Markets: For the U.S. apartment market, the first quarter, which is typically a slow leasing period in other years, appeared to be a solid one this year, with impressive demand for rental units, thanks to employment growth that spurs household formation and housing absorption. Moreover, the recovery continued in April with improvement in rental rate and healthy occupancy levels. Rental collections are also holding up well. The widespread vaccinations and reopening of local economies are, in fact, raising hopes for more household creation and rental demand. Also, improvement in job market, stimulus payments and other government benefits are helping the financial status of households, aiding rent collections. This healthy demand, however, has been the most noticeable in the Sun Belt metros so far, backed by in-migration trend of population and business. Demand is also encouraging in the sub-urban ones though the situations are still turbulent in some of the gateway markets. Given the continuation of the work-from-home flexibility this year even with immunization process underway, the low-density and less-expensive sub-urban sub-markets are poised to lead the overall market performance in the near term, while the gateway markets are likely to lag. Particularly, in some of the major gateway metros, rents are still down and there has been substantial usage of concessions in stabilized properties. In addition, low mortgage rates and the desire for spaces are spurring home sales and adversely impacting rental demand. Nevertheless, in the student housing market, pre-leasing activity has gained pace on possibilities of fully-reopened campuses and in-person classes as well as extracurricular activities, including sporting events this Fall.
Elevated Deliveries of New Units and Rent Control: It is also feared that the struggle to lure renters is here to stay now, as supply volumes will likely remain elevated. In fact, though demand was strong during the March-end quarter, apartment absorption lagged the property completion tally, with new supply aggregating 84,794 units, per a report from RealPage. The trend is likely to continue in the rest of this year, with the ongoing construction standing at 611,202 units, indicating a sizeable number of apartment deliveries in the upcoming period. While widespread vaccinations are anticipated to give rise to more jobs, particularly in the retail and hospitality sectors, the competitive leasing environment might prevail in the days ahead, with elevated supply, specifically, in the gateway markets, keeping concession activity high and limiting scopes for rent growth in areas of high supply. Besides, cash flows are likely to remain affected amid the eviction moratoriums and regulations.
Technology Adoption: Technological adoption already gathered steam last year amid the social-distancing trend. Landlords are now emphasizing more on existing technologies and supplements aimed at driving revenues, trimming costs, improving operating margins, as well as enhancing customer experience. Residential REITs are focusing on virtual leasing assistance, virtual and self-guided tours and digital move-in process. Other moves include improvement in search and tour booking as well as smart home access.
Zacks Industry Rank Indicates Bleak Prospects
The REIT And Equity Trust – Residential industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #207, which places it at the bottom 18% of more than 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bleak near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
The industry’s positioning in the bottom 50% of the Zacks-ranked industries is a result of the negative funds from operations (FFO) per share outlook for the constituent companies in aggregate. Looking at the aggregate FFO per share estimate revisions, it appears that analysts are losing confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2021 and 2022 moved 12.1% and 19.5% south, respectively.
Before we present a few stocks that you might want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Lags on Stock Market Performance
The REIT And Equity Trust – Residential Industry has lagged the S&P 500 composite as well as the broader Finance sector in a year’s time.
The industry has gained 16.8% during this period as against the S&P 500’s rally of 40.8%. During the same time frame, the broader Finance sector has appreciated 50.1%.
One-Year Price Performance
Industry’s Current Valuation
On the basis of the forward 12-month price-to-FFO ratio, which is a commonly-used multiple for valuing Residential REITs, we see that the industry is currently trading at 22.75X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 21.69X. The industry is trading above the Finance sector’s forward 12-month P/E of 16.80X. This is shown in the chart below.
Forward 12-Month Price-to-FFO (P/FFO) Ratio
Over the last five years, the industry has traded as high as 22.75X, as low as 15.74X, with a median of 18.50X.
3 Residential REIT Stocks Trying to Survive Industry Challenges
Sun Communities, Inc.: The Southfield, MI-based REIT is engaged in ownership, operation or enjoys stake in manufactured housing communities, RV resorts and marina properties located across 39 states throughout the United States, and Ontario, Canada. The continued demand for affordable housing is acting as a tailwind, while demand for RV vacations is picking up pace amid increased pace of vaccination and resumption of normalcy.
Sun Communities currently carries a Zacks Rank #3 (Hold). The Zacks Consensus Estimate for the current-year FFO per share has been revised 1.4% upward in a month’s time. The company’s shares have rallied 19.5% over the past six months.
Mid-America Apartment Communities, Inc.: The Germantown, TN-based residential REIT is engaged in owning, acquiring, operating and development of apartment communities, located primarily in the Southeast, Southwest and Mid-Atlantic regions of the United States. Healthy demand for the company’s well-positioned Sunbelt properties will likely aid its performance in the days to come.
Mid-America Apartment Communities presently holds a Zacks Rank of 3. Over the past month, the Zacks Consensus Estimate for 2021 FFO per share witnessed marginal upward revision to $6.54. The stock has also gained 18.3% over the past three months.
American Homes 4 Rent: This Calabasas, CA-based REIT is focused on acquiring, developing, renovating, leasing and operating attractive, single-family homes as rental properties. Markedly, the pandemic has prompted a new wave of demand for single-family rentals, which positions the company well to deliver decent performances in the upcoming period.
The stock currently carries a Zacks Rank of 3. The Zacks Consensus Estimate for the ongoing year’s FFO per share moved marginally north in the past month to $1.28 and calls for a year-over-year increase of 10.3%. The stock has appreciated 22.4% in three months’ time.
Note: Funds from operations (FFO) is a widely used metric to gauge the performance of REITs rather than net income as it indicates cash flow from their operations. It is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.
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