Rising interest rate environment changes focus on residential REITs

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The real estate investment trust (REIT) industry is highly fragmented with several sub-sectors. Each subsector has a unique set of characteristics and factors that influence its performance. REITs typically distribute 90% of their earnings as dividends, making them an attractive investment option for people looking for a steady stream of income.

Let’s dive deeper into one of these promising sub-sectors, residential REITs, which are poised for exponential growth in 2022. With interest rates rising, mortgage rates are reaching unprecedented highs. precedent of about 4%, which makes buying a house expensive. Thus, people prefer to live on rent, thereby propelling the residential REIT segment.

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Notably, residential REITs have seen an increase in occupancy and rental rates through the end of 2021, and the rise is expected to continue through 2022. The sub-sector is further divided into various segments based on the location of the markets, namely coastal ones. , suburban, central business district (CBD), etc., as well as depending on the type of property, i.e. apartment, multi-family, student housing, etc.

Deutsche Bank analyst Derek Johnston, who recently revisited the residential REIT industry, has compelling insights into the sector. Based on the current economic environment, Johnston has increased capitalization rates (return on investment) and reduced premiums applied to the net asset value (NAV) of the company. Additionally, the analyst also adjusted the earnings forecast and lowered the stock price target due to the changes.

Despite a below-market valuation and a murky macro environment, Johnston remains bullish on the sector. The analyst forecasts average growth in funds from operations (FFO) of 18.8% for 2022 and 15.2% in 2023 for the SCPI segment of apartments and single-family residences (SFR).

Johnston noted the forces that fuel his bullish view of the sector. “Aging millennials are starting families, roommates have largely decoupled during the pandemic, and spikes in home valuations can lead to a cycle of downsizing, while first-time buyer affordability is stretched,” noted the analyst.

Additionally, the analyst believes the industry is poised to witness lower year-over-year expense offset benefits as past technology investments begin to pay off, reducing costs. wage costs. Additionally, COVID-19-related expenses are decreasing, further reducing the burden on margins. The analyst expects outsized earnings growth in 2022 for the sector based on the points above.

Let’s take a closer look at three major residential REIT companies and what the analyst thinks about them.

AvalonBay Communities (AVB)

AvalonBay engages in the development, redevelopment, acquisition and management of multi-family communities, primarily in the high-barrier urban markets of New England, the New York/New Jersey metropolitan area, Midtown Atlantic, Pacific Northwest, and Northern and Southern California.

Exposure to major metropolitan areas exhibiting favorable characteristics such as job growth in high-wage sectors of the economy, low housing affordability, and a diverse and vibrant quality of life all drove returns higher for the company’s investments.

As of December 31, 2021, AVB’s portfolio included 297 apartment communities housing 87,992 apartments across 12 states.

According to analyst Johnston, AVB’s portfolio is “best positioned to benefit from ongoing suburbanization and the revival of the coastal market”, as shown in its February update on revenue, occupancy and rents. Additionally, the analyst predicts 15% savings in labor costs through continued digitization.

Based on robust rental growth forecasts, development completion and tailwinds for stabilization, the analyst raised AVB’s FFO per share estimate to $9.59 (from $9.35 ) in 2022 and at $10.68 (compared to $10.17) for 2023.

The analyst reiterated a buy rating on AVB stock but cut the price target to $272 (from $285), implying 8.8% upside potential from current levels. AvalonBay has a dividend yield of 2.57%.

Other Wall Street analysts have a moderate buy consensus rating on the stock with five buys and eight takes. AvalonBay’s average price forecast of $270.31 implies upside potential of 8.1% from current levels. Its shares are down just over 1% year-to-date, down from a 37.4% gain in the past year.

Camden Estate Trust (CPT)

Camden has a portfolio of apartment communities with a focus on the Sunbelt region across the United States. The company specializes in the rental, management, marketing and maintenance of apartments.

As of January 31, 2022, CPT’s portfolio comprised 171 properties housing 58,300 apartments.

Compared to its peers, who had suffered a negative impact on their results from the pandemic over the past two years, CPT has seen very little impact. Additionally, the company continued to record favorable rental growth in January and February 2022 and is expected to continue its upward trend.

According to analyst Johnston, for CPT “This absence of a ‘hole to fill’ in revenues (in terms of rental rates and occupancy) opens the way for additional investment in acquisition/development, such as the recently announced $1.6 billion TRS acquisition.”

CPT operates in markets where the supply of inventory in 2022 is limited, allowing for a favorable “sticky” occupancy trend, which currently stands at around 97%. Additionally, the analyst expects CPT to experience FFO growth of 19.6% in 2022, which would translate to an increase in forecast FFO per share of $6.45 (including the acquisition of TRS) against $6.22.

For 2023, the FFO per share goes from $6.76 to $7.11. The drivers of the increased FFO growth are improving tenant demand coupled with strong rental spreads.

The analyst reiterated a buy rating on CPT stock while reducing the price target to $190 (from $200 previously), implying 12.5% ​​upside potential from current levels . Camden Property has a dividend yield of 2.08%.

Overall, the Wall Street community is cautiously bullish on the stock with a Moderate Buy consensus rating based on nine buys and four holds. The average Camden property price forecast of $184.69 implies upside potential of 9.4% from current levels. CPT stock has lost 4.3% since the start of the year, compared to a gain of 55.4% last year.

Residential Equity (QRA)

Equity Residential is focused on acquiring, developing and managing rental apartments in high-density coastal urban and suburban markets, including Boston, New York, Washington, DC, Southern California, San Francisco and Seattle. EQR also has a growing presence in Denver, Atlanta, Dallas/Ft. Worth and Austin.

As of December 31, 2021, EQR’s portfolio comprised 310 properties housing 80,407 apartments.

According to analyst Johnston, EQR operates a top-notch portfolio in the coastal market. Meanwhile, the company aims to increase its presence in growth markets, financing through divestments in its California, New York and DC markets.

Commenting on the same, the analyst said: “While the Toll Brother partnership should ease this transition, we expect some dilution in the near term as EQR expands to scale to match efficiencies. benefiting long-standing markets such as New York and Southern California.”

For EQR as well, year-to-date metrics in February showed continued momentum in rental rates. However, the occupancy rate has lost ground (-20 basis points since the start of the year) and stands at 96.4%.

Notably, through improved AI-powered prospect communications and self-guided tours, management expects cost savings of approximately $25-30 million going forward.

Based on the above assumptions, analyst Johnston increased FFO per share estimates for EQR to $3.45 (from $3.31) for 2021 and $3.83 (from $3.61) for 2023.

The analyst reiterated a Hold rating on EQR stock while reducing the price target to $93 (from $94), implying upside potential of 3.2% from current levels. Equity Residential has a dividend yield of 2.73%.

Other analysts on the street are also cautiously bullish on the stock, with a moderate buy consensus rating based on five buys and 10 takes. The average residential stock price forecast of $98.33 implies upside potential of 9.2% from current levels. Its shares have remained nearly flat year-to-date, down from a 28.3% gain in the past year.

Points to consider

The very nature of REITs makes them an attractive investment option since investors are exposed to the real estate sector with so many diverse segments. Additionally, the mandatory dividend payouts ensure steady income streams and return on investment, which could also be a motivating factor for investors.

Residential REITs should do well in 2022, making them a compelling investment option with so many players to choose from. The majority of companies in the subsector have consistently exceeded FFO expectations in 2021 and several have raised their full-year 2022 outlook due to strong underlying demand and favorable growth rents.

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