This is the kind of story I was expecting, pointing out how rising rates are good for some REITs, like MAA.
>>HEARD ON THE STREET
Sam Zell Could Be Sitting Pretty Mogul's REIT Stands to Gain If Higher Mortgage Rates Awaken A Sluggish Apartment Market
By GREGORY ZUCKERMAN and RAY A. SMITH Staff Reporters of THE WALL STREET JOURNAL June 24, 2004; Page C1
As interest rates climb, so may Sam Zell's fortunes.
The white-hot real-estate market has masked one area that has been stone cold: apartment rentals. New home buyers have come out of the woodwork in the past few years, even as home prices soared, thanks to low interest rates, which kept a lid on the costs of buying a house. The buying frenzy, however, siphoned business from the rental market. High unemployment also weighed on the rental business, forcing some would-be tenants to double up in existing apartments or move back in with Mom and Dad. It didn't help that new apartments continued to be built, despite the downturn, creating a glut of empty flats.
But mortgage rates have shot up in recent weeks, in anticipation of a series of interest-rate increases by the Federal Reserve aimed at keeping inflation in check. At the same time, hiring is on the rise, crucial to the health of the apartment-rental market.
All this has some investors excited about the outlook for Equity Residential, Mr. Zell's giant apartment real-estate investment trust. The company is the largest publicly traded apartment REIT in the U.S., with a market value of more than $8 billion, and something of a proxy for the apartment-rental business. Shares of the Chicago-based company traded at $29.66 yesterday in 4 p.m. composite trading on the New York Stock Exchange, up from a recent low of $26.65 in April, though the stock is essentially flat over the past two-and-a-half years.
Now some investors say shares will climb as the apartment market strengthens. Apartment stocks "are poised for outsized growth relative to other areas in real estate," says John Robertson, a portfolio manager at RREEF America LLC, an investment unit of Deutsche Bank. The firm purchased more than two million shares of Equity Residential in the first quarter, and was the third-largest holder of the stock as of March 31, with 14.5 million shares. "Granted [apartment-rental] stocks are not cheap, but earnings expectations are going to go up for 2005 and 2006, and Equity Residential is one of the best bets in the apartment world," Mr. Robertson says.
>>Mr. Zell, the 62-year-old Chicago mogul who serves as Equity Residential's chairman, says the company could benefit if rates keep rising.
"Rising rates, assuming they reflect increased business activity, will translate into higher demand for family [rental] housing," says Mr. Zell, who owns almost two million shares of Equity Residential, his third-largest stock holding. "Interest rates are higher, so monthly payments [on homes] are higher, making renting an apartment more attractive."
Mr. Zell adds that about 80% of Equity Residential's debt has a fixed rate, so if rates move up the company's financing charges won't surge.
That will only help so much if recent employment stalls out, some argue. Equity Residential's properties are focused on moderately priced, multifamily apartment buildings whose health is tied to ups and downs of the employment rolls.
At the same time, the apartment recovery may take longer than some investors expect, in part because things have been so weak. The average vacancy rate for the 61 largest metropolitan markets in the U.S. rose to 7.1% in the first quarter, the highest level since 1986 and up from 6.7% in last year's first quarter, according to real-estate research firm Reis Inc. Many analysts don't expect landlords to be able to substantially raise rents in most regions of the country until early to mid-2005.
At the same time, lenders, home builders and the Department of Housing and Urban Development are promoting a range of incentives aimed at keeping houses affordable -- and sales humming. What's more, home builders and house sellers could react to higher interest rates by lowering their asking prices.
Meanwhile, investors tend to pay a premium for apartment REITs in large, high-barrier-to-entry markets, such as southern California and Washington, D.C., where there are constraints on construction and strong local economies. Equity Residential's portfolio is spread throughout the country, with a large presence in the Sunbelt, and some of its markets have lower barriers to entry.
>>And the stock isn't cheap. Equity Residential trades at 13.7 times estimates for this year's funds from operations, barely below the 14 average multiple for apartment REITs, according to Legg Mason. On average, apartment REITs' funds from operations -- a REIT earnings measure -- fell 4.3% in the first quarter, but Equity Residential's funds from operations fell 8.8%, not a good sign. And the company's 5.9% dividend yield is slightly below the 6.2% median for apartment REITs, according to Morgan Stanley.
In a recent research note, UBS Investment Research analysts Keith A. Mills and Chris Pike wrote that apartment-stock multiples have become rich after a recent rise in shares. The analysts said they expect apartment stocks will begin to trade flat to slightly down for the remainder of the year because the likelihood of improving fundamentals is already baked into the stocks' prices.
Still, Equity Residential hasn't risen as much as some other stocks in the group. The stock is up 2.6%, including dividends, while a basket of 15 apartment REITs is up 5.7% so far this year, on a weighted-average basis, according to UBS.
There already are signs the apartment-rental market is perking up at the expense of home sales. Last month, Equity Residential saw rentals in existing apartments grow compared with a year earlier, the first such improvement in more than a year. At the same time, Dominion Homes Inc., a midsize Ohio home builder, recently warned that second-quarter results would fall short of expectations, a potential sign of problems for at least some parts of the home-sales market. Dominion cited a 15% drop in gross sales for April and May from a year earlier and a jump in cancellations.
"We are starting to see some signs of some slippage in the single-family home market" which will help the rental market, says Bruce Duncan, Equity Residential's chief executive, who notes that the company has been weeding out underperforming properties, reducing its apartment portfolio to 30 markets from 44. "The last three years have been tough sledding in our space, but rising interest rates are definitely beneficial to the multifamily market."<< END