The REIT And Equity Trust - Residential constituents are expected to benefit from the healthy fundamentals of this industry. Rental housing demand remains robust, with young adults forming new households and the job market showing improvement. De-densification and the desire for more space is leading to fewer adults per apartment, thereby creating incremental demand for renting units. Moreover, mortgage rates are high, and with the high cost of homeownership, transition from renter to homeowner is difficult, making renting of apartment units a viable option.
While product absorption continues in the Sun Belt and other non-gateway metros, the gateway metros are also showcasing a strong rebound. Therefore, residential REITs like Equity Residential EQR, Independence Realty Trust, Inc. IRT and BRT Apartments Corp. BRT are expected to ride the growth curve, despite interest rate hike, elevated deliveries and regulation woes.
About the Industry
The Zacks REIT And Equity Trust - Residential category 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 residential REITs also focus on specific classes or types of residences, or a particular geographical region. Moreover, unlike apartment buildings, manufactured homes and single-family homes that are open for leasing to all, the 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 of student housing assets.
What's Shaping the REIT and Equity Trust - Residential Industry's Future?
Healthy Rental Demand, Rent and Occupancy Growth: The urban and job-centered suburban markets have been experiencing a continued flow of residents with the reopening of offices and returning of lifestyle amenities to the established markets. Moreover, de-densification and the desire for more space are resulting in fewer adults per apartment, thereby creating incremental demand for renting units. Also, higher household income is supporting rent growth. There is strong demand from young adults who are gaining from tight labor market conditions and record wage growth. Also, since high mortgage rate has increased the cost of homeownership, the transition from renter to homeowner is becoming difficult, making renting of apartment units a viable option. These positives are supporting high occupancy and rent growth for properties of residential REITs. While in most parts of the United States, apartment rents are climbing, growth is taking place at a moderate rate reflecting a more seasonal trend. This indicates that the fundamentals are still healthy but trending toward a sustainable level. In terms of markets, while there is a rebound in demand for the coastal markets, the Sun Belt markets too, continued to experience high demand compared to supply. There has also been a significant rebound in demand for student housing properties on the reopening of campuses and in-person classes, as well as extracurricular activities, driving leasing activity and rent growth. In fact, the fall 2022 pre-lease season closed with record occupancy and growth in rents.
Technology Adoption: Technological adoption gathered steam amid the social-distancing trend, and now the residential REITs are combining technology with sales and service expertise, aiming at driving revenues, trimming costs, improving operating margins, as well as enhancing customer experience. The REITs are now focusing on virtual leasing assistance, virtual and self-guided tours, digital move-in process and process enhancements. Improvement in search and tour booking as well as smart home access has gained much attention, and residential REITs are focusing on these. Such efforts are aimed at generating incremental net operating income in the years ahead.
Rent Control and Higher Interest Rates: The rent-control regulations in some of the major markets might curb the growth tempo. In fact, in recent years, there has been an increase in states and municipalities implementing or considering rent control or rent stabilization laws and regulations. This is limiting the residential REITs’ power to raise rents or charge non-rent fees. Moreover, the hike in interest rates to counter inflation poses a risk to the flow of capital for this asset category. This is likely to lead to volatility in asset prices. Also, interest expenses are expected to climb with rate hikes.
Zacks Industry Rank Indicates Bright Prospects
The REIT And Equity Trust - Residential industry is housed within the broader Finance sector. It carries a Zacks Industry Rank #87, which places it at the top 35% 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 bright 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 top 50% of the Zacks-ranked industries is a result of the positive 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 gaining confidence in this group’s growth potential. Over the past year, the industry’s FFO per share estimate for 2022 and 2023 has moved 4.2% and 0.6% north, 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 Zacks REIT And Equity Trust - Residential industry has underperformed the broader Zacks Finance sector as well as the S&P 500 composite over the past year.
The industry has declined 20.7% during this period compared with the S&P 500’s fall of 16.2% and the broader Finance sector’s decline of 14.7%.
One-Year Price Performance
Industry's Current Valuation
On the basis of the forward 12-month price-to-FFO (funds from operations) ratio, which is a commonly-used multiple for valuing Residential REITs, we see that the industry is currently trading at 16.76X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 16.30X. The industry is trading above the Finance sector’s forward 12-month P/E of 12.83X. 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 25.47X, as low as 15.90X, with a median of 19.03X.
3 Residential REIT Stocks Worth Betting On
Equity Residential: Based in Chicago, IL, this residential REIT is one of the leading, publicly-traded multi-family REITs in the United States. It is well-positioned to benefit from the improving demand for apartment living, its portfolio rebalancing efforts in the urban and suburban markets, and a strong balance sheet.
It concluded a strong leasing season, driven by healthy demand and pricing for its apartment units. As a result, same-store revenue growth is on track to either match or surpass the projections mentioned in the company’s second-quarter earnings release. Also, occupancy levels remained high.
Equity Residential’s efforts to diversify its portfolio in the urban and suburban markets, with an affluent tenant base, bode well. Its strategic buyouts and focus on technology and organizational capabilities to drive innovation and efficiency of its operating platform act as tailwinds.
Analysts seem bullish on this Zacks Rank #2 (Buy) stock. The Zacks Consensus Estimate for the company’s 2022 FFO per share indicates a favorable outlook, with estimates revised marginally upward over the past month to $3.51. The company’s shares have declined 4.1% in the past three months.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
Independence Realty Trust, Inc.: This Philadelphia, PA-based residential REIT is focused on ownership and operations of multifamily apartment properties across non-gateway U.S. markets, including Atlanta, Louisville, Memphis, and Raleigh. IRT targets boosting its presence in amenity-rich submarkets that offer good school districts, high-quality retail and major employment centers.
Independence Realty Trust is poised to benefit from the healthy fundamentals in its non-gateway markets and its value-add program. The company is targeting the expansion of its presence in core markets through its capital recycling and joint venture development efforts.
Independence Realty Trust currently carries a Zacks Rank of 2. The Zacks Consensus Estimate for the current-year FFO per share has been revised 1.9% upward in two months to $1.08. The company’s shares have declined 14.5% over the past three months.
BRT Apartments Corp.: This residential REIT, headquartered in Great Neck, NY, is engaged in the ownership, operation and, to a lesser extent, development of multifamily properties mainly in Sun Belt locations.
With well-located properties in growth markets, this residential REIT is poised to benefit from the growth in population in-migration of jobs in its markets. Also, the shortage of quality housing is likely to act as a positive.
This Zacks Rank #2 stock has witnessed upward estimate revisions in recent times, indicating analysts’ bullish stance. The Zacks Consensus Estimate for 2022 FFO per share has been revised 5.8% upward over the past two months to $1.63. The stock has also declined 1.6% over the past three months.
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. FFO is obtained after adding depreciation and amortization to earnings and subtracting the gains on sales.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Equity Residential (EQR) : Free Stock Analysis Report
BRT Apartments Corp. (BRT) : Free Stock Analysis Report
Independence Realty Trust, Inc. (IRT) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research