Summary
- Residential apartment REITs develop, own and manage residential apartment buildings.
- There are 15 public Residential Apartment REIT constituents traded on US markets.
- Of the total REIT market cap of $1,132 Trillion, residential apartment REITs represent a market cap of $126,982 Billion.
- Residential apartment REITs generate an average dividend yield of 3.02%.
- Spending on housing makes up 12%-15% of the US GDP.
- 36% of households in the US rent, 15.5% rent apartments. (NMHC, 2019)
- REITs own 2% of total apartment units in the US. (NMHC, 2019)
- Millennials are choosing urban apartment living in far greater numbers than earlier generations.
What are Residential Apartment REITs?
Residential Apartment REITs significantly outperformed the broader REIT sector and S&P 500 in 2018 and continue to trend favorably in 2019. Dividend yields have averaged 3.97% for the trailing twelve months. Many factors are influencing favorable returns for the industry including favorable demographics, population trends and the growing millennial influence. REITs own 2% of residential apartments in the US and have a tremendous amount of potential for on going growth.
Millennials are driving a massive shift in housing preferences. Encumbered with more than $1.2 Trillion in student loan debt millennials are waiting longer to buy homes and remaining in apartments longer than ever before. This is a trend that has led to growing demand for apartments and has resulted in housing shortages in some markets. 15.5% of the US population resides in apartment communities of five or more units; the number is even higher in markets with high concentrations of millennials, and markets with high costs of home ownership and new construction. Markets with the most apartment dwellers per capita include many of those in the most popular west coast markets (i.e. Southern California, Northern California/San Francisco and Seattle).
As tenants, millennials spend more on premium level services and amenities than prior generations, and prefer premium service offerings such as concierge service, high end finishes and functional common areas. A survey done by NMHC indicated the amenities most important to millennials include fitness centers, outdoor recreation areas, barbecue grills and community wifi. (Biznow, 2019) These amenities and services are much more attainable in rental communities, and would likely be well beyond the means of most millennials in starter homes. This is interesting considering the following data points on apartment demographic data points:
- Millennials are the largest living generation in the US, with more than 70 million people falling within the age range, born in years 1982-2000.
- Millennials have an average savings rate of -1.8% and the highest level of student loan debt in history.
- 50% of renters are under the age of 30, 73% are under the age of 44.
- Renters earn on average 70% of the average US household income. (NMHC, 2019)
The multifamily housing market forecasts a need for 4.3 million more units by 2030 due to the continued growth of the millennial population, and preference for the apartment lifestyle. A broad shift from residential apartments to single family homes among the millennial generation is unlikely according to multifamily housing experts, primarily for financial reasons, but also because millennials prefer the comfortable life style they’ve become accustomed to. This shift has created a unique opportunity for residential apartment REITs, one that has yet to be fully realized. (Multi Housing News, 2019)
Residential apartment REITs tend to have lower capital expenses related to leasing. Leasing fundamentals of apartments differ from other types of real estate in that lease terms are shorter; tenant improvements are minimal and tenant turnover occurs more often. Apartment leases are usually for terms of one year with a renewal provision and include a defined rent increase following the first year. Tenant improvements are limited to minor cosmetic repairs related to wear and tear caused by the previous tenant. Residential tenants, particularly apartment renters, tend to move more frequently than tenants of other asset classes with an industrywide renewal rate of 50%.
The most successful residential apartment REITs have developed investment strategies that balance an effort to target the most desirable demographics, with traditional real estate fundamentals. For example, several of the top performing residential apartment REITs invest solely in markets with above average incomes, in areas with leading employers and growing populations. These REITs also seek markets where new supply is extremely restricted, like San Francisco who has zoning and laws in place that make it virtually impossible to build new housing and has some of the highest rents in the US.
Pros and Cons of Residential Apartment REITs
Pros
- A US housing shortage exists, particularly among affordable housing.
- Total shareholder returns over the long term have exceeded other asset classes.
- Millennials are driving a material shift in the housing industry, namely the .
- Cost of home ownership in many of the most populated US markets has made renting a far more appealing option.
Cons
- Shorter lease terms subject apartment REITs to greater market volatility than other REIT subsectors.
- A glut of new inventory has created increased competition in certain leading markets, putting downward pressure on rates in some cases.
- High construction costs prohibit development of new inventory in markets with weaker economics.
2019 Outlook for Residential Apartment REITs
Residential apartment REITs have realized a total return of 2,743% since 1992, compared to the broader REIT index total return of 1438%. (Seeking Alpha, 2019) While the long-term outlook and fundamentals are favorable, it will likely take time for rents to catch up to projections.
Focusing on REITs with solid strategies, well located portfolios and strong management is key to long term success in the apartment sector. Many of the top US markets are experiencing a wave of new inventory that will likely take time to occupy, putting downward pressure on rates in the short term. The broader growing supply will be absorbed over time with the growing population of renters but identifying REITs over exposed to markets with excessive development would be wise.
As discussed above, millennials are the driving force in residential apartment supply and demand. As the generation ages and starts families, it is unlikely for financial and lifestyle reasons, that the trend will shift suddenly to starter homes in the suburbs. For developers and owners of apartments, this means adjusting floor plans and amenities to accommodate their evolving lifestyles, including more family friendly floor plans, common areas designed for families and integrating technology that appeals to this demographic.
REITs own 2% of total apartment units in the US, which indicates that there is still a great deal of opportunity for REITs to acquire assets, grow portfolios and generate higher returns. That being said the current cap rate environment and competitive nature of high-quality assets presents challenges for REITs. REITs are leveraging their brands and management platforms to partner with local owners. Others are lending on multifamily assets and generating accretive returns without the same level of risk as ownership. Ultimately, the REITs ability to thrive as the market continues to evolve depends largely on flexibility and creativity. (NMHC, 2019)