Equities had a tough 2022. Inflation and the Fed’s efforts to curb it by raising interest rates, coupled with weak economic forecasts and the invasion of Ukraine have dragged the S&P 500 down more than 10% this year. In early March, the index experienced its largest one-day decline since 2020 and iInvestors now expect a bear market in 2022.
But analysts say one industry is poised for growth: real estate investment funds focused on multi-family properties.
For one thing, after a difficult first year of the pandemic, their fundamentals now look good.
The recovery of REITs varied by region. Companies with portfolios concentrated in large coastal cities, such as the Essex Property Trust, which owns exclusively West Coast assets, or the bi-coastal communities Equity Residential and AvalonBay, did not recoup their losses from the pandemic until renters they returned to urban life last summer.
Sun Belt REITs, like Mid-American apartment communities, have recovered more quickly. Shares rose to pre-pandemic levels by May 2021, driven by fewer Covid restrictions and an influx of renters to more spacious southern suburbs.
“Across the south, many markets remained open, more government-friendly,” said Handel St. Juste, senior REIT analyst at Mizuho Securities. “So the rents were better.”
In the following months, solid fundamentals for the sector fueled a story of steady return for equities. Nationwide, rents have risen 17% from before the pandemic, according to Zillow. And demand for multi-family living has reached its highest level ever, the National Apartment Association reported, with most of that coming from the Sun Belt and parts of the Southwest.
These REITs experienced year-over-year earnings growth throughout 2021. Mid-America Apartment Communities’ fourth quarter earnings per share increased 122% from the prior year. Equity Residential doubled.
Shares have risen hand in hand. Shares in the four aforementioned companies all outperformed the S&P, led by Mid-America Apartment Communities’ 44% gain since March 2021.
Do they still have room to grow? Analysts say yes.
Many leases signed last spring included multi-monthly concessions. Those discounts have disappeared in the hot market, guaranteeing rental earnings for landlords.
“If you remove the free rent from one to two months, that’s 16 percent more rent for a given year,” St. Juste said. “You have a pretty big increase and I think we will continue to see it for the next few months.”
The analyst warned that year-over-year comparisons this summer may be less impressive as rents had rebounded and concessions had started to decline by June.
But record demand for apartments, coupled with construction delays blocking new development, means those REITs still have “pricing power and the ability to generate rental growth,” he said.
The ability to raise rents has enabled REITs to outrun inflation. In February, the consumer price index had increased 7.9% in the past year versus 12.3% of the national median rent for a bedroom. “The economic fundamentals that drive rents will not go away anytime soon,” wrote Zumper data scientist Jeff Andrews.
Aside from high demand and low inventory, a key factor driving the performance of apartment REITs is employment, said Piper Sandler analyst Alexander Goldfarb.
“As long as you have job growth, apartments will be fine,” he reasoned.
While labor shortages, a byproduct of the so-called Great Resignations, still stand in the way of hiring, recent employment figures tell a story of growth.
In February, the unemployment rate fell to 3.8 percent, the lowest since February 2020, when it hit its 50-year low. And the economy created 92,000 more jobs than estimated in December or January, Reuters reported.
Essex and other West Coast REITs are uniquely positioned to benefit from employment growth. Across Northern California, rents are still 10% down from pre-pandemic levels, Goldfarb said, as tech workers have been slow to return to cities. In San Francisco, Zumper reported rents 16% below their March 2020 levels.
But with big technology requiring workers to return to their offices next month, apartment owners are expecting an influx of employees that will bolster rental growth.
“This is a huge benefit for investors looking for late games,” Goldfarb said.
Of course, REIT apartments are not a perfect hedge against a bear market. The stock prices of Mid-America, Essex, Equity and AvalonBay have been rising and falling since Russia invaded Ukraine three weeks ago. But while the S&P 500 fell 4% over that range, all four REITs, including Essex, gained 6%.
St. Juste said that even as oil costs rise and inflation weighs on household budgets, “central housing is a necessity.”
“Yes, the global economy, global issues, all of that impact the markets,” he said, “but ultimately, from an investor who looks [apartment REITs]job growth is fundamental “.
For investors, the expected performance of REITs should mean higher dividends for an industry that already distributes substantial gains to shareholders. And full-year forecasts for all four companies are for growth in 2022.