Credit Suisse Report Questions Recent Success of Apartment REITs

Real estate investment trusts (REITs) that specialize in apartment buildings are far exceeding other types of REITs, but a number of headwinds may slow the sector’s continued momentum, according to analysts at Credit Suisse. While the sector will hold value “in the midst of sanguine second quarter reports,” questions remain for 2011 and profit-taking during a strong earnings season an acceptable trade, a team of analyst led by Andrew Rosivach wrote in a report, “Affordable Condos?” published this month. As HousingWire previously reported, the National Association of REITs, NAREIT, said the US REIT sector raised $22bn for investments in the first half of 2010, adding the apartment REIT segment led the overall REIT sector in growth from the beginning of 2010. The report said the apartment REITs it follows have risen 23.2% since the beginning of this year, compared to growth of 6.9% in its overall REIT index. While its been a remarkable run, Credit Suisse said, but historically, the sector could soon be poised for a decline. Historic trends don’t bode well for future apartment REIT performance. From Q197 to Q110, apartment REITs performed on average 17% better than the entire REIT sector. During that time, apartment REITs exceeded that average, reaching a spread of more than 25%, in 10 quarters. In eight of those instances, the multifamily sector later went on to underperform the REIT sector in the following three months. In addition, there are concerns about marco-variables that have turned much less attractive than at the beginning of the year, which could impact apartment REITs’ ability to maintain that growth. Job growth and the apartment REIT operating performance are historically closely aligned, Credit Suisse said. But as the graph below shows, that trend has changed in recent quarters. While the apartment REIT sector is experiencing growth, job growth has paused in the middle of 2010, with the US adding only 123,000 jobs during May and June combined, compared to 246,000 in April alone. Apartment REIT same store revenue growth has tracked one year trailing employment change over the past 10 years,” the report said. “Only in 2010, apartment same-store revenues appear to be recovering faster than with a one year lag to employment, a major break from the historical relationship.” The difference between the two metrics may be an anomaly, but if so, August employment numbers will be a critical factor in predicting the future performance of apartment REITs. If the recent trend is not in fact an anomaly, and the relationship between employment and apartment performance no longer holds, that must be taken into consideration when analyzing apartment operating and share price performance, Credit Suisse. Another headwind for apartments is the ever-increasing affordability of homes. Low mortgage rates and property values makes homeownership more attractive than renting for many. The percentage of median household income needed to pay the mortgage on a median priced home is at a 30-year low, as seen in the below chart. Despite the cause for concern, there are positive signs for apartment REITs, the report said. Apartments typically sign shorter leases than other rental properties the REIT sector controls, and 12 month leases allow apartment companies to push rental rates with “immediate bottom line results,” the report said, adding in contrast, REITs in other sectors “continue to face rolldown from leases signed in the bull market.” In addition apartment occupancy remains high, even as more borrowers can afford to own a home, but chose not to. Positive Q210 reports from apartment REITs may help boost stock value in the short term, but need to be taken into context when considering future performance, the report warned. Many renters may not purchase a home immediately because they are locked into a lease and can’t take advantage of low mortgage rates, or other factors that increase the “lead time” to making a home purchase. The leases that boosted apartment performance this year are now six months old, before recent drops in mortgage rates. Once renters are out of leases, they may not return, instead turning to homeownership. If a substantial number of renters decide to become homeowners, that income may not replenish with new renters. Without a new spike in rentals in 2011, apartment REIT performance could decline. Write to Austin Kilgore. The author held no relevant investments.