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Wall Street JournalInvest in 3 Residential REITs on Promising Industry Prospects
This outlook is promising for industry players like AvalonBay Communities, Inc. AVB, Equity Residential EQR and Essex Property Trust, Inc. ESS. However, an increase in new unit supply may constrain rent growth and occupancy levels, while improving mortgage rates could divert some demand away from the rental market.
About the Industry
The Zacks REIT and Equity Trust - Residential category includes companies that own, develop and manage various residential properties such as apartment buildings, student housing, manufactured homes and single-family homes. These REITs generate revenues by renting spaces to tenants. While most residential REITs lease properties like apartments and single-family homes to a broad range of tenants, student housing is exclusively leased to students. As a result, student housing properties are typically located near colleges and universities to serve their target demographic. Also, the demand for student housing is closely tied to enrollment growth at educational institutions, making it a key driver for this market segment. Some REITs may also focus on specific types of residences or regions to cater to the needs of local markets or particular tenant groups.
What's Shaping the REIT and Equity Trust - Residential Industry's Future?
Healthy Rental Demand: Despite elevated supply in several markets, demand for rental residential units remains strong, as indicated by high absorption rates. Key drivers include a strong labor market and favorable demographic trends that are fueling household formation. Moreover, a rebound in international migration is driving multifamily demand.
While mortgage rates have improved, renting remains significantly more cost-effective than purchasing a home. Meanwhile, U.S. student housing saw strong pre-leasing momentum in August, capping Fall 2024 with a notable surge in activity, per RealPage data.
Technological Initiatives: In response to evolving market dynamics, residential REITs are increasingly embracing modern technologies to enhance the customer experience and attract tenants. Innovations such as self-guided property tours, digital move-in processes, smart home technology, building-wide Wi-Fi and AI-powered sales tools have not only improved tenant engagement but also streamlined operations, leading to reduced costs.
As the industry adapts to the digital age, effectively leveraging these technological advancements and organizational capabilities is poised to provide residential REITs with a competitive edge, ultimately driving long-term growth in net operating income (NOI).
Elevated Supply of New Apartment Units: The residential real estate market is witnessing a notable influx of new deliveries, which is creating pressure on rental rates despite strong demand. Operators are prioritizing maintaining occupancy levels to ensure steady cash flow, a strategy expected to continue in the near term.
While the current wave of nationwide supply begins to peak, the construction pipeline is quickly depleting, suggesting promising occupancy and rent growth prospects in the coming years.
Improving mortgage rates: The residential real estate market is currently experiencing strong demand. However, improving mortgage rates could shift some of this demand away from the rental market. With the Federal Reserve's recent rate cut and expectations of further reductions, many renters are likely to consider transitioning to homeownership, especially as borrowing becomes more affordable. As a result, residential REITs may face a softening in rental demand, particularly in regions where homeownership becomes a more viable option for residents.
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 #64, which places it in the top 26% of around 250 Zacks industries.
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates robust near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperform 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 upward 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.
Before we present a few stocks that you may want to consider for your portfolio, let’s take a look at the industry’s recent stock-market performance and valuation picture.
Industry Underperforms the Sector & the S&P 500
The Zacks REIT and Equity Trust - Residential industry has underperformed the broader Zacks Finance sector and the S&P 500 composite over the past year.
The industry has advanced 17% during this period compared with the S&P 500’s increase of 33.5%. The broader Finance sector has rallied 31.4%.
One-Year Price Performance
Industry's Current Valuation
On the basis of the forward 12-month price-to-FFO ratio, which is a commonly used multiple for valuing residential REITs, we see that the industry is currently trading at 17.37X compared with the S&P 500’s forward 12-month price-to-earnings (P/E) of 22.24X. The industry is trading above the Finance sector’s forward 12-month P/E of 16.72X. 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 26.24X and as low as 13.68X, with a median of 18.35X.
3 Residential REITs to Bet on
AvalonBay Communities: AVB is a key player in the residential REIT sector, with a strong portfolio of premium apartment communities. It is well-positioned to benefit from solid renter demand in high barrier-to-entry U.S. regions, driven by favorable demographics and rising homeownership costs. AVB’s focus on leveraging technology and scale to boost margins and efficiency is promising. Additionally, strategic acquisitions and development projects, supported by a healthy balance sheet, bode well for long-term growth.
AvalonBay’s third-quarter 2024 operating update highlights an increase in economic occupancy in August from the previous month, while like-term effective rent change decelerated in August from the previous month and second-quarter 2024. In August, economic occupancy for its same-store residential portfolio came in at 95.6%, up from 95.5% in July. The company recorded economic occupancy of 96% in the second quarter. The like-term effective rent change for same-store residential portfolio was 3.5% in August, down from 3.6% in July. The figure also marked a decrease from 3.7% in the second quarter.
AvalonBay currently carries a Zacks Rank of 2 (Buy).
The Zacks Consensus Estimate for the current-year FFO per share has been revised marginally north over the past month to $11.02. The consensus mark for 2025 FFO per share has also been revised upward over the past week to $11.56, implying a 4.9% year-over-year increase. The company’s shares have risen 7.5% in the past three months.
Equity Residential: Equity Residential, with a strong presence in urban and high-density suburban areas, stands to gain from favorable apartment market conditions. High homeownership costs are expected to sustain renter demand in its markets. The company's efforts to diversify into suburban areas are promising, capturing additional demand. Its focus on technology and enhancing organizational capabilities supports margin growth and operational efficiency, positioning the company for continued success.
In September 2024, Equity Residential reported that it witnessed healthy demand and pricing for its apartment units during the primary leasing season. The company reiterated its earlier guidance of blended rate growth between 2% and 3% for the third quarter of 2024 and a physical occupancy level of 96.2% for full-year 2024. It added that its same-store revenue growth would be able to meet its previous guided range, per its second-quarter earnings release.
Equity Residential currently carries a Zacks Rank #2. The Zacks Consensus Estimate for its 2024 FFO per share has been revised marginally north to $3.89 in the past two months and suggests a year-over-year increase of 2.9%. Moreover, the consensus mark for 2025 FFO per share indicates for a 3.5% increase. The company’s shares have risen 6.2% in the past three months.
Essex Property Trust: This residential REIT, which has a robust property base in the West Coast market, is poised to benefit from the healthy demand for its residential units. The West Coast is home to several innovation and technology companies that drive job creation and income growth. The West Coast region has higher median household incomes, an increased percentage of renters than owners and favorable demographics.
With layoffs in the tech industry slowing and return to office gaining momentum, the West Coast markets are likely to see an increase in renter demand in the near term. Due to the high cost of homeownership, the transition from renter to homeowner is difficult in its markets, making renting apartment units a more flexible and viable option. Essex Property is also banking on its technology, scale and organizational capabilities to drive margin expansion across its portfolio and improve operational efficiency by lowering costs. Essex Property maintains a healthy balance sheet and enjoys financial flexibility.
ESS currently carries a Zacks Rank #2. The Zacks Consensus Estimate for the company’s 2024 FFO per share has been raised marginally over the past month to $15.55, which indicates an increase of 3.5% year over year. Moreover, the Zacks Consensus Estimate for 2025 FFO per share has been revised north 0.8% over the past two months. The company’s shares have rallied 25.8% in the past six months.
Note: Anything related to earnings presented in this write-up represents funds from operations (FFO) — a widely used metric to gauge the performance of REITs.
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AvalonBay Communities, Inc. (AVB): Free Stock Analysis Report
Equity Residential (EQR): Free Stock Analysis Report
Essex Property Trust, Inc. (ESS): Free Stock Analysis Report