Apartment REITs are still cheap.
Some investors are going to yell: “I won’t buy anything related to apartments until all of the issues impacting apartments are gone.”
Wonderful. That’s how investors can pay a much higher price. It is the fear over the current issues that drove apartment REIT prices lower.
Don’t worry, I won’t just say the REITs are cheap without math. We’re not your typical analyst:
Rather than just saying it is cheap, we want to show you. This is a sector we’ve been emphasizing lately for subscribers of The REIT Forum. We want to share part of our latest housing REIT Update.
Let’s run through the apartment REITs:
|Company Name||Ticker||Div Yield||AFFO or Core Yield|
|NexPoint Residential Trust Inc||NXRT||2.85%||5.10%|
|Mid-America Apartment Communities Inc||MAA||3.26%||4.55%|
|Camden Property Trust||CPT||3.45%||4.31%|
|Essex Property Trust Inc||ESS||3.98%||5.53%|
|Independence Realty Trust Inc||IRT||4.06%||5.89%|
|AvalonBay Communities Inc||AVB||4.06%||5.12%|
|Bluerock Residential Growth REIT||BRG||7.87%||6.83%|
|Preferred Apartment Communities Inc.||APTS||12.50%||7.10%|
We need to highlight that APTS is not like the other apartment REITs. It invests a material amount of the portfolio in properties which are clearly not apartments. We intend to have a longer article coming up on that in the future, but it isn’t ready yet. We want to focus on things that impact the entire sector. The yields are much higher than normal for the sector:
Source: The REIT Forum
Market-Implied Cap Rates
One way to evaluate equity REITs is to use the market-implied cap rate. This can be a useful tool for evaluating if prices might be reaching absurd levels. For reference, typical market-implied cap rates for apartment REITs over the last few years are in the general range of 4.5% to 5.5%. Based on the individual REIT and the time of the measurement, the value will change. However, that’s a good range to use for general values.
We pulled the financial statements across the big 7 apartment REITs, then added CLPR, Sun Communities (SUI), and Equity Lifestyle (ELS) to the mix. We pulled the data for the last 16 quarters, along with the closing share prices, and estimated the market-implied cap rate based on the last day for each of those quarters. For instance, using Q2 2019 trailing NOI with the share price from 6/30/2019.
We will highlight a few numbers here. The full table is in the subscriber housing REIT update.
For EQR, using prices from late September through early October, we calculated implied cap rates ranging from 6.05% to 6.39%. Why is there a range? Because we were pulling prices on several days and those prices were different. The highest cap rates came with a share price near $51 and the lowest cap rates came with a share price closer to $55. For those calculations, we’re using annualized NOI from Q2 2020.
That contrasts with an average market-implied cap rate of 5.15% for the last 16 quarters. That is a substantial gap. Despite a materially lower value for NOI in Q2 2020 compared to Q4 2019, the share price had simply dropped dramatically further.
Comparing annualized NOI from Q2 2020 with Q4 2019, the annualized value for Q2 2020 was lower by about 5.4%. That’s very material and has a significant impact on the calculations. To be clear, Q3 2020 and Q4 2020 could still involve lower NOI than Q2 2020. However, we are looking at a time horizon measured in years, rather than months.
We added to our EQR position recently:
Source: The REIT Forum
That isn’t a large purchase, but it isn’t our only purchase of EQR. It expanded our position in EQR to having a weight today of about 3.9%. Since we maintain diversification in our portfolio, a 3.9% weight is one of the larger allocations to a common share. We also own positions in some of the other housing REITs.
Price to NAV
The price to NAV ratios throughout the sector show significant discounts to analyst estimates for NAV:
Source: The REIT Forum, data from TIKR.com
That’s a substantial discount and the consensus estimates were already reduced materially.
We’re maintaining a positive outlook on the sector (despite the expected headwinds to NOI). We are highlighting a bullish rating on EQR. With a substantial discount to NAV and a high market-implied cap rate, shares are offering a nice bargain to long-term investors. Short term, there may be plenty of noise and some extra volatility. For the long-term investor, this is a solid stock for dividend growth.
Our method works. We know because we buy the same shares we recommend. We track our results on a real portfolio and we compare our returns with the major ETFs for our sector:
Those four ETFs are:
- MORT – Major mortgage REIT ETF
- PFF – The largest preferred share ETF
- VNQ – The largest equity REIT ETF
- KBWY – The high-yield equity REIT ETF
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Disclosure: I am/we are long SUI, ESS, ELS, EQR, AVB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.