No Upturn Seen for Multifamily REITs Until 2012

NEW YORK CITY-Multifamily may be one of the better property sectors to invest in, but when it comes to REITs, don’t expect to see much improvement for at least another two years. According to a year-end brief from Bank of America-Merrill Lynch, current REIT valuation does not fully take into account the impact of continued high unemployment for the next few years. As a result, the firm remains underweight on the apartment REIT sector.With unemployment expected to hover around the 9% to 10% range through 2011, landlords will be hard-pressed to increase rents. BofA-ML analysts believe year-over-year NOI declines will be in the mid-single digits in 2010, and anticipate that 2011 will be a transition year. Significant recovery isn’t expected until 2012 or 2013. Among the greatest risks to apartment REITs is the possibility that a new entity will replace GSEs Fannie Mae and Freddie Mac, which have provided the bulk of financing to the multifamily industry of late; the change may lead to an increase in the cost of capital. Also a factor is homeownership, particularly as housing prices decline and become more affordable, which will result in a shrinking renter pool. In fact, one-fifth of the top 20 markets had estimated monthly mortgage payments below effective rents as of the third quarter: Atlanta, Las Vegas, Riverside, CA and Tampa, FL. Monthly mortgages are about equal to effective rents in Boston, Chicago, Los Angeles and Orlando, FL. “As home affordability continues to increase as the housing market forms a bottom, we believe that there will be more move outs from apartments to home ownership,” says BofA-ML research analyst Michelle Ko. Yet there are some caveats, she notes. “Some may argue that home ownership has increased largely in part to government stimulus and when that is no longer available, home ownership could drop,” she points out. “Additionally, even though it may be cheaper to own a home versus renting, the psychology of renters may have changed. Some renters may now be wary of owning, as they have witnessed housing prices plummet or do not want the hassle of owning a home.” A close eye is being kept on these trends. Using data from Axiometrics, BofA-ML researchers believe the best performing markets in terms of rental revenue changes over the next two years will be Dallas, New York City and Washington, DC; on the flip side, Phoenix will be among the worst areas for multifamily performance. By taking Axiometrics rental revenue estimates for various markets, and gauging each company’s exposure to those markets, the analysts were able to rank apartment REITs nationally. Their top pick for 2010 to 2012 is Home Properties, thanks to “its defensive characteristics and exposure to better-performing markets,” reports Ko. “HME has outperformed its peers on a same-store NOI basis for year-to-date 2009,” at a 40-basis-point decline versus a peer average decline of 4%. Though the company tends to underperform during economic booms, its “slow and steady” FFO growth outperforms its counterparts when the economy hits rough patches. The firm should continue to outperform in 2010 and 2011, thanks to such factors as having lower-priced units in infill locations in the better-performing markets and a tenant base that is less likely to move out to purchase homes.Also in the top three from 2010 to 2012 is AvalonBay Communities, and Essex Property Trust is in the top three from 2011 to 2013.