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With 4Q21 earnings season having just ended, it is a good time to take a look at the U.S. apartment REIT sector to see how it fared at the close of 2021 and what we can glean going into 2022.
The overall performance of the industry was quite strong in the fourth quarter, extending gains made throughout 2021 as all regions of the economy reopened, albeit at varying degrees based on the health impact from Covid and local government mandates. Sunbelt markets in the southeast and Texas have continued to benefit from powerful in-migration trends, strong employment growth and an overall lower cost of living compared to coastal markets.
That said, New York and San Francisco have seen a massive return to the apartment rental market as large and small employers alike begin the arduous process of figuring out the right mix of hybrid work that keeps employees productive, motivated and culturally engaged.
Earnings Power
We saw traditional apartment REIT common shares perform well over the course of 4Q earnings season driven by a large number of positive earnings surprises within the subsector. Two standouts that materially beat consensus estimates for the quarter were NextPoint Residential (NXRT) and Independence Realty (IRT) with funds from operations (FFO) beats of 9.2% and 5.8%, respectively.[1]
The key driver of outsized performance at these companies, and at the industry level overall, comes down to property level performance of the existing, in-place portfolio. A sampling of apartment REITs achieved property level occupancy levels above 96% at the end of 2021 and rental rate growth in excess of 7.0%. [2] This strong ‘top line’ growth coincided with fairly modest expense growth, which in turn led to property level net operating income (NOI) growth in excess of 10%. [3]
Taking a closer look at this dynamic, we believe it implies that apartment landlords have real pricing power to drive rents higher. We are also seeing resident turnover levels that are near historic lows, one example of the supply/demand imbalance for housing which is keeping residents in place and making it possible for landlords to push up rents.
The second point to note is that operating efficiencies have been derived from economies of scale and years of investing in technologies which streamline all aspects of the business and reduce costs.
Outlook For Apartment REITs
Looking out towards 2022 earnings expectations, we believe the apartment sub-sector is poised to achieve FFO growth in the 15-16% range, one of the highest amongst all property types. [4] Again, these gains will be driven by powerful growth at the revenue line and relatively modest expense growth expectations, a real accomplishment given the inflationary pressures that are impacting all aspects of the economy.
Balance sheets within the apartment sector are conservatively capitalized and most of the companies have minimal exposure to short-term, floating rate debt. Thus, they would not be negatively impacted if interest rates rise in 2022.
According to several sell-side analyst reports, the sector is trading at approximately 24x 2022 FFO, a modest premium to the broader REIT sector. However, that’s arguably attractive given the potential growth that may be achieved by apartments relative to other property types such as office or retail. [5]
Looking at apartment REITs through a private market lens, or net asset value (NAV), the sector is trading at an attractive 5-8% discount to NAV. [6] Given the attractive fundamentals underpinning the apartment sector over the next several years, coupled with strong internal growth characteristics, we would make the case that this group should be valued at a premium to NAV. We have seen several large private equity firms make this determination as evidenced by several merger and acquisition (M&A) deals recently announced for apartment REITs, demonstrating the potential for greater value.
The Home Appreciation U.S. REIT ETF (HAUS) held the following companies mentioned in the commentary in the following percentages as of 3/09/2022, NextPoint Residential, 1.49% and Independence Realty, 3.03%.
[1] Jefferies Equity Research 4Q21 Apartments Review: Multifamily (Particularly Sunbelts) Don’t Miss February 21, 2022
[2] Jefferies Equity Research 4Q21 Apartments Review: Multifamily (Particularly Sunbelts) Don’t Miss February 21, 2022
[3] Jefferies Equity Research 4Q21 Apartments Review: Multifamily (Particularly Sunbelts) Don’t Miss February 21, 2022
[4] Jefferies Equity Research 4Q21 Apartments Review: Multifamily (Particularly Sunbelts) Don’t Miss February 21, 2022
[5] Stifel Multifamily REIT: Industry Update; 4Q21 Multifamily REIT Wrap-Up February 21, 2022
[6] Stifel Multifamily REIT: Industry Update; 4Q21 Multifamily REIT Wrap-Up February 21, 2022
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Definitions for technical terms:
Funds from operations (FFO) to total debt is a leverage ratio that is used to assess the risk of a company, real estate investment trusts (REITs) in particular. The FFO to total debt ratio measures the ability of a company to pay off its debt using net operating income alone.
Funds From Operations (FFO) – a non-GAAP measure of operating cash flow utilized by real estate companies
Net operating Income (NOI) – determines the revenue and profitability of invested real estate after subtracting necessary operating expenses
Earnings Expectations – a view or forward projection of earnings put forth by a company or sell-side analysts that provide research on a company
Sector – A broad indices of REIT stocks such as the FTSE NAREIT Equity Index
The Fund is distributed by Foreside Fund Services, LLC.
References:
- Jefferies Equity Research – 4Q21 Apartments Review: Multifamily (Particularly Sunbelt) Don’t Miss February 21, 2022
- Stifel – Multifamily REITs Industry Update 4Q21 Multifamily REIT Wrap-Up February 21, 2022
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