As the housing market has recovered, apartment real estate investment trusts (REITs) have struggled. That’s a buying opportunity says Scott Hasting, Assistant Portfolio Manager of Delaware Global Real Estate Opportunities Fund (DGRPX). He likes BRE Properties Inc (NYSE:BRE), AvalonBay Communities Inc (NYSE:AVB), and Camden Property Trust (NYSE:CPT).
A Positive Hidden by the Negative
When Hastings looks at the home market in the United States, he sees an industry that has changed in some important ways. For example, the decision to buy a home is being put off by more and more people. That makes complete sense, given that many younger adults are starting their lives with heavy school debt. And with increasingly less secure jobs, buying a home is a weighty commitment at any age if you might have to sell it to move closer to your next employer.
So, while the uptick in the home market is nice to see, there are notable changes that are leading people to rent longer. That works to the benefit of apartment REITs. As the housing market has recovered, however, investors have looked less favorably on the sector even though such underlying trends haven’t changed.
About the Businesses
Hastings notes that apartment REITs have notable tailwinds. For example, they can access cheap capital in both the equity and bond markets. That gives them a leg up on private owners of apartments. Despite this, Hastings believes the REITs are trading at discounted valuations to private owners.
Location, Location, Location
While the apartment industry in general is interesting, it boils down to location in the end. Hastings likes the West Coast market and is particularly fond of AvalonBay Communities Inc (NYSE:AVB). The company is known for its higher-end, amenity-rich apartments and is an astute developer. Moreover, it just purchased a large portfolio of properties that it is redeveloping, adding additional internal growth opportunities to the mix.
AvalonBay Communities Inc (NYSE:AVB) owns over 270 communities, of which 121 are on the West Coast. Its other markets are generally on the East Coast between Boston and Washington D.C. Although Hastings doesn’t like some of those markets as much as the West Coast, virtually all of AvalonBay Communities Inc (NYSE:AVB)’ communities sit in space-constrained markets. That gives it the ability to charge higher rents and supports higher rent growth.
The REIT’s rent roll dipped slightly in 2009, but has otherwise headed higher over the past decade. The dividend has also headed higher, though not on an annual basis. That said, the company didn’t cut the distribution during the 2007 to 2009 recession like many other REITs.
With a yield of around 3.2%, income investors won’t get too excited about AvalonBay Communities Inc (NYSE:AVB) shares. However, the REIT is well positioned in space constrained markets, so it’s worth a look for those seeking a mix of growth and income.
A Turnaround Story
Hastings also highlights BRE Properties Inc (NYSE:BRE), but for a different reason. The company has been struggling, partly because of an effort to reposition the portfolio. BRE Properties Inc (NYSE:BRE) is selling properties that it no longer sees as strategic and is building new apartments from the ground up.
A sale is relatively quick and pulls rent earning assets out of the portfolio. Although the sale proceeds are going toward new construction in space constrained markets, it takes time to build and rent out an apartment building. So there’s a mismatch that only time can heal. This is why the shares have been stuck in neutral for a couple of years.
The REIT yields around 3.2% and the repositioning complicates its financials. However, as the portfolio repositioning progresses, Hastings expects the underlying value of owning good properties in tight markets to shine through. Note that all but three of its apartments are in core West Coast markets.
That said, Hastings believes the board is aware of the market’s perception of BRE Properties Inc (NYSE:BRE) and is willing to take action if needed. He sees this taking the shape of faster asset sales or even the sale of the entire company. The relatively small size of the portfolio (74 buildings) and tight regional focus would make it a nice bolt-on acquisition for a larger company looking for West Coast exposure. Such a sale would also lead to a quick boost in the share price, since BRE Properties Inc (NYSE:BRE) would likely sell at a premium to what the shares trade for today.
A Growth Market
Texas is another market that Hastings is fond of, with Camden Property Trust (NYSE:CPT) providing fairly direct access. The REIT owns over 190 apartments, with 55 located in Texas. That’s the largest single state exposure in the portfolio.
Although the REIT could be described as boring, Hastings believes it has one of the top five management teams in the REIT industry. It has a history of successfully allocating capital which, combined with its solid but boring business, allows it access to relatively low cost capital to fund future growth. Sometimes boring can be a good thing.
The REIT yields around 3.6% and has material exposure to one of the best performing states in the country. Although the dividend was cut during the recession, the disbursement is back in growth mode along with the rent roll. Investors looking to tap into Texas should consider this relatively high yielding apartment REIT.
Cheap Apartments
BRE Properties Inc (NYSE:BRE) Properties and AvalonBay Communities Inc (NYSE:AVB) both provide exposure to space constrained West Coast markets. BRE should be of interest to investors seeking turnaround opportunities, while AvalonBay is a high-end industry leader. Camden Property Trust (NYSE:CPT)’s future, meanwhile, is closely tied to strongly growing Texas and it offers the highest yield of the trio.
Delaware Global Real Estate Opportunities Fund offers one-stop REIT exposure and a management team that digs up these kinds of ideas across the globe. The fund ranks in the top quartile of Lipper’s Global Real Estate peer group over the trailing three- and five-year periods through May, so it’s a solid option for long-term investors looking to outsource their REIT investing.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Reuben is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Three Apartment Picks From Delaware Funds originally appeared on Fool.com is written by Reuben Brewer.
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