As the economic recovery steadily marches on, young adults have accounted for “about 45% of net new jobs since 2010.” These younger workers are less likely to buy homes, in part because of job instability, and in part because of the substantial debt many are already carrying from college loans. Many young professionals gravitate toward apartments. Three Real Estate Investment Trusts (REITs) are well-positioned to make the most of this shift in living: Equity Residential (NYSE:EQR), AvalonBay Communities Inc (NYSE:AVB) and UDR, Inc. (NYSE:UDR). Given the macro fundamentals, these companies are great investments.
Market choice
All three companies focus their capital in coastal markets and big cities, where the population is often more transient and the homes more expensive. Since homes are less affordable, more people choose to rent – given these markets’ strong rental proclivities, focusing capital in them is a smart allocation. That said, these firms have done a good job of diversifying geographically – they aren’t just focused in one geographic area.
A single natural disaster, however, will not do nearly as much damage to UDR, AvalonBay, or Equity. For example, UDR, Inc. (NYSE:UDR) took a hit when Hurricane Sandy damaged two of its apartment complexes in Manhattan, but due to the company’s geographic dispersion, earnings were not drastically affected.
Development, expansion, and acquisition
AvalonBay Communities Inc (NYSE:AVB) and Equity Residential (NYSE:EQR) recently finished the purchase of the Archstone portfolio of apartments. Both have opted to keep elements of the portfolio (including several development parcels) and to sell certain properties for solid short-term gains. This is a big expansion; AvalonBay and Equity sold other non-core assets and took on additional debt to raise the funds for this purchase. Even so, their Debt/Equity ratios are still very reasonable – particularly for REITs (Equity Residential’s Debt/Equity ratio is 0.6; AvalonBay’s is 0.7; UDR, by way of comparison, has a Debt/Equity ratio of 1.2).
AvalonBay Communities Inc (NYSE:AVB) wins the new development contest, with 30 new apartment communities under construction for a total expected cost of $2.4 billion and another $3.6 billion of planned construction, which will commence in the next few years. Equity Residential (NYSE:EQR) anticipates about $800 million in development through calendar year 2013, and UDR is working on a $1.2 billion development and redevelopment pipeline which will deliver over the next three years.
AvalonBay Communities Inc (NYSE:AVB) and Equity Residential (NYSE:EQR) plan to acquire additional properties this year; UDR is focusing its capital strictly on redevelopments and developments. Given the excellent revenue increases UDR is achieving on its redevelopments (for example: the 15% rental-rate increase at the Westerly in Marina del Rey, Calif., the 12% increase at the Rivergate in New York’s Manhattan and the 21% increase at the 27 Seventy Five in Costa Mesa, Calif.), this is a wise use of capital.
Financials
Occupancy was roughly even for all three companies at the end of Q1 2013 (95.5% at UDR, a little over 96% at AvalonBay Communities Inc (NYSE:AVB), and 95% at Equity). UDR reported a solid same-store net operating income (NOI) growth of 6.3% for Q1 2013, including a 5.4% increase in revenue and a 3.4% increase in expenses. AvalonBay reported a 4.9% increase in same-store revenue and a 3.3% increase in expenses, while Equity Residential (NYSE:EQR) reported a 5.1% increase in same-store revenue and an expense increase of under 3%.
AvalonBay and Equity both took a pretty steep dive in earnings per share (EPS) and funds from operations (FFO – I will define the term a little further down) for Q1 of 2013, but that was due to the costs of their joint venture to acquire the Archstone portfolio. I expect EPS and FFO to stabilize for the rest of the year, and the high- quality apartments in the Archstone portfolio will accrete additional earnings in the long term.
Valuation
REITs use FFO as a supplementary measure to EPS. FFO functions like EPS but ignores depreciation and the gains/losses from one-time items like the purchase or sale of property. The idea is that the depreciation schedule used by the IRS does not accurately reflect the fact that real estate held for investment purposes may hold value for longer and/or appreciate in value. I will be using a Price/FFO ratio for the trailing-12 months instead of the traditional P/E ratio when looking at valuation for these reasons.
Price/FFO is 19 for UDR, assuming a share price of $25.50. For AvalonBay Communities Inc (NYSE:AVB), the Price/FFO is roughly 28 assuming a share price of $135.00; Equity Residential (NYSE:EQR)’s Price/FFO clocks in at about 21, assuming a share price of $58.00. Keep in mind, as I mentioned above, the valuation difference is partially attributable to the costs surrounding the purchase of the Archstone portfolio. Nonetheless, the difference between UDR and Equity on the one hand, and AvalonBay on the other, is substantial, and I believe UDR and Equity are better investments long-term because of it.
Foolish conclusion
AvalonBay has a lot of its future growth priced in already as the flashy market-leader. UDR, Inc. (NYSE:UDR) has sailed a bit more under the radar, which provides you with an excellent opportunity to purchase a potentially undervalued REIT – particularly given the revenue growth management can anticipate from further redevelopments. That being said, any of these three is a great opportunity – they all have credible growth plans, they all are growing revenue, and they all are geographically dispersed, which helps hedge against risk. Bet on the economic recovery and on the continued expansion of the young workforce – buy these REITs.
The article Make Money From Your Rent Increase – Buy These REITs originally appeared on Fool.com and is written by Michael Douglass.
Michael Douglass has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Michael is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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