The coronavirus outbreak and OPEC price war has punished risk asset prices, and real estate investment trusts (REITs) are no exception. Looking ahead, when markets stabilize, we believe new and persistent economic dislocations, new patterns of consumer/enterprise behavior and modified social distancing will impact property types differently. One potential bright spot is residential REITs, which could benefit from structural undersupply, affordability and the new work-from-home economy.
Potential tailwinds for residential REITs. Residential real estate encompasses several types of properties, including apartments, single-family rentals, manufactured housing, and student housing. For several years, right up to the market collapse in February 2020, this sector had performed well. Global residential real estate has been structurally undersupplied since the global financial crisis. In addition, low unemployment rates in the US and other countries helped support high residential occupancy rates. Strong growth in the young-adult age cohort, who have a higher propensity to rent, also provided a tailwind. Broader demographic changes have helped too. Structural delays in life-cycle events (e.g., starting a family) have led to an extension of the average age of first-time home ownership. Moreover, high home prices in many markets and limited availability of buildable land have hindered the transition from renter to owner. In this regard, a Freddie Mac research survey found that 84% of renters believed renting was more affordable than owning, an all-time high for the survey.1 Although visibility is limited, the US homeownership rate is expected to trend sideways (at best) in the next several years because of poor renter balance sheets, affordability headwinds and restricted lending.2 The unprecedented spike in unemployment affecting 22 million US workers in just four weeks will likely perpetuate this trend.3
Apartments. The residential sector represents 17% of the listed global real estate universe, with apartments leading all property types.4 Both occupancy and rental rates for apartments in the US were strong on average before the market hit reset. In recent years, younger adults have gravitated toward city living more than prior age cohorts, which has helped support demand for apartments. Historically, apartments have held up better during economic downturns than more commercially sensitive property types. For example, during the 2001 and 2008 recessions, apartment rents in the US declined an average of 6%. This was meaningfully less than the average rent declines for the industrial and office sectors, which ranged from 9%-16%.5
Undoubtedly, the sharp rise in the unemployment rate has reduced the pricing power of apartment landlords in many markets, and we expect to see a drop in new leases along with increased tenant requests for concessions. However, there are some potential offsets. Extreme financial dislocation for many consumers combined with stress in the banking sector has likely reduced the number of renters who can afford the move to home ownership. This, in turn, could lead to higher retention rates for apartment landlords. In addition, any pause on short-term construction or the lengthening of delivery timelines could put a damper on new supply.
Single-family rentals. This segment of residential REITs is much smaller than apartments but is growing faster. In fact, single-family rentals have one of the most attractive multi-year demand profiles in US real estate according to industry analysts.6 Job growth across Sun Belt-focused footprints has been solid, homeownership is stuck in neutral, and this segment’s demographic tailwind will accelerate in the next several years as apartment renters age toward prime single-family renting years.7 This property type has also benefited from changing views among Millennials and Gen Xers as fewer of them own a home, or even live on their own compared to prior generations.8 The single-family rental market bridges the gap between apartment living and home ownership.
Manufactured housing. This segment of residential REITs has also enjoyed solid growth.9 In the US, approximately 22 million people across nine million households live in manufactured homes, representing 9% of single-family housing stock.10 Millennials and baby boomers account for more than 75% of manufactured home sales. Industry analysts expect manufactured housing to remain one of the most attractive property types going forward because of strong and sticky demand, minimal capex requirements, and structural barriers to new supply.11
Student housing. There were more than 11 million students in the US who attended a four-year university in 2019.12 Most on-campus housing is outdated and expensive, while most off-campus housing was not designed with students in mind.13 Student housing REITs own properties on and off campus that offer modern living spaces with student-focused amenities., The prices are comparable to (or even less than) school-owned housing.14 After several corporate transactions over the last few years, there is one remaining publicly listed student housing REIT in the US, although there are others outside the US.
The outlook for student housing REITs is likely more mixed than for other residential property types. In terms of potential tailwinds, student housing has historically been one of the most countercyclical segments in commercial real estate as students typically return to college (and stay longer) in more challenging labor markets.15 In addition, the current student housing stock is physically dated and functionally obsolete with a median age of more than 40 years.16 Furthermore, cash-strapped schools are increasingly using public/private partnerships with student housing REITs to modernize dorms in an effort to attract students.17 However, there are some potential headwinds. For instance, the coronavirus pandemic has closed down most college campuses, so student housing today is essentially empty. In addition, the Millennial generation—the largest age cohort in US history—has largely graduated from college and entered the workforce. Moreover, enrollment at full-time four-year colleges has been flat over the past four years as the strong US labor market has pulled students out of the classroom and into the labor force.18 Finally, the prime college-aged population is expected to grow at just 0 to 1% over the next decade.19
Residential sector in the current crisis. While residential REITs won’t be immune from the pandemic fallout, the hit to net operating income and asset values could be more benign than for many other property types, as residential REITs have historically been less economically sensitive. In this regard, having a home or residence is necessary – more so than farmland or other real estate investments, so residential REITs should continue to grow and receive income. This is especially true for those now working from home. Not surprisingly, the drop in the occupancy rate for the residential sector has typically been lower than the drop for many other property sectors during prior economic downturns. In addition, several provisions of the recently-enacted CARES Act should help mitigate some of the economic pressure on renters and help support the residential sector, including increased unemployment benefits ($260 billion), one-time payments to households ($290 billion) and individual tax relief ($20 billion).20 The new law also provides an additional 13 weeks of benefits, expanded coverage for self-employed workers who would not normally be eligible as well as student loan deferrals.
Potentially attractive valuations. US and global REITs have on average traded close to net asset value (NAV) versus private real estate valuations over time. This has been observed over the last 30 years for US REITs and 15 years for global REITs. As of March 31, 2020, US and global REITs traded at 21.9% and 19.5% discounts to NAV, respectively, amidst the current market turmoil. The apartment sector of the US REIT market traded at a 27% discount to NAV as of that date. (See Figure 1.) Discounts of this magnitude have only been observed during the 1990/91 recession and the global financial crisis of 2008/09.These periods historically provided investors with a window for deeper value opportunities as there was fragmentation between underlying real estate fundamentals and asymmetrically steep declines in valuation. We may see something similar in this current environment.
To be clear, there are many uncertainties with respect to the current global health and capital markets hurdles. However, we believe that in any forthcoming market recovery, REITs in supply-constrained markets with higher quality assets operating, healthier balance sheets and greater potential for above-average earnings growth may present an attractive investment opportunity. Furthermore, looking beyond the current market turmoil to a point when the capital markets have stabilized, investors can likely expect low interest rates around the world, slower economic growth and new levels of fiscal and monetary stimulus. A slow growth and low-interest rate environment has historically been favorable for commercial real estate and may prove to be so again.
Figure 1: US Real Estate Securities Valuation Metrics by Sector (%)
As of March 31, 2020
Of course, the new operating environment in commercial real estate is not risk-free for any property sector. Landlords are facing (sometimes steep) declines in rent collections along with increased tenant requests for rent forbearance or rent reductions. Residential landlords also face the risk of temporary policies designed to curb rent hikes and limit evictions. The sharp increase in the unemployment rate has likely reduced the pricing power of many landlords. Finally, residential landlords in certain markets have faced periodic efforts to implement local rent control regulations.
Residential sector could be a potential bright spot in commercial real estate. Despite the current dislocations in the property market, we believe that residential REITs could continue to benefit from a host of factors including structural undersupply, relative affordability and growth in the work-from-home economy. This sector is comprised of real estate that has historically exhibited lower economic sensitivity than many other property types. The severity of this economic crisis, coupled with the unprecedented spike in unemployment, suggests that the number of potential homebuyers has shrunk, which should help support demand for apartments, manufactured homes and single-family rentals. Once the market turmoil subsides, we believe residential REITs that own high-value physical assets and have a stable tenant base along with predictable and growing cash flows could present a potentially attractive investment opportunity.
1. Source: Freddie Mac Research, Profile of Today’s Renter & Homeowner, August 2019.
2. Source: J Pawlowski, et al., Green Street Advisors, Residential Sector Update, 3/3/20.
3. Source: Bloomberg L.P., 4/16/20.
4. Source: Invesco Real Estate based on data from MSCI Global Quarterly Property Fund Index and FTSE EPRA/Nareit Global Real Estate Index, 11/1/19.
5. Source: Invesco Real Estate using data from CBRE-EA as of March 2020.
6. Source: J Pawlowski, et al., Green Street Advisors, Residential Sector Update, 3/3/20.
7. Source: J Pawlowski, et al., Green Street Advisors, Residential Sector Update, 3/3/20.
8. Source: John Burns Real Estate Consulting, LLC, 10/2019.
9. Source: J Pawlowski, et al., Green Street Advisors, Residential Sector Update, 3/3/20.
10. Source: Manufactured Housing Institute and US Census Bureau, 2019.
11. Source: J Pawlowski, et al., Green Street Advisors, Residential Sector Update, 3/3/20.
12. Source: National Student Clearing House Research Center, Term Enrollment Estimates, 2019.
13. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
14. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
15. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
16. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
17. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
18. Source: Alex Pettee, Hoya Capital Real Estate, Student Housing REITs: Spoiled by the Millennials, 9/12/19.
19. Source: National Student Clearinghouse Research Center, 2019.
20. Source: Invesco Real Estate using data from NMHC, Committee for a Responsible Federal Budget, Bloomberg and Moody’s Analytics as of March 2020.
Blog Header Image: Nat Sumanatemeya / Stocksy
Global REITS are represented by FTSE EPRA/NAREIT Global Index is designed to track the performance of listed real estate companies and REITs in both developed and emerging markets
US REITS are represented by FTSE NAREIT All Equity REITs Index is an unmanaged index considered representative of US REITs
Manufactured housing is a type of prefabricated housing that is largely assembled in factories and then transported to sites of use.
Investments in real estate related instruments may be affected by economic, legal, or environmental factors that affect property values, rents or occupancies of real estate. Real estate companies, including REITs or similar structures, tend to be small and mid-cap companies and their shares may be more volatile and less liquid.
The opinions expressed are those of the author, are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.
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