Rental units are hot again. How to invest.
Stephane Fitch, 12.06.10, 12:00 AM ET
As millions of Americans were looking in vain to unload their homes this summer, Thomas Toomey bought 1,374 of them for an average of $300,000 each. The $412 million outlay left his Denver-based apartment company, UDR, with 58,800 units worth $7.6 billion.
Toomey is buying for a simple reason. He's convinced that rising rents will drive up the profits he can earn leasing out those homes to record levels over the next several years.
"Our industry will do for apartments what Holiday Inn and Marriott did for hotels," Toomey says of his brand-building plans.
Rather than your Realtor, it's your stockbroker who can tell you that a housing boom has been going on in apartment real estate investment trusts for at least a year.
"Apartment demand is rebounding in dramatic fashion," says analyst Andrew McCulloch of Green Street Advisors. With little new development under way rents have risen 5% nationally in the past year, apartment-data firm Axiometrics says. McCulloch expects the gains to flow through as a 12.5% annual average earnings increase over the next two years among the dozen U.S. apartment REITs he follows.
The average apartment stock, meanwhile, has produced a total return (price gains plus dividends) of more than 40% this year. Apartment REIT shares are now at an average 12% premium to their underlying equity values, McCulloch figures. Even so, he rates only 3 of 12 U.S. apartment stocks as "sell."
Even if future gains are more tempered, investors can enjoy average 3.2% yields on apartment stocks (slightly below the overall REIT average) and good prospects that payouts will grow. That's partly because after rising to 69% in 2006, homeownership is heading back down. With the children of baby boomers now in their early 20s and looking to live on their own, the number of renters will grow by 4.5 million, or 13%, by 2015, analyst McCulloch figures.
Why not just buy apartments directly? Diversification, for one thing. UDR owns 58,800 apartments in numerous cities, and Equity Residential owns nearly three times as many units. Professional management is another plus for top REITs.
"On a scale of one to ten for management skill, I rate all the companies I follow an eight, nine or ten versus the private guys," says McCulloch.
Big apartment managers are figuring out how to use amenities like outdoor grilling kitchens, gyms and movie theaters, as well as electronic systems for paying rent or requesting a repair. Facebook-style apps enable tenants to organize parties, find jogging partners or even dates. Such amenities should help keep residents in place even if owning continues to become cheaper relative to renting.
The table shows eight apartment stocks, all rated "hold" or "buy" by Green Street. The picks have an average leverage ratio of 45%. The entire group should benefit from rising rents and pay rising dividends over the next three years.