Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.
Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.
You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More
House prices are falling, according to home price evaluators like the Case-Shiller Home Price Index. The recent drop is related to rising mortgage rates and overheated home-price growth in the aftermath of the COVID-19 pandemic. Now, it looks like apartment rents are beginning to decline as well, at least according to recent data.
Falling rents would appear to be a concern for the big apartment-focused real estate investment trusts (REITs) like Equity Residential (EQR 0.71%). Does this signal lower earnings going forward?
Image source: Getty Images.
Equity Residential focuses on upscale apartments for young, affluent urban professionals. These people are currently the most likely to be first-time homebuyers but are shut out of the single-family housing market due to high rates, low inventory, and high prices. The company has properties in Southern California, along with San Francisco, Washington, D.C., New York City, and a few other metropolitan statistical areas (MSAs). The company’s strategy is to focus on building apartments in MSAs characterized as having a large knowledge-based job market, expensive single-family detached homes, and strong apartment demand.
While some studies are showing that apartment rents are declining, there is a seasonal aspect to housing, and winter is a seasonally slow period. Home prices also exhibit the same phenomenon, and often the best time to buy a home is January. Rents also tend to lag home prices by a period of about 21 months. This means that rents should continue to increase for almost two years after home price appreciation stops. This is because rents generally reset once a year, and the big increases happen when the tenant vacates.
Despite the slowdown, Equity Residential forecasted record same-store sales growth of 10.6% for the year. Occupancy remains strong, and was 96.5% as of Sept. 30. The pandemic caused Equity Residential to “buy occupancy,” or make concessions in order to keep people in their apartments. These concessions depressed rental growth in 2021 and the beginning of 2022. However, this effect has largely run its course and should result in higher rental growth as tenants leave and these units reset to market.
The fundamental economic backdrop for the apartment market remains robust. The job market is still exceptionally tight, and the apartment vacancy rate was at 6% at the end of the third quarter of 2022, which is historically extremely low. If the Fed’s tightening regime causes a recession, this number could tick up, however we are still bouncing around the lowest levels since the early 1980s. The U.S. has underbuilt since the Great Recession, and the National Association of Realtors sees a housing gap of 5.5 million-6.8 million units. As long as this imbalance remains, Equity Residential should have pricing power.
Equity Residential is guiding for full-year 2022 normalized funds from operations (FFO) per share to come in between $3.52 and $3.54. Based on current guidance, this gives the company a multiple of 16.7 times normalized FFO per share, which is a decent valuation for a market-leading REIT. The company pays a dividend of $2.50 per share, which is easily covered by its FFO guidance and gives the stock a yield of 4.1%.
Note that Equity Residential raised its dividend earlier this year. So far, it appears that the decline in apartment rents is probably just seasonal noise and shouldn’t be a near-term issue for Equity Residential.
Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services.
Making the world smarter, happier, and richer.
Market data powered by Xignite.
