If real estate investing is anathema to you, that’s understandable. Enormous problems in residential housing — including declining values, weak sales, high inventories and legal problems with foreclosures — have turned many people off to buying a home.
But perhaps the best-kept investment secret of the past 18 months is that multifamily dwellings, and the exchange-traded funds (ETFs) and individual real estate investment trusts (REITs) that invest in them, are quietly making a terrific comeback after several years of lackluster performance.
Demand for rentals is growing so strongly that Realtor.com, the largest real estate website, is planning on listing apartments on its site for the very first time.
According to the Census Bureau, demand for rentals remained high in the second quarter of 2011, while homeownership rates declined slightly 65%. The national apartment vacancy rate dropped to 9.2%, a one-year decline of 1.4%.
Demand for rentals will likely continue to rise, due to several key factors:
1) Any decline in unemployment will spur renters in the 21-to-35 age group to move out of their parents’ homes.
2) The ongoing trend of families losing their homes to foreclosure will continue to increase demand for rentals.
3) A new generation of households that lack down payments, sufficient credit scores or courage to buy a home in the face of declining prices will continue to create demand for rentals.
None of this has been lost on builders, which have now turned to developing multifamily dwellings and apartment buildings, more than single-family homes.
For example, in June 2011, the number of multifamily home starts with at least two units surged over 30% from the previous month. Similar results were reported in October by the National Multi Housing Council’s (NMHC) latest Quarterly Survey of Apartment Market Conditions.
The NMCH reported that 67% of the developers it surveyed said they either broke new ground or engaged in ongoing construction of multifamily units.
ETFs or individual stocks?
Let’s look at different ways that investors can profit from the recent boom in multifamily construction, as well as an improving single-family building environment.
After a painful nine-month downtrend, the iShares Dow Jones U.S. Home Construction ETF (NYSEARCA:ITB) has finally shown signs of a bottom (see chart).
Standard Pacific (NYSE:SPF), which builds both multifamily and single-family homes, has also trounced the S&P 500. Over the last three months, SPF is up over 31%.
If you do prefer to trade ETFs, you may want to consider an apartment-related ETF. These funds are made up of a large number of REITs whose assets are heavily invested in large-scale apartment complexes.
Apartment REIT funds have clearly outperformed the S&P 500 over the past 12 months. One that specializes in multifamily residential is the FTSE NAREIT Residential Index Fund (NYSE:REZ) (see chart). Its largest holding is Sam Zell’s Equity Residential (NYSE:EQR), which owns 579 properties and 152,821 units across the U.S.
REZ is up about 40% in 2011. In addition, like many REIT funds, it has a dividend yield of just over 3%. It currently trades around $42.
Individual REIT stocks
If you prefer to buy individual REIT stocks, rather than ETFs, you can also do very well right now with REITs that invest in apartment buildings. Over the past 200 days, apartment REITs such as Education Realty Trust (NYSE:EDR), Equity Residential, and Post Properties (NYSE:PPS) have far outpaced the S&P 500. Returns on these REIT stocks during that period have averaged 7% to 11%, while the S&P 500 is down over 4%.
The main advantage of buying an individual REIT, as opposed to an ETF, is for the higher potential return.
Still, an ETF will provide you with far more diversity than you have with an individual stock, so your losses will be tempered if the apartment market suffers another decline.
I believe that the intermediate to long-term future looks bright for this sector, and buying an ETF rather than an individual REIT could provide substantial returns while reducing your portfolio risk. So if you’re looking for some “high risers” to add to your portfolio, consider the apartment-related stocks and ETFs.