As a resident of Los Angeles, I spend way too much time in my car. While traveling the city from one end to another, I’ve noticed a fair bit of construction going on. I started paying closer attention and realized that well more than half of these projects appear to be multi-family residential projects, also known as apartment buildings.
As it happens, I also know a lot of folks in the real estate space out here. I ask about all these projects, and they invariably reply that they themselves are investors in these apartment buildings.
The reasons for the apartment building boom are not surprising. During the housing crisis, lots of people got kicked out of their homes. Since then, with wages remaining flat in the face of ever-increasing inflation, and with more than five million people leaving the workforce since 2009, people cannot afford to pay huge mortgages.
The result is that homes have started selling rather briskly again. All those people need a place to live, so they move into apartments. That explains why rent prices have soared in the Los Angeles area. It isn’t just here, either. It is happening all over the country.
That leads to the notion that apartment rental REITs are a good place to look to invest. This trend towards apartment living and rising rental rates is likely to continue for some time because this macroeconomic trend is not going to change anytime soon. With that in mind, here are three of the best stocks to play this trend.
Equity Residential (EQR)
Equity Residential (EQR) is perhaps the biggest name in the space, with 580 properties stretching across 24 states, representing some 152,000 rental units. Its annual revenue has exploded 50% since FY11, but it is struggling a bit with expenses. It carries $10 billion in debt, which is costing it some $600 million annually in interest payments.
The owner of EQR stock, the legendary Sam Zell, also points out that high levels of student debt are preventing younger people from buying homes. He’s also focusing on apartments in expensive cities like New York and San Francisco. So while I’d like to see EQR stock cash flow more quickly, I have faith in Zell. Plus, FY13 saw a strong free cash flow trajectory.
I like the company, the management and especially the 3.2% yield.
Avalonbay Communities, Inc. (AVB)
Avalonbay Communities, Inc. (AVB) goes one step beyond apartment buildings. The company actually owns and operates multifamily residential communities. AVB either develops the communities itself, or buys and renovates existing communities. Avalonbay’s 164 communities are in several different area of the country, from New England to Southern California, and they comprise more than 45,000 rental units.
The market shows no sign of slowing down, which is why AVB stock has acquired the rights to develop 27 other communities and has ownership interest in another 14 that are presently under construction. Of course, that comes at the cost of a lot of debt. Long-term debt increased from $3.9 billion in FY12 to more than $6.9 billion today. It has also blown through $2.5 billion in cash.
Overall, I’m a little concerned that AVB is overextended. The 3.3% yield is enticing, but I want to see a bit more cash flow from these properties.
Two Smaller Plays — PPS & MAA
These two companies don’t have the same scale as our previous picks, but they’re worth investigating just the same:
Post Properties (PPS) is much more concentrated REIT, with 60 communities in just ten cities. It recently retired all of its debt, and has $70 million in cash. As a smaller play, PPS stock may have the prospect of larger capital gains and higher dividends (over its present 3% yield) without that debt to service.
Mid-America Apartment Communities (MAA) completed a merger in October with another REIT and now has 275 communities in 14 states (primarily in the south and southeast), representing more than 83,000 rental units. MAA stock sits on $3.4 billion in debt and $160 million in cash. With core FFO growth of 7.2% and 5.2% same store sales growth, the 4% dividend is both sustainable and has room to grow.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities. He is president of PDL Broker, Inc., which brokers financing, strategic investments and distressed asset purchases between private equity firms and businesses. He also has written two books and blogs about public policy, journalistic integrity, popular culture, and world affairs. Contact him at email@example.com and follow his tweets at @ichabodscranium.