As expected, the apartment REITs reported strong first quarters. The recovery that began last year seems to have now spread throughout the country. So for analysts listening in on the REIT conference calls, the optimism was contagious, particularly with fundamentals looking even better heading into the summer.
“The trends were accelerating into April,” says Paula Poskon, a senior research analyst with Robert W. Baird & Co., a Milwaukee-based wealth management, capital markets, asset management, and private equity firm. “That gives us a lot of comfort with operating fundamentals [heading into peak leasing season].”
Here are three areas where apartments shone in first-quarter REIT earnings calls.
1. Strong Fundamentals
The improving rental market was probably the main theme in first-quarter calls. Despite that, most companies held their guidance in check. “We’re seeing the continuation of the improvement trends,” says Haendel St. Juste, an analyst with Keefe, Bruyette & Woods (KBW), an investment banking and security brokerage firm based in New York. "As we enter peak leasing season, apartment REITs' properties are full. There’s significantly improved pricing power. But we didn’t see a rash of guidance increases.”
That could change soon. “Guidance raises were limited, but market trends indicate that more are forthcoming,” says Andrew J. McCulloch, an analyst for Newport Beach, Calif.-based Green Street Advisors.
One company that did raise its top line guidance numbers was Houston-based Camden Property Trust. St. Juste thinks this emblematic of the increasing health of markets that had been lagging in the recovery. “They’ve seen improvement in their Southwestern portfolio,” St. Juste says. “The Sun Belt East improved middle of last year; Sun Belt West stayed soft. Now, the Southwest has picked up.”
St. Juste does point out that the gains made over the past year may not be sustainable, especially with food and gas prices rising. “As we go into the year and comps get tougher, it will be interesting to see the sustainability of the growth,” he says. “It will be interesting to see how those conversations on rent growth go as people face their second increase in rents. Consumers are cautious about spending their money. They are sensitive to price increases. It will be interesting to see how successful the companies are in sustaining the rent growth trends.”
2. Acquisition/Disposition Activity
REITs are still making buys, as announcements from companies such as Chicago-based Equity Residential; Arlington, Va.-based AvalonBay Communities; and Memphis-based MAA indicate. But that market is stiffening. “On the transaction side, it's no surprise that the acquisition market remains extremely competitive,” said David Neithercut, CEO of Equity in the company’s first-quarter conference call, which was transcribed by SeekingAlpha.com. “There is a massive amount of capital looking to be deployed in multifamily real estate today."
But this capital, combined with the uncertainty of Fannie Mae and Freddie Mac, the possibility of interest rates rising, and the return of CMBS, might have REITs looking to sell more assets. “They maybe accelerate the sale of some non-core assets, as these are arguably more exposed to interest rate risk,” McCulloch says. “The buyers of those types of assets tends to employ more leverage. Given interest rate risk related to a Fannie/Freddie restructuring, a potentially less aggressive Fed, or any number of unpredictable events that may affect interest rates, it’s probably not a bad idea to recycle some of this capital.”
Equity recently sold six deals for a weighted average cap rate in the low 6 percents and, year to date, the REIT has sold almost $800 million with another $200 million under contract. It will sell more, but will balance those sales with the potential to buy more assets (it purchased $139 million in the first quarter). “The strong demand for assets has caused us to accelerate our distribution activity for the year,” Neithercut says. “In fact, we sold $530 million of assets in April alone.”
3. Development Pipelines
A couple of years ago, REITs may have held an advantage when it came to buying existing assets. Now they seem to have the advantage in development. Companies such as AvalonBay are taking advantage of that. Over the last two quarters, it has added 14 development rights, totaling $950 million for the pipeline.
“While we didn't start any new communities in the first quarter, we recently authorized the start of construction for three communities, totaling around $200 million, which have either already begun or will begin construction shortly,” said Tim Naughton, president of AvalonBay in a conference call transcribed by SeekingAlpha.com. “We anticipate that we will begin construction on almost $900 million for the full year.”
Development is alive at other companies, including San Francisco-based BRE Properties, which completed a recent stock offering to complete development; as well as Birmingham Colonial Property Trust, which has two communities on the way and another two underway. But some analysts are asking why companies aren’t pushing for development even further, given the strong outlook for rentals.
Meanwhile, there were also the obligatory questions about overbuilding. “There were a lot of discussions on the calls about what new supply expectations are and when it will happen,” Poskon says.
But most CEOs don’t seem to see new development as a threat yet. “There are an awful lot of people out there that are trying to create development opportunities for themselves by raising equity and arranging for debt,” said Thomas Lowder, CEO of Colonial in its first-quarter conference call transcribed by SeekingAlpha.com. “But we don’t see that activity resulting in shovels going in the ground.”