As 2010 arrives, multifamily REITs find themselves in a much different position than a year ago. Instead of tidying up their balance sheets and tapping into liquidity, they seem a lot more open to deploying their dry powder.
“The situation is clearly opposite of early last year when everyone was staring into the abyss, worried that there was going to be no capital available at all,” says Alexander Goldfarb, associate director of equity research of REITs for New York-based Sandler O’Neill + Partners.
Here’s a look at three trends to watch for in the apartment REIT space this year:
1. They will play more offense.
In 2009, the apartment REITs were quiet. Outside of a handful of deals by Alexandria, Va.-based AvalonBay Communities and Memphis, Tenn.-based Mid-America Apartment Communities, there weren’t any significant purchases until Equity Residential bought a trophy asset in Arlington, Va., later in the year.
So should we expect more of the same this year? While no one expects the floodgates to open up, acquisitions should pick up this year. Already, Palo Alto, Calif.-based Essex Property Trust announced the purchase of an REO deal in Irvine, Calif.
“REITs raised almost $30 billion of capital,” says Hessam Nadji, managing director of research services for Marcus & Millichap. “They have delevered. The next phase is moving into expansion mode and really taking advantage of the marketplace in terms of acquisition opportunities and going more on the offense and coming out of their defensive stance of 2009.”
And though it sounds slightly counterintuitive, making more purchases could ultimately help some REITs lower their leverage. “It will be less about re-equitizing and more about buying these acquisitions and putting in more equity to get over your deleveraging,” says Paula Poskon, a senior research analyst with Robert W. Baird. “Do 10 deals over the next few years and only finance at 50 percent loan-to-value instead of 70 percent. Over time, it delevers whole balance sheet.”
Others think sales pace will pick up but aren’t so sure how much. “I’m hearing that deal flow looks better,” Poskon says. “I’m not convinced that pricing will be as good as people think it is because there seems to be a lot of capital on the sidelines waiting to be put to work.”
2. They will generate more liquidity.
Just two days ago, Cleveland-based Associated Estates offered up 4.5 million of its common share stocks at a price of $11.10 per share. The REIT was happy with its pricing—and it isn’t alone. Towards the end of 2009, other major players in the business, including Essex, Mid-America, and Home Properties, made equity offerings.
“In the latter part of last year,” Poskon says, “we saw more companies continue equity raises. The intention is to match funds when they sell acquisition opportunities. They can access equity markets without having to do a marketed deal.”
The goal of these types of programs: To pay debt and maybe, just maybe, get ready to buy. “There are plenty of REITs that need to raise capital to delever,” Goldfarb says. “The REITs that have capital to be offensive are few.”
Eventually, Goldfarb isn’t so sure REITs are as focused on their debt as they were a year ago. "The equity markets remain open,” he says. “The credit markets have greatly improved. There’s probably a bit of complacency out there as far as debt levels. If you look at leverage levels on a historic basis, they’re above where they were prior to the credit bubble. A company could argue that they have access the debt markets and there’s no fear of bankruptcy and everyone is lending or extending, so why should we reduce leverage further? If the credit environment changes, you will see the tone become a bit different.”
3. They will be equipped for the recovery.
As it will be for rental owners all across the country, 2010 could be ugly. But 2011 and beyond could signal brighter days. And the REITs, maybe even more so than their private peers, are positioned to take advantage of that recovery.
Green Street Advisors, a Newport Beach, Calif.-based consulting and research firm, projects NOI declines of 12 percent through the downturn. Poskon thinks this pessimism will show in 2010 guidance from the REITs
“Is there any reason for companies to be overly rosy?” she says. “I don’t think so because it’s pretty bad out there for fundamentals.”
But there’s a feeling that even minimal job growth combined with no new supply could lead to better times very soon. Green Street projects NOI increases of 15 percent to 20 percent from 2012 to 2015.
“Because of the favorable demographics and pent-up demand that’s being created because people have moved in with family and friends, we will be seeing demand come back maybe even ahead of job growth,” Nadji says.
Right now, some REITs, including Highland Ranch, Colo.-based UDR, are using the downturn as a time to look inward and improve technology and operations. That will have them well-positioned for the future. “Having gone through the downturn, you’re looking at the best operations,” Nadji says. “They have economies of scale, ability to market units, having technology in place, ability to control costs, ability to have efficiencies. It is easy to have confidence in apartment REITs because of the operational expertise that they have.”