Coming into fourth quarter earnings, analysts were expecting to hear more of the same good news from apartment REIT executives. And they weren't disappointed. 

Five years into the apartment recovery, the sector continued to hum along. In fact, 2014 might have brought a second wind, as rents rose 10 straight months and actually grew in the traditionally slow fourth quarter.

“The leasing trends through January and early February were strong,” says Conor Wagner, a senior associate at Green Street Advisors. “Pretty much across the board we saw every company report a better start to 2015 than to 2104.”

One of the big drivers of the past half-decade run was the lack of new supply. Over the past couple of years, however, that tide has turned. Last year, 246,579 new completions arrived in the nation’s 100 largest metros, according to MPF Research. And as more units come on line every day, Morgan Stanley’s Haendel St. Juste says REIT executives are starting to take notice.

“This year I heard more caution in their tone, as far as the outlook for the impact of new supply,” he says.

But St. Juste acknowledged that operators in D.C., Boston, and downtown Seattle might have more to fear than most.

“More and more markets and apartment REITs will face that supply pressure,” he says. “It was good to hear them acknowledge that concern. This year well be the year of transition and certainly, by the back half of the year, supply will become more of an issue.”

Reducing the Pipeline

Analysts expect the REITs to adjust their own pipeline is response to this supply wave. Most public REITs started more development in 2014 than 2013.

But as construction costs rise and supply increases, the returns of a few years ago are no longer available and St. Juste expects the tides to shift in 2016.

“As you enter year six of the recovery, NOI is less than it was two or three years ago. The risk has increased and the profit has come down,” he says.

If REITs do pull back on development, investors hungry for REIT assets may be left disappointed. That’s because when REITs sell, they need to recycle the proceeds into something else. Most recently, that has been development. “They just don’t have anywhere to recycle it,” Wagner says.

So, if they pull back on construction, St. Juste thinks a lot of REITs will probably hold more assets, despite attractive pricing. “Their need to sell assets, despite what is a pretty full price, probably isn’t what it used to be a year or so ago,” he says.