Apartment REITs in coastal markets might benefit from the side effects of 2017 tax reform.
With rent growth climbing and demand hitting its highest level in eight years, 2018 proved to be a good year for the multifamily sector. But what’s on tap for 2019?
This year could be a mixed bag for the sector. According to the 2019 Multifamily Outlook from commercial real estate company CBRE, multifamily completions will remain high this year, but construction starts will fall. Meanwhile, CBRE envisions robust net absorption in 2019 in the face of an uptick in vacancy rates and rent growth that’s lower than the historical average.
Given those dynamics, multifamily REITs could feel headwinds or tailwinds this year, depending largely on their geographic footprint. Industry observers say three multifamily REITs in particular—AvalonBay Communities Inc., Equity Residential and UDR Inc.—could rack up solid performance in 2019, thanks to the desirable location of some of their core assets.
In a recent forecast, Green Street Advisors Inc., a real estate research and analysis firm based in Newport
Beach, Calif., lauded multifamily REITs’ prospects for above-average growth in NOI, their favorable environment for capital expenses and well-positioned balance sheets.
Multifamily REITs because they’re benefiting directly from the lingering U.S. housing crunch, according to Alex Pettee, president and head of ETFs at Rowayton, Conn.-based investment adviser Hoya Capital Real Estate LLC. “The simple reality is that the U.S. has not been building enough homes over the last 10 years to keep up with population growth,” Pettee says.
Pettee says he’s closely monitoring two multifamily REITs this year: AvalonBay and Equity Residential.
Why those two? Among multifamily REITS, the coastal-anchored, high-end portfolios of AvalonBay and Equity Residential are best positioned to capitalize on the short-term effects of tax reform, Pettee says.
For homeowners, the true impact of changes under the 2017 tax law won’t be felt until they file their tax returns this year, he notes. Two major shifts will hit homeowners: The law limits how much a taxpayer can deduct for state and local property and income taxes, and lowers the cap for mortgage interest deductions.
As such, some homeowners in high-tax states including Connecticut and New York will wind up paying thousands or tens of thousands dollars in extra taxes, Pettee says. Owners of high-end homes will be hit especially hard, which could tilt the buy-rent equation away from homeownership and toward luxury rentals, he says.
In line with that, Green Street notes the portfolios of multifamily REITs typically cater to older, more affluent renters than properties in the overall U.S. apartment market do.
“If, indeed, we see homebuying behavior change to a significant degree in these markets, it will show up most apparently in the strong leasing and occupancy statistics of these REITs,”says Pettee, referring to AvalonBay and Equity Residential.
This scenario could bolster both Arlington, Va.-based AvalonBay and Chicago-based Equity Residential because of their heavy concentration of high-end apartments in Northeast markets, including Boston, New York City and Washington, D.C., according to Pettee.
Green Street researchers emphasize the attractive supply-and-demand balance in 2019 and 2020 for multifamily REITs with a heavy East Coast presence, contrasting it with the likely risk of oversupply in markets such as Oakland, Calif.; Seattle; Austin, Texas; Dallas; and Charlotte, N.C.
“While it is difficult to isolate the impact of tax reform from the effects of rising rates and broader economic trends, the market-by-market comparisons of leasing results provided by these REITs will offer perhaps the best insight into the impact of tax reform on housing trends,” Pettee says of AvalonBay and Equity Residential.
Although not tying its outlook to tax reform, Equity Residential is forecasting year-over-year revenue growth of 1.8 percent in the New York market and 2.8 percent in the Boston market.
According to the Hoya Capital Apartment REIT Index, Equity Residential posted a total return of 7.1 percent in 2018, with AvalonBay at 1.0 percent. Last year’s average return for publicly-traded apartment REITs was 3.5 percent, compared with an average return of negative 4.6 percent for the REIT sector as a whole, the index shows.
In October, Tim Naughton, CEO of AvalonBay, told Wall Street analysts that several factors are driving higher demand for apartments, including strengthening job growth among young adults, increasing wage growth and decreasing affordability of housing.
“We expect that 2019 will be another good year for us, with strong demand across our markets creating high occupancy conditions,” Mark Parrell, president and CEO of Equity Residential, recently told Wall Street analysts.
For his part, former REIT executive Lonnie Vidaurri, director of investments and capital markets at StarPoint Properties LLC, a Beverly Hills, Calif.-based real estate developer and operator, is keeping an eye on multifamily REIT UDR.
Denver-based UDR is on Vidaurri’s radar because StarPoint Properties, when assessing REITs, pays close attention to development pipelines, joint venture activities and divestitures of non-core assets. In the case of UDR, Vidaurri is watching its projects under development, most notably in the Los Angeles market, where it already has seven communities.
“They stand out for the rents they’re achieving on new urban infill projects in Los Angeles, as well as their developer capital program,” Vidaurri says of UDR.
Overall, UDR aims to maintain a development pipeline of $900 million to $1.4 billion.
In addition, like AvalonBay and Equity Residential, UDR has exposure to high-tax Northeast markets, including Boston, New York and Washington, D.C.
In October, Thomas Toomey, president and CEO of UDR, told Wall Street analysts that the REIT expects apartments to “remain a consistent short-term and long-term performer in a very volatile global economic landscape.”