Prevalent takeaways from the National Association of Real Estate Investment Trusts REIT Week Investor Conference in New York City last week.
This past week (June 7-9th) marked the in-person return of the National Association of Real Estate Investment Trusts (NAREIT) REIT Week Investor Conference in New York City following two years of a virtual venue due to the pandemic. Roughly 100+ companies and over 2,200 registrants were on hand for the event, which is one of two signature conferences organized by NAREIT each year. The timing of this conference in early June is opportune for the residential REIT sub-sectors in that it occurs at the “halfway mark” for the critical spring/summer leasing season which runs from April through August and is a period when a high percentage of annual leasing is completed.
The tone from investors at this year's conference was one of “cautious pessimism” which was not too surprising given the widespread weakness in risk assets that has been registered since the start of the year. Hallway conversation revolved around inflation, recession fears, war and a political landscape that is as toxic as any time in modern history. Luckily, the commentary from the two-dozen plus meetings we attended with senior management teams from across our constituent companies was considerably more upbeat. The record setting activity reported in the first quarter of the year across the landscape of multifamily, single-family rental and manufactured housing REITs is on track to be even stronger in the second quarter, giving us a high degree of comfort that these companies are extremely well positioned to weather a proverbial storm if some of the doomsday forecasts for a deteriorating economic backdrop come to fruition in 2023 or beyond. Several REIT CEOs made the point that residential real estate (and really all real estate that includes a lease) is a lagging indicator as it relates to economic activity and thus will be late in feeling the impact of a pending downturn. They also make the point that in prior recessions, the fundamental condition of the residential sector going into recession was a key factor in determining how the industry will perform during the downturn and dictate the trajectory of the rebound as the environment improves following the pause. Thus, we take a high degree of solace in the 2Q22 and full year 2022 updates which we received over the past several days.
One recurring theme worth noting from our meetings include the persistent supply/demand imbalance across the U.S. housing spectrum which has its roots in the great financial crisis of 2008-2010 and has been exacerbated more recently by the pandemic. Affordability and lack of availability remain barriers to single-family ownership across many U.S. markets, resulting in a larger potential multifamily renter pool. Even if residential development increases in coming periods, third-party forecasts indicate approximately 5 million additional apartments should be needed by 2030 to satisfy housing demand.[1]
The large, coastal market apartment companies such as Equity Residential (EQR), AvalonBay (AVB) and Essex Property Trust (ESS) all provided mid-quarter updates for April/May which showed accelerating trends relative to reported 1Q22 data. ESS was a standout because they raised full year 2022 operating expectations and earnings guidance for the second time this year. The midpoint of their funds from operation (FFO) guidance was increased by 1.5% while new lease growth for April/May was over 20% causing the company to raise assumptions for both revenue growth and net operating income growth (NOI) for the full year by 100bps and 140bps, respectively. It was also encouraging to see a sharp drop in delinquencies which fell more than 200bps to 0.1%, a very solid rebound given California centric portfolios have been struggling with high delinquency rates as a result of rent moratoriums that were in place through the pandemic. ESS also is a “canary in the coal mine” as it relates to concerns about job losses within the technology sector. Following a significant slowdown in jobs during the height of the pandemic, ESS markets have rebounded to a faster rate of job creation, outpacing over 88% of other major markets. As of May 2022, job openings at the Top-10 technology companies in California and Washington have increased 77% since the prior peak in 1Q20.[2]
Based on conversations with senior management teams within the single-family rental (SFR) sub-sector, we received confirmation that technological innovation, which was critical to the birthing of the industry going back to 2011/12, continues to be a driving force in maximizing profits and creating a seamless customer experience. Tricon Residential (TCN) credits technology for providing the capability to deliver a “hotel ready” experience to the consumer where everything from furnishings to internet to cleaning services can be provided to residents at a discounted cost due to national vendor relationships. We are also seeing highly creative and accretive capital allocation decision-making coming from the SFR companies in the form of third-party capital raises for joint ventures with homebuilders, lease-to-own strategies and even the allocation to higher price point rentals for premium quality homes.
The manufactured housing (MH) sector tends to have the least amount of historic variability in their operating model and thus has proven to be quite defensive in past recessions. This segment also tends to provide the most “affordable” housing option of all residential categories. Recent updates from management teams in this sub-sector centered on the increasing level of demand for both renters and owners within MH communities. Historically, we have seen very light volumes of greenfield development in manufactured housing due to high barriers to entry and the impetus for municipalities to take a not in my backyard (NIMBY) approach to zoning for this property type. (a concept covered in a recent posting) More recently however, developers including the public REITs, have seen greater success in launching communities as stabilization periods have been reduced by high levels of resident interest. The biggest constraint to occupancy in today's market environment has been order backlogs from the manufacturers of factory-built homes. With signs of improving home deliveries, managements are confident that new communities will fill and stabilized communities will continue to benefit from high single-digit NOI growth.[3]
In summary, we remain confident that residential REIT fundamentals are on track to meet, and most likely exceed expectations during 2022. We are disappointed that the group's stock market performance has not kept pace with property-level fundamentals since the start of the year and it does appear that financial markets are discounting a material slowdown for 2023 and beyond based on the sizeable discounts to net asset value (NAV) currently reflected in stock prices. While a normalization in operating metrics such as blended lease rate growth, occupancy and resident retention rate will occur in coming quarters, the disconnect between fundamentals and stock price has gotten to a level where shares appear to be “oversold” and could lead to proactive measures such as stock repurchases by companies and additional use of third-party capital to fund growth.
Glossary:
BPS: Basis points - A customary unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%. BPS is used to indicate the percentage change in a financial instrument.
Footnotes:
[1] UDR Inc. June 2022 Investor Presentation (Page 22)
[2] Essex Property Trust: June 2022 Investor Presentation
[3] UMH Properties: June 2022 Investor Presentation
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