Residential REITs in a Bear Market

Apartment REITs Prosper Amidst Economic Downturn

• REITs have historically served as a strong inflation hedge and have direct exposure to primary drivers of the U.S. economy

• Apartment REIT total shareholder return (TSR) has outperformed that of other REITs and the broader market by a wide margin over the past 20 years (5% NAREIT Equity Apartment Index CAGR vs. 11.4% NAREIT Equity Index CAGR vs. 7.7% S&P 500 CAGR)

• Apartment REIT outperformance has been driven by 1) an ongoing shortage of U.S. housing, 2) better long-term net operating income (NOI) growth and lower capital expenditure costs than other REIT sectors, 3) the sectors status as a necessary, non-discretionary expense, and 4) a higher propensity to rent from Millennials and Baby Boomers, the two largest U.S. cohorts[1]

Recent Bear Market Has Led Towards Indiscriminate Selling

We are confident in the above commentary which came from the investor presentation of one of our constituent companies at this past week’s NAREIT conference, and would also highlight that during periods of financial market dislocation such as we are currently seeing across risk assets, there tends to be a high ‘correlation to the downside’ until we achieve some level of market capitulation. Having reached official bear market territory (down 20%) across many of the major stock market indexes over the past few days, indiscriminate selling has resulted with little or no regard for fundamentals.

Residential REITs During High Inflation Period

While not immune from a 40-year high in inflation which was recently set, nor from the potential for recession which seems to be top of mind for many forecasters, residential REITs have entered this current economic environment in an extremely strong position. This group will benefit from the supply/demand imbalance in housing which has been growing over the past ten years, causing occupancy rates to remain high along with operating margins and rental rates. Even under a scenario where the economy dips into recession in 2023 or beyond, residential real estate should still perform extremely well on both an absolute and relative basis. Also, with consumer confidence waning as concerns over the economy linger, some REIT investors may be hesitant to maintain exposure to the entire universe of property sectors including malls/retail REITs (non-essential), office (continued hybrid work models) and hotels (discretionary spending). These more risk averse investors could take a tactical approach of consolidating their REIT holdings into a sector like residential which has more attractive characteristics in a challenging macro environment.

Entry Point Opportunity For Sizeable Portfolios

Residential REITs are well positions to undertake shareholder friendly initiatives such as raising their common stock dividends and buying back common stock at material discounts to the underlying values of their portfolios. These activities may not garner much investor attention while in the midst of an indiscriminate market correction, but such activities can be beneficial to those able to look beyond the current melee. Also, spiking interest rates or the threat of recession may not be ideal for M&A (merger and acquisition) activity, but with residential being one of the most sought-after and liquid sectors within the real estate realm, substantial discounts to private market value and replacement cost could be viewed opportunistically by private capital as an entry point to acquire sizeable portfolios.

Stay The Course

We would encourage our holders to “stay the course” and potentially add to the residential REIT sector given the recent dislocation in stock prices as markets will eventually settle and investors will once again focus on demographics, fundamentals and valuation. All of which bode well for our constituents.

Footnotes:

[1]UDR Inc. - Investor Presentation; June 2022

Glossary:

NAREIT Equity Index: The FTSE Nareit Equity REITs Index contains all Equity REITs not classified as Timber REITs or Infrastructure REITs.

NAREIT Equity Apartment Index: A free float adjusted market capitalization weighted index that incorporates all tax qualified REITs listed in the NYSE, AMEX, and NASDAQ National Market

CAGR: Compound Annual Growth Rate

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