To state the obvious, it has been an extremely challenging twelve-month period for the residential REIT sector of the market. Are things looking up?
Sun Belt Apartments: The Big Three See Stable but Moderating Results in 2Q
The trajectory of rent growth continues to moderate across the U.S. with coastal market performance outpacing sunbelt markets.
Apartment industry information provider, RealPage, released their July monthly rent data which showed a 0.8% year over year increase for blended rents, a slowdown of 80bps sequentially from June and a continuation of a decelerating trend which began in March of 2022. New lease growth remained positive at 3.2% and renewal lease growth experienced a slowdown to 5.8%. The trajectory of rent growth continues to moderate across the U.S. with coastal market performance outpacing sunbelt markets. Effective rent growth for sunbelt markets turned negative at –0.9%. [i]
CoStar Group, another data provider that tracks property level apartment fundamentals across the U.S., recently noted a solid return in apartment demand for 2Q23, which was in excess of 105,000 units of absorption. To put this number in perspective, it was the strongest period of absorption since 3Q21. The much-anticipated delivery of new apartment units also ramped up in 2Q23 with approximately 145,000 units delivered in the period, with the negative net adsorption leading to further moderation in rent growth nationally, from 2.9% to 1.2%. CoStar also highlights the underperformance of sunbelt markets relative to coastal markets with Austin and Las Vegas showing the sharpest decline in rents for 2Q23 with a year over year reduction of –3.3%. Two of the better performing sunbelt markets in the period were Houston and Fort Lauderdale, which outpaced the national average in 2Q. Current projections are calling for 520,000 units of deliveries in 2023 with a large percentage of those deliveries coming in large sunbelt metros. [ii]
Mid-America Apartments (MAA)
MAA set the tone for sunbelt apartment 2Q earnings season with a modest beat to guidance and a full year 2023 raise to their earnings outlook. The guidance increase was driven by lower operating expense growth as the same-store revenue outlook remains unchanged at this time. On their 2Q earnings call, management described leasing conditions that were reflective of solid employment, steady migration trends and healthy resident retention. The spreads between new leases and renewal leases have continued to narrow with new lease rates slightly positive in the quarter and renewal rates that were just shy of 7%, for a blended lease rate of 3.8%. Portfolio occupancy held steady at 95.5% and while major sunbelt market metros are working through high levels of supply, demand has been strong. Operating expense pressures will moderate in the second half of 2023 as wage inflation has improved along with several other larger expense line items. Transaction activity across the company's markets remains quiet as dislocations remain prevalent across the financing market. Given the lack of acquisition potential going into the second part of the year, the company may elect to rachet up their redevelopments as a use of capital. These projects have historically provided attractive yields on cost, in the range of 18-20%. MAA continues to have one of the premiere balance sheets in the REIT sector and they ended the period with a net debt/EBITDA ratio of 3.41x.
Looking across MAA’s portfolio, strong results continue to dominate the Florida markets of Tampa and Orlando which generated same-store NOI growth and effective rent growth that were well above the weighted averages for the total portfolio. Nashville and Charleston also produced strong results in the quarter. The primary laggards in the period were Atlanta and Austin where supply pressures are weighing on rents.
Camden Property Trust (CPT)
CPT was able to report a “beat and raise” quarter along with many of its peers, primarily driven by lower property taxes. The velocity of growth continues to moderate, although CPT did see sequential improvements in leasing trends for July which were encouraging.
Research conducted for CPT by Witten Advisors points to multifamily starts which should begin to decline by the second half of 2023 and completions of newly developed projects are expected to peak in 2024. The Witten analysis determines that under 40% of units currently under construction are in submarkets where CPT operates, and only half of that supply may be competitive on a price basis with CPT communities. Demographic trends in CPT markets benefit from a steady stream of 20–34-year-olds and these young adults are a consistent source of demand for CPT’s properties. It is also noted that more than 50% of these young adults aged 18-24 live at home and a large percentage transition into an apartment lifestyle. While overall homeownership rates have been constant at roughly 65%, the homeownership rate for young adults has been trending down and currently stands at approximately 39%. [iii]
Overall, the CPT portfolio is seeing good occupancy momentum in the mid-95% range and blended lease rates are in the mid-single digits. CPT reported solid operating metrics for 2Q23 with revenue, operating expenses and net operating income (NOI) performance of 6.1%, 5.8% and 6.2%, respectively. CPT’s portfolio performance was driven by markets including Charlotte, Houston and Raleigh, with below trend results coming out of Phoenix, SE Florida and Austin.
Independence Realty Trust (IRT)
IRT’s 2Q results had a familiar ring with an earnings beat and a slight bump to full year 2023 guidance. The company has seen a positive turnaround in occupancy after struggling with the integration of a sizeable portfolio merger in 2021. This has resulted in a 140bp improvement in occupancy since the first quarter. Guidance for same-store operating metrics has remained unchanged as most of the guidance raise is driven by lower general and administrative expenses (G&A) and interest expense. Through the first part of July, occupancy increased 40bps sequentially. Renewal lease rates are tracking in the 4-5% range, which is in line with expectations and new lease rates have flattened out at 2.7%. [iv]
IRT is known for its sizeable commitment to portfolio renovations as a key driver of growth and they completed 625 value-add renovations in 2Q23. Returns on this capital came in at 16.2%, which was down from 17.8% in 1Q23. Management still expects to complete 2,500-3,000 units of renovations for 2023. [v]
The IRT balance sheet has come a long way in recent years and does maintain leverage above those of the top tier names in the sub-sector. Net debt/EBITDA is 7.2x and improving, with $300 million of liquidity and floating rate debt is only 4% of the total debt stack. The company has made enormous strides and is now on track to eventually achieve an investment grade credit rating.
The sunbelt markets across the U.S. continue to boast solid demand drivers including positive migration patterns tied to affordability and overall quality of life factors. Employment and wage growth, while moderating across the economy, have proven to be highly resilient through the critical summer leasing season as evidenced by new lease growth which has remained positive in 2Q23 and through July. Renewal lease rates have been trending down for the past year yet are still expected to achieve low-to-mid single digit growth in the back half of 2023. Occupancy levels for the sunbelt REITs have struggled somewhat to stay above 95% in the face of rising deliveries of new units, but the strong economic tailwinds have made all the difference, leading to improved absorption and the ability of talented operators to differentiate their offerings from the new build inventory which is most prevalent in larger sunbelt metros such as Las Vegas, Phoenix and Austin. While it could take upwards of 12-18 months for these high growth metros to fully absorb the supply that is being delivered in 2023 and 2024, the longer-term growth drivers for these regions remain intact along with their longer-term attractiveness to investors.
The across-the-board improvements in operating expense line items including repairs and maintenance, wages and even property taxes won’t be fully realized until later in 2023 and into 2024, partially offsetting some of the same-store operating pressures being precipitated by the development cycle.
The wide bid/ask spread which has hindered transaction markets since the Spring of 2022 is now being exacerbated by the dislocation in lending markets and has dragged on more than anticipated. We would expect external growth opportunities to favor the larger, low levered, listed REITs by the end of the year and external growth could drive incremental profitability into 2024.
We would anticipate 2024 to be somewhat of a “reset” year for the apartment REIT industry overall as peak supply is absorbed and operating fundamentals revert fully to a steady and predictable level of inflationary rent growth and focused expense management. The “big three” sunbelt names are estimated to generate 2024 funds from operations (FFO) growth of 4-5% and are currently trading with well-covered dividend yields of almost 4%, which imply a total return potential of approximately 8%. [vi] While a high single-digit return potential seems suitable for this sub-group as it completes its transition to normalization, a more bullish “upside” narrative could develop if investors begin to factor in a return to external growth and the potential for multiples to expand from current levels.
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[i] RealPage – July Monthly Update (August 7, 2023)
[ii] Costar Group: Multifamily National Report (August 7, 2023)
[iii] Camden Investor Presentation: June 2023
[iv] Independence Realty: Second Quarter 2023 Earnings Release
[v] Independence Realty: Second Quarter 2023 Supplemental Disclosure
[vi] NAREIT: REITWatch – June 2023