Wall Street Analyst Views for Residential REITs

Following NAREIT’s REITWorld Conference, Armada ETF Advisors checked in with several Wall Street REIT analysts to get their thoughts on Residential REITs heading into 2023.

1. What are your views on the broader stock market over the next six months?

Haendel St. Juste: We expect the macro (continued Fed hikes, more layoff announcements) and negative earnings revisions (higher op ex and interest expense) to support continued volatility. So it’s tough to say definitely when the bottom will be. We think the still tough macro will make it hard for REITs to outperform in FY23, so we remain Neutral weight on the space…for now.

Alan Peterson: Relative to other asset classes (e.g., S&P 500, corporate bonds), REITs in general look on the pricier side of fair.

Neil Malkin: Even though I think we are in for continued economic weakness domestically and abroad, the fact that inflation seems to be slowing, and incremental Fed rate hikes appear likely to be smaller and close to the end, the market will probably be higher. To be clear, I am concerned about the US economy for a lot reasons: 1.) labor force participation & overall capacity/output; 2.) untenable government debt and the desperate need for the Fed to continue quantitative tightening (prob won't happen); 3.) money center banks appear less willing/able to extend as much credit or as favorable of terms in the coming year; 4.) terrible leadership in Washington; 5.) potential long term inflationary pressure to service sector wages; 6.) accelerating layoffs that could easily spread beyond the tech sector.

2. Where do you think interest rates are headed over the next six months?

Haendel St. Juste: Expecting continued hikes, but fewer / slower…to around 4.5% in the next 6 months and potentially as high as 5% by YE23.

Neil Malkin: I think we get more inverted over the next 6 months as inflation slows, recessionary fears/indicators increase, but the Fed also keeps increasing the Fed Funds rate into early 2023. I think the 10-year will be determined by global recessionary fears vs. quantitative tightening impacts. I am no Fed prognosticator, but I don't think Fed Funds gets above 5%

3. What is your view on apartment rent growth?

Haendel St. Juste: Apartment rent growth is slowing in FY23 (to ~6% ssRev vs >10% in FY22) from a variety of factors. 1). Typical seasonality is returning, which means slow leasing/occupancy focus until March. 2). There are signs of underlying demand slowing as well (above typical seasonality) from increased concessions to reports of more doubling-up to reduced pricing power/occupancy in some markets. 3). The strength of 4Q21 and 1H22 leasing is now turning into tough comps for the resi sector. From these, we expect muted rent growth in the next 6 months, with renewals holding up better than new.

Alan Peterson: Apartment rent growth is decelerating after a stellar year of growth that has played out in ’22. Our Market-to-Revenue Per Available Foot (M-RevPAF) growth estimates, which combine market rents and occupancy are heading from 12.8% in ’22 to 2.7% in ’23. With a softer economic backdrop, the deceleration seems reasonable.

When looking at apartment REIT revenue growth, ’23 should see growth of close to 7% largely driven by earn-ins between 4-6% across the peer group

Neil Malkin: I am bullish on the apartment space, especially relative to other REIT sectors. I do not expect rent growth to be negative in 2023, but do expect continual deceleration towards long-term trends by 2024. Moreover, the historically strong earn-ins the apartment REITs are carrying into 2023, on top of meaningful loss-to-lease % and very low turnover (for-sale unaffordability) should drive SS revenue growth in the high single digits.

4. Where do you see value in the residential REIT sector?

Haendel St. Juste: At a high-level, we think public residential REITs (down ~30% YTD) generally are undervalued vs its own history (5 turn discount to long-term AFFO multiple) or vs sectors like Strips (trading within 1 turn of each other at 18x and 17x respectively, despite apartments historically/logically trading at a premium to Strips). However, we do acknowledge the numerous headwinds facing the resi sector (higher op ex, cap rates and supply in FY23) and favor names with good expense management/external growth opportunities such as EQR and AIRC.

Alan Peterson: We see the most value in apartment and single-family rental (SFR) REIT stocks. Both sectors are trading at ~20% NAV discounts and a high-5%/low-6% implied nominal cap rate, which seems like good relative value versus buying the asset class in the private market.

Neil Malkin: I think the whole sector looks attractive given the sell-off this year. Per my above commentary, residential REITs should post some of the best SS and earnings growth in REITland in 2023, and balance sheets/liquidity are arguably in the best positions in many of these company's histories. This should allow for opportunistic acquisition opportunities, which will likely be driven by a highly dubious debt market/lending environment (LTV's, terms, rates, etc.) through at least 1H23. I think IRT looks attractive given its sell-off. I think SFR REITs have a more favorable backdrop in 2023 than apartment REITs, given limited supply, and very high retention which allows them to capture loss-to-lease more efficiently. I DO NOT think ESS, or Coastal markets represent opportunity right now. I think there are too many unknowns, particularly regarding tech layoffs, as well as longer term growth, and political/legislative uncertainty. I would be long the Sunbelt vs. Coastal markets 11 times out of 10.  

5. What markets do you think will outperform next year? Which underperform? What’s the next Raleigh/Nashville that nobody is talking about?

Haendel St. Juste: We think East Coast (NYC, Boston, DC) are set up better into next year vs. West Coast (San Fran and Seattle tech / RTO delay headwinds), while Sunbelt faces aforementioned headwinds, including expense headwinds (property taxes, labor, insurance), supply/cap rate headwinds, and slowing rent growth on comps and affordability.

Alan Peterson: Strong demand in the Northeast and pockets of Southern California should see the best rent growth in ’23. Additionally, suburban Sun Belt markets should perform well although near-term elevated levels of supply in Sun Belt MSAs could create pockets of concern. The coasts won’t see a lot of the supply issues the Sun Belt is running into.

Neil Malkin: Outperforming markets: Dallas, Nashville, Tampa, Orlando, Charlotte, Atlanta. I think Phoenix and possibly Austin lag due to very meteoric rise in rents and home values. No. Cal should be the worst region in the US in 2023, followed by LA, Seattle, and DC. The next Raleigh/Nashville markets could be Huntsville, Boise, Salt Lake City, or even a Columbus, OH. However, on a simplistic level, I truly believe markets like Dallas and Tampa should see some of the strongest population/job creation over the next 5 years which in my mind puts them at the top of the "markets to own" list.

In light of recent layoff announcements and work from home trends becoming the new normal, tech centric markets like the Bay Area and Seattle will likely underperform on a relative basis. Longer-term these markets should fare better than most.

For the current holdings of the Armada Residential REIT Income ETF (HAUS), click here. Holdings are subject to change.