Why Apartment REITs Are Primed to Move Up

Alternative investments are increasingly sought-after by institutional investors, and among alts, real estate—in particular, real estate investment trusts—have a lot of promise.

What kinds of REITs show promise? Apartments.

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So says Green Street, a commercial real estate analytics firm. It noted in a report that apartment REITs are staging a comeback and should resume their spot as leading performers, following a horrible 2022. That’s because Federal Reserve interest-rate hikes appear close to an end.

Why are apartment REITs a big deal? Apartments as a sector have a built-in advantage, both economic and demographic: Renting multi-family housing—as apartments are also called—is more affordable than buying dwellings. Prices for single-family homes remain elevated, as do mortgage rates. Millennials, the nation’s largest generation, are moving into real estate, but most start first in rented apartments. Plus, many Baby Boomers are retiring and looking to downsize from empty-nest houses to apartments.

The Fed-engineered rate spiral that began last year slammed REITs, which are pools of properties traded like stocks. As real estate depends on borrowing, REITs were especially vulnerable to the Fed’s tightening. Construction of new apartment buildings require a lot of debt.

Apartment REITs’ revenue stream appears to be copious and expanding. A Franklin Templeton report on alts found that “apartment rents have surged in response to consumers demanding more living space as lifestyles adjust to a new, more home-centric post-pandemic normal.” REITs, the report argued, “have the potential to provide investors with higher returns, higher income, lower volatility and diversification benefits relative to traditional investments.”

Green Street sees apartments’ cap rate, which measures its yield from rents based on the property price, expanding at a solid 6% in 2023. Rent growth should be low but positive for the next five years, the firm’s analysts say.

Among REITs, apartments this year have staged a comeback from 2022, according to FTSE Nareit data. Thus far in 2023, multi-family is up 10.9%, trailing only lodging and industrials (meaning factories and warehouses), which are ahead 14.8% and 12.6%, respectively. By contrast, over the past 12 months, apartments were the second-worst REIT performer, down 21.4%. Offices was the cellar-dweller, off 28%.

The pummeling that apartment REITs took last year has, in fact, made them value plays. The trusts are priced about one-third less than their underlying properties, according to Green Street.

Real estate, especially in REITs, is very popular among alts. A 2022 Nareit survey found that REITs grew 22% to $34.2 billion among the 200 largest retirement plans. What’s more, over five years, REITs grew faster than directly owned properties among allocators, with REIT assets increasing 40.7% versus 40.5% for directly owned.

Institutional investors are embracing alts in a big way: 86% of them now have money in alternative investments, per a 2021 survey done by Nuveen, the investment manager for TIAA. Real estate figures high on their investment lists.

The New York State Common Retirement Fund, for instance, last month announced it would invest $15 million into a fund that aims to buy or develop apartments, among other commercial uses. The Canada Pension Plan Investment Board is in a partnership to construct apartments in Brazil, as well as in Boston, Miami and Denver.