Micro Apartments Good For REITs

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Big cities have been a draw for many years, with people willing to cram into apartments the size of shoe boxes. While that used to be a joke, New York City, Boston, and San Francisco are taking the legal size of an apartment ever closer to that mark, with San Francisco going as small as 220 square feet. Such desirable and property constrained markets have long been the focus of a select group of real estate investment trusts (REITs). The properties they own clearly have a lot of value and plenty of rent growth potential.

The Lure of the City
Young adults have always flocked to major cities, looking for culture, fun, and people their own age. On that front, you can't beat New York City, Boston, San Francisco, or Chicago. The opportunities in these cities are second to none, with enough wonderful museums, restaurants, bars, and dance clubs to fill up a social calendar for years.

If you want to be in the middle of the action, however, the cities are all space constrained. There simply aren't enough apartments for everyone who wants one, particularly if someone is on a budget. This is why these cities regularly see young folks banding together and sharing apartments. Complicating matters for these aspiring city dwellers is the fact that many wealthy baby boomers desire the same lifestyle and are moving back into the cities while they can still enjoy them physically.

This makes finding an affordable apartment that much harder. Apartment hunting in New York City, in fact, is often a matter of seeing an apartment once and making an offer before walking out of the door. It is such a competitive market that real estate agents can charge prospective tenants exorbitant finder’s fees. Landlords in other markets would usually pay such fees.

A Solution
Solving a space issue in a land constrained city is a tough issue. You can build up, of course, but cities are now thinking that allowing smaller apartments would be beneficial, too. New York City is set to allow apartments as small as 250 square feet, with San Francisco going even smaller at 220 square feet. That really is close to the size of a large closet.

New York expects the smallest apartments to go for around $1,000 a month for low-income residents. The larger units, at around 370 square feet, will likely rent for as much as $1,875. That's a huge cost that shows the value of rental real estate in these space constrained cities. Luckily for investors who think the trend toward urbanization has some legs to it, a collection of high-quality REITs offer access to these very types of markets.

Equity Residential (NYSE: EQR)
Equity Residential describes its portfolio as “concentrated in high-barrier, high-growth markets.” Although its total portfolio includes over 400 properties across 14 states, it has material exposure to Southern California (20.2% of 2012 net operating income), Washington, DC (15.9%), the New York Metro Area (13.6%), Boston (8.0%), the San Francisco Bay Area (7.4%), and Seattle (7.3%). Note that two of the three micro apartment cities are included in this list. A recent yield of over 5% makes this one of the higher yielding apartment REITs at present.

AvalonBay (NYSE: AVB)
AvalonBay owns and builds high-end apartment buildings in “high barrier-to-entry markets.” The company owns or has an interest in over 200 apartment communities in nine states and the District of Columbia. It has a focus on just 15 markets, including Boston (31 communities), Metro New York and New Jersey (45), Washington D.C. and Baltimore (25), San Francisco (13), Los Angeles (18), San Diego (8), and Seattle (17). Avalon Bay is an industry leader with a clear focus, for which investors have historically been willing to pay a premium. With a recent yield below 3%, it is pricey. However, it is a great REIT with equally great assets.

Apartment Investment & Management Co. (NYSE: AIV)
Apartment Investment & Management Co. is another major apartment company that focuses on “areas where target customers want to live – coastal and job growth markets.” The company has operations in 20 markets, with about 200 properties in its portfolio. Note that it also provides management services to others. Key markets include Los Angeles (14 properties), San Diego (10), San Francisco (7), Chicago (13), the Washington D.C./Maryland area (17), Boston (11), and Manhattan (22). Another high quality REIT that is afforded premium prices, it currently yields less than 3%.

UDR, formerly United Dominion Realty, used to focus on second tier markets and rehabilitating older properties. It brought in a new CEO who used to work for Apartment Investment & Management that changed the company's focus so that it more closely resembles that of his former employer. In fact, the company recently purchased its first building in Manhattan. Yielding around 3.5%, the company recently went through a material and transforming property sale. It is a solid company trying to turn itself into one of the industry leaders, which may make it worth a look for more aggressive investors.

Location, Location, Location
The old saying in real estate is “location, location, location.” That's particularly true when you are looking for apartments with pricing power. The above REITs own properties in desirable markets, providing them with solid foundations for rent increases.


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