Rental REITs are a Good Choice in a Bad Housing Market
Kevin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you’re like me and you believe that the market for housing ownership will be noticeably depressed for years to come, than you want to look at rental REITs. REITs (real estate investment trust) can be in slightly different forms. The type to embrace in this market deals exclusively with rental properties. Being a part of a rental REIT allows an investor to make money off of the surge in renting without having the headaches associated with being a rental property owner or manager.
First, here's a bunch of numbers. The vacancy rate in the United States is less than 5% making it as low as it was prior to the “housing boom.” Now builders aren’t making many new homes but Avalon Bay Communities (NYSE: AVB) is spending $1.6 billion to construct 20 new communities making them the current leader in new apartment creation.
Despite record low mortgage rates, the market for home ownership remains depressed. In 2010 apartment stocks saw a stunning 40% total return. While no one is predicting such numbers for the near future, it’s not out of the question. On top of that the opinion of analysts is that rental stocks will return in the area of 12.5% per year for the next few years.
In the 20 most populated U.S. metropolitan areas rental rates increased 3.75% in 2011 while the same time period saw a drop of about 2% in home value. Reuters reported in July of 2012 that rental vacancy rates had fallen to the lowest level in a decade. This is why Apollo Residential Mortgage (NYSE: AMTG) has been recently upgraded to buy according to analysts.
Any argument for rental stocks should be accompanied by an argument against any form of housing rebound. Those arguments include a sagging economy where employment numbers are reported then adjusted down months after the inevitable rise in stocks caused by the “accidentally incorrect report.” Banks are still smarting (see articles here at the Fool advising against Bank stocks) and have tightened lending. Really this “tightened lending” amounts to a return to pre-housing insanity standards of lending that require good credit (gasp), a reasonable down payment (shock), properties that are soundly priced (oh, the horror) and proof of income (dismay). This return to sanity while home values have not completely corrected has slowed home buying dramatically. One side effect is more people per housing unit which has helped a REIT like UDR (NYSE: UDR) that specializes in multifamily units see a double digit increases in yield over the last year.
A Morgan Stanley report in the last year calculated home ownership in the US at 59.2%, the lowest level since ownership statistics starting being calculated in 1965. An argument against an upswing in home ownership could be several articles or even a whole site full of pages. Suffice it to say a dramatic turnaround in the US economy is needed for home ownership to increase. That’s why Associated Estates Realty (NYSE: AEC) which has 13,600 units and has produced some of the highest returns in the rental REIT game in recent quarters, is a smart move.
Interestingly, the old adage about real estate being local applies here. In other words, the rental vacancy rate in a given area impacts the yield and value of a REIT with units in that area. For the record, the following REIT recommendations were picked taking into account rental vacancy rates per state as reported by the US Census Bureau. Some quick stats: Michigan, Arizona and Florida have the highest rates of rental vacancy at upwards of 14%. This makes a REIT like Home Properties (NYSE: HME) good because it functions in the supply constrained East Coast area and specializes in redevelopment.
California, Minnesota, Montana, Oregon, Vermont, New York, Washington, Wisconsin and Wyoming have the lowest rates of rental vacancy with levels as low as 4.2%. You can see for yourself the history of rental vacancy rates by state or metropolitan area at the US Census Bureau’s website.
With housing staying in the dumps (wait, realtors are predicting a rebound- really? again?) there will be double digit returns on rental stocks for the foreseeable future so it’s not too late to get involved and build some wealth.
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