TLDR: REITs that own apartments, single family homes and manufactured homes have seen drops in prices in the wake of COVID-19. Data shows that they will bounce back.
Over the past few months, REITs have been impacted by adverse economic circumstances. However, not all sectors have been impacted in the same manner, nor are expected to perform similarly in the future. Overall, REITs have shown signs of bouncing back, with apartment REITs performing especially well compared to other sectors.
Fundamental performance drivers – ability to collect rent
NAREIT conducted a rent collection survey of listed equity REITs which own and operate c. 10% – 20% of US commercial real estate . The results indicated an improvement in rent collection with collections for apartments moving from 93% (May) to 97% (June) vs. Shopping centers from 49% (May) May to 60% (June) . Free standing retail improved from 70% in May to 79% in June. Some of these are slated to change as “second waves” of COVID-19 emerge, or not.
Macro-economic factors and money supply
Looking back in time over 1994 to 2019, we can understand patterns in performance through periods of economic uncertainty and credit expansion. From 1994 to 2019, we have seen stability in apartment REIT dividend returns as highlighted by the standard deviation of these returns which is lower than other sectors. This is correlated with the beta of these sectors where only healthcare had a lower beta as of November 2019. Beta measures the standard deviation of the returns as measured against a benchmark (risk free interest rate in this instance). A higher beta implies more volatile dividends, which real estate investors don’t like.
|Sector||Median 15-year dividend return (%)||(+/-) Standard Deviation (%)||Beta|
But what can we expect for the future of apartment REITs? If the past is any indication of the future, then based on previous performance of apartment REITs post economic crisis as interest rates rose and the economy recovered from adverse circumstances, such as the dot-com crash/terrorist attacks of 2001-2002 and the global recession of 2007-2008, we can expect price returns to grow strongly in the next few years.
According to research conducted by S&P Global, this is because:
- Rising interest rates are often associated with economic growth and rising inflation, both of which tend to be positive for real estate investments.
- A strong economy usually signals greater demand for real estate and higher occupancy rates, supporting growth in REIT earnings, cash flow, and dividends.
- During periods of inflation, real estate owners have the capacity to increase rents, and REIT dividend growth has historically exceeded the rate of inflation as a result as can be seen from the chart below
- The chart below highlights the positive correlation from 2002 – 2004 and 2008 – 2013 between REITs and interest rates
The price return for apartment REITS for 2002 was -13%, but then rebounded in 2003 and 2004 with price returns of 17% and 26% respectively. Congruently, GDP growth rate increased from 2.86% in 2003 to 3.8% in 2004 and interest rates rose from 4% in January 2003 to 4.3% in December 2004. Similarly, after producing a negative price return of -29% in 2008, apartment REITs produced a return of 22% in 2009 and 41% in 2010 once the housing market began resurging from the recession as the GDP growth rate increased from -2.54% in 2009 to 2.56% in 2010 and interest rates increased from 2.46% in January 2009 to 3.3% in December 2010.
If we extrapolate from these times to predict movements for 2021 and beyond, it seems likely that positive price returns for apartment REITS will return as COVID wears down, GDP bounces back, and interest rates increase as demand for credit rises. We may even see gains as large as the double digit returns seen in years past.
Moreover, beyond past quantitative indicators, future market trends such lower affordability of homes and increased credit restrictions by lenders predict continued demand for apartments.
About the Author: William Marin is a former Deloitte senior consultant with 5 years of experience covering financial services institutions. He worked in the Advisory practice helping clients improve their regulatory and operational capabilities across various functions of their organization. He will commence his studies at The University of Chicago Booth School of Business this fall. The views expressed above are personal, academic and do not constitute investment advice.