EUR 850.00 For Business Accounts Only

Morningstar | Apartment REITs Appear Fairly Valued as Supply Levels Off. See Updated Analyst Note from 26 Jun 2018

After transferring coverage, we are maintaining our no-moat rating for the apartment REITs (AvalonBay, Equity Residential, Essex Property Trust, and Aimco). We have increased our fair value estimate for AvalonBay to $181 from $170 after increasing our medium-term outlook for the company, and we are maintaining our fair value estimates of $64 for Equity Residential, $259 for Essex, and $43 for Aimco. While there are differences between the portfolios and management teams, the differences have decreased over time. All four companies regularly dispose of lower-quality assets and exit noncore markets. Since the companies currently target owning properties in mostly the same markets (which feature above average growth prospects), they have sold out of the assets and exited the markets that used to differentiate their portfolios. Additionally, rising construction costs have made accretive development opportunities more difficult to source, which reduces the external growth capabilities that have distinguished certain companies. As a result, the growth profile and uncertainty is very similar for all four companies and investors should focus on relative valuation when choosing an entry point into the sector. In our view, Essex is the most attractively valued at this point, although the discount to our fair value estimate is fairly slight.

Apartment demand has benefited from several demographic trends over the past decade. The tastes, desires, and economic situation of the Millennial generation have driven many of these trends, such as falling homeownership, the rising relative cost of single-family housing, and urban gentrification, which has favorably shifted the population of urban, coastal markets toward renting an apartment over owning a home. These coastal markets have high job growth and income growth, which support rising occupancies, high rents, and above average rent growth. They own high-quality properties that distinguish themselves by offering better amenities, better services, higher quality finishes, larger floorplans, and other desirable features that generate additional demand. Supply has been elevated over the past few years as there are few barriers to entry to the apartment market and apartment communities face competition from other residential property types, which limits the ability of the apartment REITs to realize high growth over long periods of time. However, increasing construction costs and tighter lending standards should reduce the number of construction starts and will reduce forward supply growth. On the other hand, these same factors will reduce the impact of external growth as the companies are finding it more difficult to refill their development pipelines with accretive projects. Thus, we believe the next few years should see higher internal growth as demographic trends lead to continued demand growth while supply abates, but the companies will find it harder to create value for shareholders through external growth.