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Can Residential REITs Bounce Back on Solid Demand in Early '21?

For the U.S. apartment market, the first quarter, which typically remains a slow leasing period in other years, appeared to be solid one this year, with solid demand for rental units. Thanks to employment growth that spurs household formation and housing absorption, demand for 52,661 apartments were registered across the country’s 150 largest metros during the quarter, per a report from the real estate technology and analytics firm RealPage (RP).

This tally is well ahead of the year-ago volume of 29,657 units. Not just that. This year’s first quarter demand is more than double the average first-quarter demand of about 25,200 units witnessed in the past 10 years. Considering that the first quarter comprises the cold weather months that affect leasing activity, this year’s performance is definitely a notable one.

However, the healthy demand has been the most noticeable in the Sun Belt metros. This looks good for apartment REITs like Mid-America Apartment Communities, Inc. MAA and UDR Inc. UDR that have exposure to the Sunbelt markets. Demand also remained impressive in the sub-urban ones though situations still remain turbulent in some of the gateway markets.

Given the continuation of the work-from-home flexibility this year even with the immunization process underway, the low-density and less-expensive sub-urban sub-markets are poised to lead the overall market performance in the days to come, while the gateway markets might fall behind. In addition, record-low mortgage rates and the desire for spaces are fueling home sales and adversely impacting rental demand.

Though the occupancy level was encouraging in March, the rent results have been mixed. Particularly, March occupancy came in at 95.5% in the United States’ 150 largest metros. This suggests stability and in fact, the occupancy level has been somewhere between 95.2% and 95.8% since late 2019. Considering that the world has been battling a pandemic in the meantime, this stability is particularly encouraging.

Nonetheless, considering the annual rent change, it is important to note that with some of the largest markets having suffered significant declines, the national shift in effective asking rents is still a tad negative at -0.7%. Specifically, San Francisco, San Jose and New York saw significant annual declines in effective asking rents. Nevertheless, the U.S. apartment rents moved up in the first three months of 2021, with a 0.2% increase in January and 0.6% in February, prior to the 0.7% rise in March.

However, the struggle to lure renters is here to stay now, as supply volumes will likely remain elevated. In fact, in the March-end quarter, though demand was strong, apartment absorption still lagged the property completion tally, with new supply aggregating 84,794 units. The trend is likely to continue in the rest of the current year as well with the ongoing construction standing at 611,202 units, indicating a sizeable number of apartment deliveries in the upcoming period.

While widespread vaccinations are anticipated to result in more jobs, particularly in the retail and hospitality sector, the competitive leasing environment is likely to prevail in the near term with elevated supply, keeping concession activity high and limiting scopes for rent growth in areas of high supply.

Amid these, AvalonBay Communities, Inc. AVB is likely to suffer as it has significant exposure to challenged urban residential assets. In the first-quarter operating update, this residential REIT announced that its total residential rental revenues for established communities for the two-month period ended Feb 28, declined 9.1%, year on year. (Read more: AvalonBay Updates on Q1 Operations, Rental Revenues Fall)

Apart from AvalonBay, other residential REITs, including Equity Residential EQR and Essex Property Trust’s ESS businesses have exposure to troubled markets and hence, the performance of these REITs might suffer in the meantime.

Currently, Mid-America Apartment Communities and UDR Inc. carry a Zacks Rank of 3 (Hold), while AvalonBay Communities and Equity Residential have a Zacks Rank #5 (Strong Sell) and Essex Property Trust has a Zacks Rank of 4 (Sell).

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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