Apartment REITs Are Hot Now, But Mortage REITs Will Stage a Comeback – Some Day

The employment report for December contained some good news for real estate investment trusts (REITs) specializing in owning and operating apartment buildings. As the number of Americans employed edged higher, the gains by two age cohorts – 25-to 34-year-olds and those 55 and older – continued to expand at a rate greater than the national average.

These groups form the basis of a bullish investment story first told as the home equity bubble began to deflate in 2007: It was said that home owning, especially as an investment strategy, would be replaced by renting among younger workers seeking their first homes and elderly Americans seeking to downsize.

In 2011, residential REITs, particularly REITs focused on apartment buildings, outperformed the broad market by double-digit percentage gains. As the New Year opened, Reis Inc. (REIS), a real estate research service, reported that apartment vacancies in the United States dropped to 5.2%, a 10-year low, in the last three months of 2011. Reis cited foreclosures against home owners and tough mortgage approval standards at banks.

The age demographic data plus consensus forecasts of more foreclosures and continued tight mortgage lending standards in 2012 make a convincing case for apartment REITs as a solid, dividend-yielding domestic investment for 2012 based on a preference for renting. Price appreciation of residential REITs has eaten into dividends yields, but they are holding at or above 3%, significantly higher than the benchmark S%P 500 yield of about 2%.

BRE Properties Dividend Yield Chart by YCharts

Megabuck investor Sam Zell, who knows something about apartment REITs, is struggling to boost the portfolio of his Equity Residential REIT (EQR) by picking up Lehman Brothers Holdings' stake in the bankruptcy of apartment manager Archstone for $1.3 billion. At least in real estate, Zell has a good track record for buying low and selling high, but Equity Residential's price has slumped amid uncertainty about the Archstone deal.

Archstone owns 74,000 units in America and Germany. Equity Residential is the largest residential REIT, currerntly paying a dividend of more than 4%.

Location, location location: BRE Properties (BRE) and Essex Property Trust (ESS) operate apartment complexes on the West Coast. The share prices slumped in the second half of the year along with the general market but entered 2012 on a strong note.

Equity Residential Dividend Yield Chart by YCharts

But value investors need to ask whether the story about apartment REITs is too well known. On a price basis, residential REITS track closely the benchmark S&P 500 index. More important, it may be a stretch to assume that home owning will decline as a goal of Americans, in favor of renting, in sizable-enough numbers to place a long term bid under apartment REITs.

S&P 500 Stock Chart by YCharts

The political narrative behind the “ownership society” was implanted in the American psyche years ago. The urge to rent may be only a short-term, if rational response to falling home prices and tight mortgage credit.

Finally, the macroeconomic case for a global market in home mortgage-backed securities has not disappeared, despite the financial debacle of 2007-2008. In an era of low interest rates worldwide, mortgage-back securities still offer higher yields.

For now, REITs comprising mortgage securities, as represented by the NAREIT mortgage REIT index (REM), rather than direct residential real estate equity, tracked by the NAREIT residential REIT index (REZ), continue to underperform as the mortgage securities industry faces fresh regulations by the SEC and rating agencies.

iShares FTSE NAREIT Mortgage REITs Index Fund Stock Chart by YCharts

Some of the big names in mortgage REITs include American Capital Agency (AGNC), Annaly Capital Management (NLY) and MFA Financial (MFA). These and other mortgage REITs often boost results by borrowing, a risky practice now under scrutiny by regulators.

MFA Financial Dividend Yield Chart by YCharts

Still, policy makers in the White House and on Capitol Hill are talking about restoring home ownership, not replacing it with rentals. Further damage to the mortgage market by regulators or Congress does not fit the Washington agenda or global investment demand for higher yields. The post-bubble era for REITS investing in home mortgage securities may be brighter than it seems in comparison to rental apartment REITs.

Bill Barnhart is an editor for the YCharts Pro Investor Service which includes professional stock charts, stock ratings and portfolio strategies.

Filed under: Investing Ideas