Combining GeoPhy COVID-19 Scores with new US Census Bureau data sheds light on REITs’ portfolio risks and valuations during the pandemic.
Co-authored by Ali Ayoub
The COVID-19 pandemic’s effects on the commercial real estate market have been hard to gauge – especially in the multifamily and office asset classes. With the transaction market virtually coming to a halt, there’s very limited liquidity. Changes in property prices are thus challenging to observe. And while it’s clear that the rental market is facing severe headwinds – whether it’s in office, retail, or lodging – its extent is again unclear.
As opposed to hard-to-observe indicators in the private real estate market, the outlook for REITs is reflected in stock prices on a daily basis. These publicly traded property companies report to investors quarterly. Analysts’ earnings and valuation guidance for REITs incorporate forecasts (and expectations) about the commercial real estate market.
If REIT pricing is an accurate bellwether, there’s indeed some real pain for private market real estate investors to come. Focusing on the housing market, the 12 largest residential REITs were down almost half from their peaks at their low points. Currently, they are still down by 27% (weighted by market capitalization). Perhaps the peak-to-trough numbers reflected an overreaction of the equity market. Current pricing indicates, however, that pricing and rents in the real estate market will see significant downwards corrections in the months and perhaps years to come – unlike Wall Street’s current bullish sentiment.
Assessing REITs’ COVID-19 Risk, Bottom Up
Within the residential universe of REITs, there’s a wide variety of exposure to the effects of the COVID-19 pandemic. Unlike many equities, REIT investments are in buildings. Each property can be identified by address and mapped against a wide variety of data points. GeoPhy tracks 12 residential REITs, which in aggregate own about 2,400 buildings or assets, including more than 500,000 units. (This total excludes single-family residential homes owned by the likes of American Homes 4 Rent and the “units” owned in “lifestyle parks” by, for example, Equity Lifestyle Properties).
We recently adjusted the GeoPhy Neighborhoods algorithm to understand the risk implications of COVID-19 for the multifamily market. Looking at 90,000 neighborhoods across the US, we identified those with the toxic combination of high rent-to-income ratios and large shares of the local labor force (previously) working in COVID-19-impacted industries. Using this data, lenders and investors can learn which of their assets are in neighborhoods with the highest risk of missed rental payment.
A simple overlay of a neighborhood’s GeoPhy COVID-19 Score and our location data on multifamily REITs shows Equity Residential (EQR) “leading” the ranks. Its assets are most exposed to areas where the economic impact of the COVID-19 pandemic will potentially hit hardest. EQR’s share price seems to reflect this risk somewhat; it’s down 34% since reaching its peak on February 21 this year.
Mid-America Apartment Communities (MAA) is by far the largest apartment owner among residential REITs. Its giant portfolio is located in areas that are somewhat less exposed to COVID-19 risk than EQR, with a GeoPhy COVID-19 Score of 55.
Rent Roll Risk and REIT Pricing
The potential damage of the current pandemic on apartment portfolios can be measured more directly by recent rent-payment behaviour of tenants in different markets. The National Multifamily Housing Council (NMHC) publishes a monthly Rent Payment Tracker, based on rental payments tracked by a number of providers, such as Yardi Systems. The Rent Payment Tracker shows quite an optimistic view on rental payments, given its focus on class A, high-quality rental units.
The latest data (as of July 13) shows just a 2.5% decrease in the share who paid rent in July 2020 as compared to July 2019. In addition to its focus on high-quality rental units and the most creditworthy tenants, the NMHC Rent Payment Tracker’s other deficiency is its lack of details on payment behavior across geographies and thus across REIT portfolios.
As reported in previous blogs (see here and here), the US Census Bureau recently started to track the economic impact of COVID-19 with a weekly survey that contains both current as well as forward-looking questions. It provides fresh, rich, and highly relevant data to identify what’s going on across the country.
Most importantly for the apartment industry, Census’ survey asks renters if they paid last month’s rent and how confident they are about paying next month’s rent. This survey offers comprehensive insight across all levels of income as well as the first forward-looking information available in the market about rent.
REITs’ Rent-at-Risk Exposure
We use this Census data to define “Rent-at-Risk” as those households that are either not paying rent or that have no- to low-confidence in paying next month’s rent. The map below shows significant variation in expected rent collection going forward: from 20.5% in Vermont to 60% in Mississippi.
We then overlay this information, which comes at the metro and state level, with the location information of each asset in each residential REIT portfolio. The assets of Camden Property Trust (CPT) are among the most exposed to rent roll risk: across the locations where its portfolio is located, an average of 38% of multifamily tenants are either not paying rent or indicating having low confidence in paying next month’s rent. All its assets are located in areas where Rent-at-Risk is at least 25%.
Although investors in Camden Property Trust have priced in some of the rent roll risk, its share price is not down as much as, for example, Equity Residential or AvalonBay. Measured by Rent-at-Risk (again, based on Census data), an average of 33% of multifamily tenants in the areas where AvalonBay assets are located are either not paying rent or indicating having low confidence in paying next month’s rent. For Equity Residential, that percentage is 32%.
Of course, different markets have different supply and cap rate dynamics, which also play into asset prices and REIT price formation. As professional owners, REITs know specific characteristics about the tenants in their portfolios’ buildings. If REITs have had a solid track record, we should expect them to be better than average.
The pandemic is so widespread, however, with enormous employment impacts on entire industries that vary across cities. We believe evaluating Rent-at-Risk from the Census survey offers clues into REIT asset performance.
So, which REIT to pick (or avoid)?
REIT analysts and investors face a dearth of reliable, timely, and granular data on the risk exposure and performance of residential investment assets. This gap makes it challenging to accurately price in the extent to which REITs will suffer from the COVID-19 pandemic.
While there are various generic metrics to assess risk at the market level, GeoPhy Neighborhoods allow for the assessment of COVID-19 risk at the granularity of a city block. And Census’ new data allows for the measurement of rent roll risk each week (albeit mostly at the metro level).
It is clear that the most-exposed REITs have some of the risk priced in when you combine these sources of data, the location of multifamily assets owned by REITs, and the most recent pricing data. (See the chart below, in which the size of the bubble depicts the size of the REIT by market capitalization.)
For the pessimists, shorting CPT or MAA might be a good opportunity. They rank #1 and #2 on rent roll risk, respectively, while their stock prices are down quite a bit less than comparable stocks.
Optimists may see upside potential in ESS and EQR, with the lowest Rent-at-Risk percentages (which, by all means, are still significant) and stock prices that are severely battered.
Of course, the numbers presented here paint just a partial picture. Factors like development pipeline and capital flows also play important roles in asset pricing. The advent of new sources of data, however, are helpful for multifamily investors – whether investing in assets or REITs.
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