- Effects from the coronavirus pandemic, including increased remote working and employee mobility, and deteriorating fiscal health at both the state and city levels, threaten to reshape where renters decide to live.
- Densely populated urban gateway cities such as New York, San Francisco, Boston, and Los Angeles are most at risk, in our opinion, while suburban areas and Sun Belt markets could benefit.
- We believe residential REITs will face modest operating pressure over the next year, with NOI declines in the low- to mid-single-digit range and some deterioration in credit metrics due to lower rents and occupancy pressure.
- We also expect rating stability as our rated residential REITs, in general, boast strong balance sheets and sufficient liquidity to manage through headwinds created by this recession.
The Pandemic Has Modestly Affected Residential REITs
While the coronavirus pandemic has had a significant financial effect on certain property types (such as retail, hotels and seniors housing), the impact on residential rental properties has been more muted. The U.S. experienced a historic level of job losses totaling 22 million at the depth of this recession, and less than half of those jobs were recovered through August. Thus far, this recession has predominantly affected lower-income workers, including those in the retail, restaurant, and hospitality industries (renters of class C or D [government-subsidized housing] quality apartments). As a result, our rated multifamily REITs (which offer almost exclusively class A or B quality product) haven't been nearly as affected, as the vast majority of their tenants have been relatively unaffected by the recession.
In the second quarter, rated multifamily REITs reported better results than we had projected, with average rent collections of 97.2%, occupancy at 95.3% (down 120 basis points [bps] from year-ago levels) and same-property net operating income (NOI) down just 2.4%. There are some inconsistencies among the peer group in their reporting of same-property NOI (some chose to include straight-line rent, while others reported strictly on a cash basis), but we don't think this impact is significant for the group as a whole. Moreover, it will normalize over the next couple of quarters as rent is either collected or written off.
In early September, President Trump announced an executive order to extend eviction moratoriums through year end. Under the moratorium, the Centers for Disease Control and Prevention and the Department of Health and Human Services will use their authority to protect renters from being evicted, provided renters can prove they have suffered from the pandemic and meet additional qualifications. Many local governments also still have moratoriums on renter evictions, and local laws aren't superseded by the federal order. While the extended moratorium adds some uncertainty to future rent collections, we think the vast majority of tenants will continue to pay their landlords rent.
Moreover, while rent controls remain a relevant topic, we see the increased rent controls in certain cities and states as having a negligible impact on residential REITs' financial performance over the near term.
We now expect operating performance for multifamily REITs to decline similarly to previous recessions, with same-property NOI falling in the low- to mid-single-digit percent area in 2020 (with modest sequential deterioration over each of the next two quarters), followed by slightly negative to flat results in 2021 (with a weak first half followed by a stronger second half). However, despite our expectation that this recovery path will follow a similar trajectory as prior recessions, there are many factors that we think will likely make this recovery unique, potentially affecting residential REITs' operating performance over the medium to longer term.
Remote Working Will Continue Driving Demand For More Space
Greater adoption of remote working across most corporations, along with increased job mobility, has allowed employees to seek alternative living arrangements. The desire for more space, as renters spend more time at home, has been a major factor in pushing renters from smaller, costly urban apartments to larger suburban dwellings. We think this, along with record-low interest rates, drove a surge of home purchases in the second quarter, pushing the national homeownership rate up to 67.9% (up from 65.3% in the first quarter and 64.1% in second-quarter 2019). Homeownership is back to where it was before the Great Recession, and near the all-time high of 69.2% set in 2004.
Despite the economic pressure facing many households, we don't expect homeownership levels to fall too far from the high-60% area. That said, the national rate is also unlikely to push through 70% anytime soon either, as the lack of affordable housing in many states, coupled with the financial hardships caused by this recession, restrain many renters from buying. As a result, we expect this yearning for larger spaces will also likely continue to prop up demand for larger rental apartments (two to three bedrooms) and single-family home rentals in suburban markets.
We think remote working is here to stay, with many corporations likely to grant employees more flexibility to work from home post-pandemic. Given this view, we do think the need for increased space will be critical for many renters and could drive a permanent shift in demand that benefits larger, suburban dwellings.
As State And Local Government Face Massive Budget Deficits, Higher Taxes Could Spur Migration
The coronavirus pandemic and resulting recession has wreaked havoc on state and local budgets, with the 50 states projecting that tax revenues will decline approximately $180 billion in 2020 and 2021 (relative to 2019 levels). California, New York, Texas, New Jersey, Massachusetts, and Illinois face the largest projected fiscal deficits. New York City Mayor Bill De Blasio announced that the city is likely facing a $9 billion loss in tax revenues for this fiscal year and New York State's budget division projected in September that receipts would be $14.5 billion less than it had projected in February. Barring a bailout from the federal government, many states may be forced to raise taxes significantly, drastically cut services, and/or reallocate funds to balance budgets.
In September, New Jersey passed a plan that will increase the tax rate on gross income between $1 million and $5 million to 10.75% from 8.97%. In California, two bills were introduced in August to tax the wealthy. The first would retroactively (from Jan. 1, 2020) raise the state's top income tax bracket to 16.8% from the current rate of 13.3% (already the nation's highest state income tax). The second proposed bill would impose a 0.4% tax on wealth exceeding $30 million. In Illinois, a series of higher tax rates has been proposed for those making over $250,000 annually, with rates rising to 7.99% (from 4.95%) for joint filers making over $1 million. While New York State has thus far resisted the idea of taxing the wealthy, it may have few other options without material aid from the federal government. Significant pension reform is highly controversial and unlikely to be widespread, in our view.
While local governments have the option to declare bankruptcy, we think a large portion of them will instead raise property taxes to narrow their deficits. While this could make the decision to own a home less attractive, further decreasing the affordability of homes in certain states (which could benefit multifamily REITs by creating a greater pool of prospective renters), higher property taxes could be a disincentive for people choosing to live in one of the more affected cities/states. The challenge here is that taxpayers are more mobile than ever before, and higher tax burdens will likely accelerate outmigration from the affected states (creating a vicious cycle that would necessitate increasingly progressive tax hikes to close budget deficits).
For residential REITs, while the lack of affordable housing in many of the most affected states makes it difficult for renters to transition to homeowners, we think significant tax hikes would accelerate outmigration trends. As a result, local businesses and economies would suffer, ultimately lowering demand for rental units as well.
Increased Crime In Major Metropolitan Markets Could Impair Filling Vacancies
Violent crime is on the rise in many major cities. According to The Wall Street Journal, homicides were up 24% year over year through July in the top 50 cities in the U.S., with double-digit increases in 36 of them. In New York City, the violence has been even more pronounced, as New York City recorded 791 shootings from May to the end of August (up 140% from the same period in 2019) and 180 murders over that same time frame (up 51%).
Several large cities, including New York City, Washington D.C., Los Angeles, and San Francisco, have recently voted to cut police budgets, which could heighten criminal activity. On its own, we don't think increased crime has necessarily been a significant factor for people leaving major metropolitan markets this year. However, a prolonged resurgence in crime could lead to additional people leaving cities or deter those thinking of moving back.
Suburban Markets Are Poised To Outperform Urban Markets In 2020 And 2021
In second-quarter 2020, there was an exodus of residents from densely populated urban markets, most notably New York, San Francisco, and Boston. Within our rated REITs, occupancy in suburban markets was averaging 300-400 bps better than in urban ones at second quarter end. For instance, at Equity Residential, the largest multifamily REIT by total market capitalization, occupancy was 96.6% for its suburban properties as of June 30, 2020, compared to 93.3% for its urban assets. Rent concessions have increased in the major urban markets (now commonly four to six weeks of free rent per year) to attract new tenants and retain existing ones.
Over the longer term, we would anticipate that this gap in occupancy will narrow. After all, cities are vibrant and dynamic, with culture, amenities and energy that can't be replicated in suburban settings. Moreover, new supply will likely be built in suburban locations to meet the heightened near-term demand. That said, given the many factors that are at play, such as remote working, we do expect suburban markets to remain in favor over the near to medium term.
Supply Pressure Should Ease Somewhat In 2022
While the pace of development has continued for projects under construction, new development starts slowed greatly during the first couple of months of the pandemic. While construction has since resumed at a solid pace, we nevertheless expect supply pressure to ease somewhat in 2022, following relatively high levels of new construction delivered in both 2020 and 2021.
Unlike many other property types, we don't think barriers to entry are significant in housing. While land is a restriction in urban, coastal markets, development of high-rise apartment buildings can minimize that factor. Moreover, given the lack of housing that exists in many markets, developers don't face the same extensive permitting and zoning hurdles that many other property types have. That said, we expect most new supply to come from markets in the Sun Belt region, given the outsized job growth and population migration expected over the next several years (relative to other regions).
The Critical Age Cohort For Renters Will Peak In 2024
While we don't see this is a significant risk factor for multifamily REITs, the prime renter cohort (those aged 25-34) is expected to peak in 2024.
While this may affect demand slightly, the population for this cohort is expected to plateau rather than fall significantly. Moreover, people are continuing to form households later in life (delaying marriages and having kids), which has extended the renters' cohort beyond the traditional 25-34 years (with many renters now in the 35-44 age cohort).
Credit Implications For Rated REITs
The rated residential REITs, by and large, entered this recession with strong balance sheets and sufficient liquidity to manage through challenging times. In fact, debt to EBITDA for residential REITs at the end of 2019 was nearly three turns lower than it was at year-end 2007, highlighting the conscious decision management teams made to reduce leverage during the late stages of this most recent economic recovery.
We think Sun Belt-focused REITs American Homes 4 Rent, Camden Property Trust and Mid-America Apartment Communities, Inc. are probably the best positioned over the near term to reap the benefits from increased workforce mobility and continued population migration to southern states. While new supply will eventually be built to meet this likely surge in demand, we expect operating performance at these REITs to exceed residential REIT peers over the next two years.
While some REITs have relatively large development pipelines that may require larger concessions to lease up, we think the relatively strong rent collections and occupancy levels portend relatively stable cash flow generation over the next two years. As a result, we don't anticipate many rating changes, and we have a stable outlook on seven of our eight rated REITs.
American Homes 4 Rent
|BBB-/Stable/--||American Homes 4 Rent (AMH) is the lone single-family rental REIT that we rate, with significant scale and exposure to faster-growing Sun Belt markets. Despite the pandemic, business trends are strong; AMH recorded record levels of leasing activity and occupancy in the second quarter (which improved further in July and August). Rent collections were slightly above 97% in the second quarter, and same-home average occupied days was 97% in August 2020 (from 95.3% a year prior). While some uncertainty remains over future collections, as eviction moratoriums have been extended through year end, we expect AMH will drive healthy rent growth given the strong underlying demand. AMH's key credit metrics have remained in a relatively narrow range over the past two years, with adjusted debt to EBITDA of 6.6x and FCC of 2.7x as of June 30, 2020. We expect the company to continue to pursue growth in a leverage-neutral manner, exemplified by equity issuance of approximately $412 million in August.|
Apartment Investment and Management Co.
|BBB-/Watch Neg./--||Apartment Investment and Management Co. (Aimco) recently announced that it would be splitting its company, with $10.4 billion of its $12.6 billion in gross assets moving into newly formed Apartment Investment REIT (AIR). The AIR portfolio will contain almost all stabilized assets, while the remaining Aimco portfolio will largely consist of development and redevelopment properties. We view this transaction as negative for Aimco, but we also expect to assign a new rating to AIR that could exceed Aimco's current rating. Aimco collected 97.2% of cash rents in the second quarter, and reported average daily occupancy of 95.5% (down 140 bps year over year) with same-property NOI declining 1.4% in the quarter. We think Aimco's portfolio is relatively well diversified by product quality (almost equal mix of class A and class B/C+ product) and location, although 61% of second-quarter NOI was derived from Los Angeles, Boston, Washington D.C., and the San Francisco Bay area. Over the past five years, Aimco has posted modestly stronger operating results than peers, which we attribute to strong redevelopment returns from an older portfolio of assets. Unlike peers, Aimco is a predominantly secured debt borrower, although we expect AIR to issue unsecured notes in the future. Leverage was elevated at the end of the second quarter, with adjusted debt to EBITDA of 8.3x and FCC of 1.9x. However, a recently completed $2.4 billion joint venture transaction will reduce debt to EBITDA by approximately 1x.|
AvalonBay Communities Inc.
|A-/Stable/--||The second-largest mutlifamily REIT by gross assets and market capitalization ($29.5 billion total market capitalization as of June 30, 2020), AvalonBay Communities (AVB) owns a young, high-quality portfolio located predominantly in coastal markets. The company has some geographic concentration risk, with Metro New York/New Jersey, Northern California, and Southern California representing nearly 62% of second quarter NOI. Although many of these markets currently face occupancy and rent pressure, AVB should benefit from an overexposure to suburban areas within its overall portfolio (66% of NOI compared to 34% from urban areas). Furthermore, over the next few years, we expect the company to recycle a modest amount of capital from New York and California into markets with higher population and job growth potential. While the company has significant development exposure (10.6% of gross assets as of June 30, 2020; highest among peers), it greatly mitigates this risk by funding the projects well ahead of completion. As of second quarter end, only $757 million of a $2.65 billion active pipeline (29%) remained to be funded. AVB maintains credit protection measures that are among the most conservative of our rated REITs, with adjusted debt to EBITDA of 4.9x and FCC of 5.6x as of June 30, 2020. In the second quarter, AVB posted a same-property NOI decline of 3.7%, with rent collections of 96.5% and average occupancy of 94.8%, slightly underperfoming the peer averages.|
Camden Property Trust
|A-/Stable/--||Camden Property Trust is a midsize multifamily REIT focused on markets with high projected employment and population growth. The portfolio is predominantly located in Sun Belt markets, with a mix that is modestly more suburban focused (61%) than urban (39%). The portfolio is also diversified by asset class, with 67% class B and 33% class A quality properties. Camden does have some geographic concentration to the Washington D.C. metro area (16.9% of second-quarter NOI) and Houston (11.2%), although we expect the company to modestly reduce its exposure to these markets by recycling capital into Phoenix, Denver, and Raleigh, among others. Like AVB, Camden has core competence in development, resulting in a younger portfolio of assets than most peers. Camden's active development projects totaled $713 million as of June 30, 2020 (7.0% of gross assets), with an additional pipeline of $920 million (projects that have yet to break ground). Its development risk is mitigated by healthy funding levels (72.3% funded), although leasing could be slightly more challenging (perhaps requiring increased rent concessions to prospective tenants) due to the recession. Camden's leverage is the lowest among peers, with adjusted debt to EBITDA of 4.4x and FCC of 5.8x as of June 30, 2020. Second-quarter operating performance was relatively strong, as Camden collected 97.7% of rents, reported average occupancy of 95.2% and same-property NOI down just 1.1%. Since the quarter ended, collections have improved to 99% in both July and August, and occupancy ticked up to 95.8% at the end of August.|
|A-/Stable/A-2||Equity Residential (EQR) is the largest multifamily REIT by gross assets and market capitalization ($31.1 billion total market capitalization as of June 30, 2020), and owns a high-quality, well-balanced mix of urban (55%) and suburban (45%) properties. EQR's portfolio is geographically concentrated in coastal gateway markets, with notable exposure to San Francisco (19.8% of second-quarter NOI), Los Angeles (19.1%), Washington DC (15.8%), New York (14.6%), Seattle (10.9%), and Boston (10.1%). These markets tend to have low single-family homeownership rates and poor affordability rates, making it harder for renters to transition to homeownership despite record low interest rates. EQR's renters are affluent, with average annual household incomes of $164,000 (the highest in the industry), which we think somewhat insulates the company from the impacts of the pandemic (which has generally affected lower-income workers). Second-quarter rent collections were 97%, and the company posted average occupancy of 94.9% with a same-property NOI decline of just 1.2%. EQR maintains a strong balance sheet, with adjusted debt to EBITDA of 4.8x and FCC of 4.5x as of June 30, 2020. Moreover, its exposure to development is less than most peers (at just 2.5% of gross assets), which we view favorably, particularly during a recession. We expect EQR to continue to gradually reduce its exposure to urban cities like New York City, recycling capital into Denver and densely suburban areas within its existing markets.|
Essex Property Trust Inc.
|BBB+/Stable/--||Essex Property Trust is a large multifamily REIT that's exclusively focused on the West Coast, with exposure to eight coastal markets within Northern California (43% of second-quarter NOI), Southern California (40%), and Washington State (17%). Approximately 90% of its properties are located in suburban areas, the highest suburban mix among peers. While population growth in California has been muted for several years (with many people migrating to bordering states), the jobs created have been higher quality and higher paying than the national average, resulting in a more favorable renter demographic. Moroever, supply growth in California has historically been lower than the national average, and the lack of housing affordability makes it more challenging for renters to buy homes. That said, increasing rent controls, which have thus far had a negligible impact, could somewhat limit future growth if controls tighten further. While second-quarter results were weaker than peers, with rent collections of 95.7%, average occupancy of 94.9% and same-property NOI down 7.4%, the company has a long track record of historical outperformance. Moreover, rent collections and occupancy have subsequently improved since quarter end, with collections of 97.4% in July and August, and occupancy averaging 96.1%. Essex's development exposure (5.3% of gross assets on its pro rata share of development commitments) is well funded, with just $162 million of remaining costs (17.8%) for Essex to fund as of June 30, 2020. The company's leverage has increased slightly over the past year, with adjusted debt to EBITDA of 6.6x as of June 30, 2020, which is higher than most peers but still within our expectations for the rating.|
Mid-America Apartment Communities Inc.
|BBB+/Stable/A-2||Mid-America Apartment Communities (MAA) was the only residential REIT to post same-property NOI growth (+2.0%) in the second quarter. The company collected 98.9% of second-quarter rents, and reported a 95.4% average occupancy rate. MAA is the largest multifamily REIT by apartment units, with over 102,000 units, and focuses on owning a diversified portfolio of communities in markets exclusively within the Sun Belt region. The company's assets are split fairly evenly among class A (53%) and B (47%) quality product, and are also divisified by location within their submarkets, with 49% located within the inner loop, 41% in suburban areas and 10% in central business districts. By geography, MAA is the most diversified multifamily REIT, as it owns properties in 33 markets. Only one market represented more than 10% of second-quarter same-property NOI (Atlanta; 13%) and its top five markets represented 42.2%. While operating performance lagged the peer group slightly over the past five years, we think MAA is poised for outperformance over the next two years given its focus on the Sun Belt region, which we think will continue to benefit from outsized job growth and population growth relative to the rest of the country. MAA's development exposure is modest, representing just 3.2% of gross assets as of June 30, 2020. The company maintains one of the most lowest leveraged balance sheets among REITs, with adjusted debt to EBITDA of 4.7x and FCC of 5.0x as of June 30, 2020.|
|BBB+/Stable/A-2||UDR is a midsize to large multifamily REIT with exposure to 21 coastal and Sun Belt markets. The company's properties are diversified between class A (57%) and B (43%) quality product, with modestly greater exposure to suburban areas (58%, compared to 42% urban). While relatively well diversified, UDR has modest concentration in Washington D.C. (16.3% of second-quarter NOI), Orange County (13.6%), Boston (11.5%) and San Francisco (10.7%). UDR has outperformed the peer average in terms of same-property NOI growth in each of the past four years, which we largely attribute to the company's keen focus on implementing innovative uses of technology to drive incremental NOI. While UDR posted a same-property NOI decline of 4.0% in the second quarter (modestly weaker than peers) strong rent collections of 97.5% and average occupancy of 96.3% both bested peer averages. In a September update, the company reported that collections in the second quarter had improved (to 97.9%), but occupancy dropped to 95.5% in August. UDR's exposure to ground-up development is modest, at just 2.0% of gross assets, with just $147 million yet to fund. The company's leverage has drifted slightly higher over the past year, with adjusted debt to EBITDA of 6.5x as of June 30, 2020 (compared to 6.2x a year ago). While higher than most peers, its credit protection measures remain in line with our expectations for the rating.|
|FCC--Fixed-charge coverage. NOI--Net operating income.|
This report does not constitute a rating action.
|Primary Credit Analyst:||Michael H Souers, New York (1) 212-438-2508;|
|Secondary Contacts:||Ana Lai, CFA, New York (1) 212-438-6895;|
|Kristina Koltunicki, New York (1) 212-438-7242;|
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