Apartment REITs on Top for Long?

After several years of not being the top REIT, real-estate investment trust, “multifamily,” or apartment REITs are finally the number one REIT. But how long will this last? The Wall Street Journal columnist, Kemba J. Dunham, explains how these apartment REITs may not be on top for very long, in her July 25, 2006 article, “Apartment REITs Go to Head of Class, For Now, but Tougher Tests Lie Ahead.”

Everything appears to be headed in the right direction for apartment REIT holders. With fewer homes being bought due to their high prices, Americans are eager to rent. Even though landlords have raised their rates, rentals are still a hot commodity.

“Apartment REITs as a group reported the best net operating-income growth during the first quarter of 2006 -- 7.5% -- since 2000, according to Lehman Brothers, which includes 12 companies in its survey.”

Analysts also report that the merger-and-acquisition activity that cemented apartment REITs as number one will likely continue. “In the past nine months, three REITs in the sector have gone private at rich premiums relative to their stock price, says Ross Smotrich, a REIT analyst with Bear, Stearns & Co. Mr. Smotrich doesn't own any multifamily REIT stocks. Bear Stearns does have investment-banking relationships with some REITs.”

So why do experts predict a quick decline of apartment REITs?

“First, a slowing economy and lower rates of job growth could weaken the demand for apartments. In addition, a number of apartment REITs have announced plans to ramp up development, so oversupply could be a factor, too.”

The cooling condominium market may also affect the value of apartment REITs. “The apartment REITs have benefited hugely from the hot condo market, either through executing condo conversions or selling assets at an extremely low capitalization rate, which is the return on investment during the first year of ownership.” Since the condominium market is not nearly as “hot,” analysts fear that this will trigger a “reversal” effect, thus contributing to the decline in value of apartment REITs.

“Signs of trouble are appearing in certain markets. Apartment demand in Dallas is waning as more home builders are luring buyers through an increasing number of sales incentives. And in Tampa, Orlando and southeast Florida, a large amount of apartment supply that had been taken out of the market for condo conversion is already returning to the rental pool.”

While apartment REIT companies are enjoying their time on top, expert investors warn the public to stay away from investing in these REITs. They have little place to go, but down.

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