High home prices in hot markets like Southern California and Washington, D.C., are destroying the dreams of many wannabe homebuyers. But some apartment owners are reveling in these sky-high price tags, which help fuel business for the rental market.
These market dynamics prompted Merrill Lynch to release a new quarterly index, which ranks apartment REITs based on their exposure to markets where homes are most expensive. The reasoning behind the index, called Apartment REIT Housing Affordability Rankings, is simple: It's best to own apartments where single-family housing is the most expensive, says William Acheson, vice president and senior analyst at Merrill Lynch.
"One of the strongest drivers of the market over the last couple of years as we've seen it has been a combination of owning properties in supply-constrained markets and housing affordability in those markets," says Acheson. Plus, as mortgage rates rise, more wealthy households will be forced to look at the rental market.
The REITs that offer the heaviest exposure to expensive markets include Essex Property and BRE Properties with heavy weightings in California, and AvalonBay Communities with weightings in California and the New York area. Equity Residential also topped the list with an 88 housing affordability ranking, which surprised the index's creators. Equity has long been viewed as the national proxy for the apartment market, but the study shows that it might be time to alter this status quo-thinking, Acheson says.
Over the past four years, Equity has focused on repositioning its portfolio by exiting secondary markets like Kentucky and Alabama and shifting its dollars to high-barrier markets, mainly in California, Florida, and New England. "The analyst community has begun to understand what our strategy has been over the last few years, and we are pleased to see they recognize what we've been doing," says Alan George, chief investment officer at Equity Residential.
The Apartment REIT rankings are based on Merrill Lynch's Housing Affordability Indices for 54 metropolitan statistical areas. This figure is calculated by taking the median household income for each market, dividing it by the estimated minimum qualifying household income for a 30-year mortgage on the median priced, in-market home, and multiplying the result by 100. To get a REIT's affordability ranking, a market's housing affordability index is multiplied by the company's percentage of total NOI/revenue derived from the relevant market.
While the index is receiving good reviews from both REITs and analysts, it does have its limitations. Some question the study's sole focus on the single-family market, especially given the much-discussed potential for housing prices to fall in these hot markets.
"I thought it was a very good study, but the real question I have is will it be a predictor of the future?" says Tom Toomey, president and CEO of United Dominion Realty Trust, which received an affordability ranking of 109. "Jobs are going to influence operating results more than taking a look at affordability." He also pointed out that the study would be more effective if it included condominiums in addition to single-family homes.
John Kriz, managing director, real estate, of Moody's Investors Services in New York agrees that other factors need to be considered to identify geographic markets with strong long-term appeal for apartment investment. "You also have to look at relative household income, and you have to look at relative ease in building new housing product," he says.
But Acheson contends that the study's metric is a strong one. "Of course if you can find a market that has good population growth, has good job growth, and is supply-constrained—well, you just hit the bull's eye."
—Rachel Z. Azoff
Federal Option? Currently, government workers can't invest in real estate through their Thrift Savings Plan—but the National Association of Real Estate Investment Trusts wants to change that. It convinced the plan's board to commission a study of real estate investing and has lobbied Congress to pass a bill adding real estate to the savings plan. If the study supports that addition, Tony Edwards, NAREIT's senior vice president and general counsel, thinks Congress could give federal workers a real estate investment option as early as 2006. —L.S.
Boston Aid Like workers in many American cities, public employees in Boston find it expensive to live near where they work. Unlike many of its counterparts, though, Boston requires its employees to live inside the city limits—and skyrocketing housing costs can make things tight. But Mayor Thomas Menino is addressing this with an Affordable Housing Trust fund that will provide workers with money for first-time home purchases, rent, mortgage payments, or emergency housing needs. —L.S.
Get in Line More than 50,000 Pennsylvania residents are on a waiting list for affordable apartments offered through the Housing Choice Program. Little hope is in sight: The program will cut more than 14,000 vouchers by 2010, according to the Center on Budget and Policy Priorities. Currently, 82,644 Pennsylvania households participate in the federally funded program. —R.Z.A.
Hot Spots Strategizing on which markets to enter next? Consider this: Nearly one-half of the total U.S. population growth between 2000 and 2030 will occur in Florida, California, and Texas with roughly 12 million people each, according to Census Bureau state population projections. Coming in next is Arizona, projected to add 5.6 million people, and North Carolina with 4.2 million. —R.Z.A.
Twisted View Twisting 90 degrees on its way up, Turning Torso in Malmo, Sweden, looks more like a science class model of a DNA helix than an apartment building. But this fall, residents will move into the 54-story tower, which is modeled after a sculpture of the human body in motion. The 147-unit building, designed by Santiago Calatrava, is made up of nine cubes with five floors each. The 43rd floor will house two saunas, a gym, and guest suites. Watch out for the architect's debut project in the U.S.: a New York City apartment complex made of 45-foot glazed cubes. —R.Z.A.
Executive Feedback
What are your plans for positioning your portfolio for the second half of 2005?
A:"Our strategic goals are to selectively de-age and grow our almost-13,000-unit portfolio by selling to condominium converters or selling longer-term-held properties to tax credit re-developers. Wasatch Properties will continue to redeploy proceeds to acquire good quality, late-'90s or newer product in growing areas of the western United States." —Bradley D. Mishler, COO, Wasatch Premier Communities
A:"We believe that cap rates should stay at today's compressed levels at least through December, meaning that we will continue selling assets. On the development side, we are scheduled to bring another six to eight projects online over the next 12 months." —Brian Dinerstein, principal, The Dinerstein Cos.
A:"Our family low-income tax credit properties have long waiting lists, while our senior properties are starting to experience some vacancies. We plan to meet with housing agencies [and] support organizations and to increase our advertising in local communities." —Percival Vaz, president, AMCAL