Apartment REITs Are Not Immune to Economic Uncertainty

Chris Wimmer, CFA

Residential REITs will continue to benefit from the dearth of affordable homes that has created incremental demand for single-family and multifamily rentals. The supply of homes for first-time buyers is at historical lows, while potential buyers continue to be faced with the highest home mortgage rates in decades. This trend is only likely to continue rise. Affordability has also been limited by investors stepping back from securitization markets into which loans are packaged. As a result, many potential buyers will choose the lower cost option of renting instead of owning.

Not everything is going in favor of residential REITs, however. Employment is a driver of residential rental fundamentals, and a likely recessionary environment of 2023, punctuated by layoffs, will slow leasing momentum after a solid two years.

Fitch is predicting a recession in the middle two quarters of 2023, and that the Fed will continue to raise interest rates to bring down inflation. This will result in a slowdown in spending for business and consumers, as well as lower employment. Growth in the U.S. will be 0.5 percent, with some rebound in GDP later in the year. Expenses have begun to rise for landlords, as inflation drives labor and material costs higher. Additionally, property taxes are rising as home values continue their ascent.

Sun Belt Shining

Camden Property Trust, Mid-America Apartment Communities, Inc. and Invitation Homes Inc. are three residential REITs rated by Fitch. Camden and MAA primarily own and operate multifamily apartment communities. Fitch has assigned Long-Term Issuer Default Ratings of ‘A-’ and a Stable outlook to both, some of the highest rated REITs by Fitch.

These REITs benefit from a portfolio of high-quality assets located primarily in the Sun Belt, though Camden also has properties in a few coastal U.S. markets. Both maintain solid balance sheets characterized by low leverage and robust alternative liquidity through high levels of unencumbered assets. Fitch expects Camden and MAA to finish 2022 with leverage in the low-4x debt-to-EBITDA range, well within downgrade rating sensitivities and below their stated maximum target of 5.0x.

Invitation is a single-family rental REIT that is rated ‘BBB’ with a Stable rating outlook by Fitch. Its solid operations benefit from demographic trends whereby aging Millennials continue to increase demand for single-family rentals, particularly in Invitation’s Sun Belt markets, and rising interest rates and costs may dampen homebuying activity. Fitch expects the SFR REIT’s leverage to continue to decrease to the mid- to high-5x range, consistent with its long-term leverage target of 5.5x–6.0x.

Fitch expects residential REITs will find tenants less willing to absorb rent increases and more likely to look closer at lease terms. While most REITs rated by Fitch have the capacity to withstand slowdowns, smaller scale developers lacking balance sheets and liquidity will be forced to dispose their projects at likely distressed prices. REITs that maintain ample dry powder will find distressed acquisition opportunities when developers are unable to finance projects to completion or to place recession-wary tenants, especially for properties built on speculation.

Chris Wimmer, CFA, is senior director, Fitch Ratings.