As the United States slowly moves past the impact of 2020, it's becoming clearer that the global coronavirus crisis was a disruption of the norm and not a new normal. Indeed, people are eager to get back to their pre-COVID lives. That said, the impact of last year was very real. This all helps explain why investors should be looking at apartment real estate investment trusts (REITs) AvalonBay Communities (NYSE: AVB), Equity Residential (NYSE: EQR), and UDR (NYSE: UDR) today.
The big problem
The coronavirus spreads easily in group settings, which is why people were asked to work from home last year. It's also why a lot of people decided to move out of major U.S. cities and toward more suburban locals and smaller cities. That has been a huge boost to apartment REITs like Mid-America Apartment Communities (NYSE: MAA), which operates in the U.S. Sun Belt. Its stock is roughly 20% above where it started out in 2020.
The numbers back up the story, with Mid-America's adjusted funds from operations (FFO) up roughly 1% year over year in the first quarter of 2021. At first blush, that may not sound so great, but compare it to UDR's adjusted FFO drop of nearly 14%. AvalonBay's core FFO decline was 18%. And Equity Residential pulled up the rear of this trio, with a first-quarter normalized FFO drop of nearly 22%. AvalonBay, Equity Residential, and UDR are all more focused on big coastal cities.
In other words, the population shifts that took place in 2020 had a big impact on apartment REITs. It helps explain why all three of these REITs are flat to slightly lower since the start of 2020. The thing is, history suggests that people will, eventually, move back into cities because of what they offer that smaller locals lack, including cultural and social opportunities. So the laggard performance could be an opportunity for investors to pick up these names while they are relatively cheap.
Long road back
To be fair, however, there's no quick fix here. To attract new tenants and retain old ones in difficult times, apartment landlords have to lower rents. AvalonBay's lease rates fell 3.6% year over year in the first quarter. Equity Residential's lease rates dropped 6.6%. That's on top of occupancy declines at both companies.
It will take time for these landlords to get occupancy back up, though the trends are strengthening, and for the leases being signed today to roll over. In other words, there's likely to be another year or so of relatively weak results.
UDR is a bit of a different beast on this front. It's more diversified than AvalonBay and Equity Residential, with some exposure to areas that are doing relatively well. So its blended lease rate actually increased just slightly in the first quarter of 2021, even though occupancy dropped 60 basis points. However, the slight increase in rents across the first quarter is notable because it shows that things are starting to improve for the better relative to the worst parts of 2020.
All in, for investors looking at the apartment REIT sector, there are clear laggards. But early signs are that the bottom has been hit, and one-time industry darlings like AvalonBay, Equity Residential, and UDR are at an inflection point. As results improve over the next year or two, investors should start to regain an appreciation for the shares, closing the gap with their less urban peers.
Time for a deep dive
There are nuances beyond this big-picture view, so investors should dig deeper into the individual stories behind AvalonBay, Equity Residential, and UDR before hitting the buy button. For example, as noted, UDR has a bit more diversification in its portfolio.
That said, all three are considered well-run, and all three are lagging peers with more suburban portfolios. As that becomes less of an issue over the next year or so, these big-city apartment landlords are likely to be increasingly attractive investments. You'll want to consider them before Wall Street catches on to the improvements that are already starting to take shape.