Last year was a mixed bag for residential REITs, or real estate investment trusts. As a group, REITs focused on residential real estate produced a minus 10.7% total return, which underperformed the minus 5.1% total return in the broader FTSE Nareit All Equity REITs Index. However, there was a lot of variation in the sector. For example, REITs focused on single-family homes performed relatively well, at a 6% total return. Meanwhile, those that own apartments in the suburbs and Sun Belt region outperformed rivals concentrated in high-cost coastal cities.
Several factors played a role in this subgroup's performance last year. Here's a look at what impacted the sector in 2020 and how that might affect it in 2021.
Single-family homes have been hot commodities
It's no secret that single-family homes have been selling like hotcakes in recent months. Sellers are cashing in on bidding wars, while builders are selling homes faster than they can put them up. Driving this surge in homebuying is a desire for more space amid the pandemic and low interest rates. That first catalyst is also driving demand for single-family rental (SFR) properties, benefitting REITs that own these properties.
Another catalyst buoying these residential REITs is increasing interest in this asset class by big institutional investors. Pretium and funds managed by Ares Management (NYSE: ARES) bought Front Yard Residential (NYSE: RESI) (one of the three publicly traded SFR REITs) at a more than 63% premium in a deal that closed earlier this month.
In commenting on the deal, Pretium's CEO stated: "There is significant opportunity in the SFR market and a clear sense of urgency among institutional investors to deploy capital to this asset class, given record-high occupancy rates, stable cash-flow characteristics, and potential for continued capital appreciation."
This means other institutional investors might try to take Invitation Homes (NYSE: INVH) or American Homes 4 Rent (NYSE: AMH) private in the future. Add that upside catalyst to the overall strong demand for SFR properties, and these REITs could continue outperforming in 2021.
Well-positioned in a post-pandemic world
REITs focused on manufactured homes cooled off considerably in 2020. After collectively generating a nearly 50% total return in 2019, the three-REIT subgroup produced a minus 1.7% total return last year. One issue weighing on the sector was the impact the COVID-19 outbreak had on their seasonal and transient RV communities due to travel restrictions early in the year.
However, that headwind should fade this year, which should bolster the results of Equity LifeStyle Properties (NYSE: ELS) and Sun Communities (NYSE: SUI) since they both own those properties. In addition to that, Sun Communities should see a boost from its acquisition of Safe Harbors Marina. With vaccines rolling out, people will likely take more RV trips and utilize marinas more, which should increase the income these properties generate.
Meanwhile, all three manufactured home REITs could benefit from surging single-family home prices. That's because these companies offer more affordable housing options. If single-family home values continue to soar, manufactured homes will stand out as better values for those looking for a home to own or rent without breaking the bank.
A return to the office could boost these REITs' fortunes
Many companies switched to remote work last year to help slow the spread of COVID-19. Because of that, many renters opted to move out of high-cost urban areas to cheaper suburban apartments and houses. That impacted REITs with highly concentrated apartment portfolios in cities like New York, Boston, and San Francisco. With occupancy levels falling, they had to reduce rental rates to attract tenants.
Unfortunately, according to the CEO of leading apartment REIT Equity Residential (NYSE: EQR), these headwinds will remain in place for a while. Because of that, its "financial results will weaken over subsequent quarters as the full effect of the pandemic is felt on our business," said Equity Residential's president and CEO.
However, as vaccines roll out, people should start trickling back to the office this year. As they do, they'll likely need to move closer to their offices. Add that to the draw of urban areas (more entertainment and cultural activities), and these REITs should eventually start seeing improved results.
Residential REITs could enjoy a bounce-back year
While 2020 was tough on some residential REIT subgroups, 2021 looks like it should be a better year. Demand for single-family homes appears likely to remain red hot, which should benefit SFR REITs and those that own manufactured home communities. Meanwhile, the headwinds facing RV communities and urban apartments should fade as vaccines roll out and people are free to travel and return to their offices. Because of that, investors should consider adding a residential REIT to their portfolio, since those stocks seem poised to rebound in 2021.