The COVID-19 outbreak has rocked apartment REITs this year. The average apartment REIT has lost more than 26% of its value, according to Nareit. Meanwhile, Essex Property Trust (NYSE: ESS) has fared even worse, as its shares have lost nearly a third of their value.
That relative underperformance might have investors wondering if now's the time to buy. Here's a look at the bull and bear cases for this leading apartment REIT.
The case for buying Essex Property Trust
Despite this year's challenges, Essex Property has a long history of creating shareholder value. The REIT has produced the highest total returns in the sector since its IPO in 1994. Further, it has increased its dividend for the last 26 years, putting in in the elite class of a Dividend Aristocrat.
One of the keys to the REITs success has been its ability to steadily grow its FFO and dividend, which it has expanded at an 8.4% and 6.4% compound annual rate, respectively, since its IPO.
Driving the REIT's consistent ability to create value is its investment success. It has grown shareholder value and its NOI by making acquisitions and investing in development and redevelopment projects and other value-enhancing opportunities. Another key to its success has been focusing on high-cost West Coast markets, where it often makes more sense to rent than own. That's enabled the company to maintain strong occupancy levels and grow rents at healthy rates.
Meanwhile, the REIT has a strong financial profile. It has an investment-grade balance sheet backed by a relatively low leverage ratio. It also has a conservative dividend payout ratio. These factors give it lots of financial flexibility to weather the current storms in the multifamily market while meeting its funding requirements for its current slate of development projects.
The case against buying Essex Property Trust
While Essex Property Trust owns a high-quality portfolio, it's highly concentrated, as the REIT operates in eight coastal markets in California and Washington. That's a concern given the outsized impact COVID-19 is having on high-cost metro areas.
For example, rents for apartments in San Francisco -- which supplies 9% of Essex Property's NOI -- have tumbled 20% over the past year, driven by a steep rise in vacancies as tech workers take advantage of their ability to work remotely by fleeing the high-priced area. Rents are also falling in Oakland and Seattle, which contribute 13% and 17%, respectively, of Essex's NOI.
All this means the company's occupancy and same-portfolio revenue have started slipping. During the second quarter, NOI in its same-property portfolio tumbled 7.4%, while occupancy fell from 96.6% the year prior to 94.9%. Those downward trends will likely continue during the third quarter as more tenants move to lower-cost areas where they can work remotely.
What remains unknown is if tech workers will return to high-priced urban areas once COVID-19 abates. Many large tech companies like Facebook (NASDAQ: FB) and Microsoft (NASDAQ: MSFT) have made headlines this year by saying they plan to make remote work permanent for more of their employees. This means demand for apartments in tech-heavy areas like Northern California and Seattle could remain under pressure for years.
However, many other companies have said working from home doesn't work. For example, Netflix's (NASDAQ: NFLX) CEO Reed Hastings said: "I don't see any positives working from home. Not being able to get together in person, particularly internationally, is a pure negative." If more companies have that view, occupancy levels and rental rates in Essex's markets could rebound quickly.
Highly concentrated in currently challenged markets
The COVID-19 outbreak has had an outsized impact on high-priced urban coastal markets. That's a concern given Essex Property's concentration in those markets along the West Coast. This creates a higher risk the REIT could perform poorly in coming years if tech companies don't bring workers back to their urban offices. Given that uncertainty, the REIT doesn't seem like a compelling buy right now despite its sell-off this year.