Zillow reported that American homes lost about $1.4 trillion in value in the fourth quarter of 2008 alone. This value vacuum is directly connected to the dismal earnings now being reported by Apartment REITs.
But first, one amazing factoid: this one quarter decline is more than all of 2007’s losses combined. This was also the eighth consecutive quarter of declining home values, and obviously the worst quarter since the crisis began. The data is based on the company’s median home-value estimates, or “Zestimates”, for homes in 161 metro areas.
According to Zillow’s estimates, U.S. homeowners lost a cumulative $3.3 trillion in home values during 2008. Since the housing market’s peak in 2006, more than $6.1 trillion in “value” has evaporated.
Having just returned from Sacramento/Stockton to look at defaulted condominium projects, I can tell you it’s a solid mess out there. Investors from all over the Bay Area, and indeed the entire country, are making the same drive across Interstate 80 and descending on more or less the same spots. Unfortunately, the smartest investors will tell you they have no idea when it will end or what their exit strategy is, so not much is getting done on any scale.
The unemployment rate in Sacramento/Stockton is now in double digits (and climbing), and most people will have no choice but to relocate in order to find work. Consequently, there are some projects that will simply need to be bulldozed and plowed under. Talk about adaptive re-use.
At one point late last year, Fannie Mae was foreclosing on 66,000 houses a day nationwide. Undoubtedly, that number has climbed even higher. Nationwide, foreclosures made up almost 20% of all home sales in 2008. In Merced, Stockton and Madera California, more than half of all sales were foreclosures. To be clear about that figure, this indicates that more than half of the homes sold in the Merced, Stockton and Madera areas were purchased by banks. They still must be sold on or rented to an actual end-user with a job.
What it Means For Apartment REITs
This latter issue is a big, big problem for many Apartment REITs. These foreclosures not only create additional supply of “shadow” rentals, but home prices in these hard hit areas will eventually drop (if they haven’t already) to levels where it will be much cheaper to buy than to rent. The federal subsidies and tax credits about to be doled out will tip the balance even further in favor of owning.
Don’t get me wrong, I love apartments more than anything right now. Very favorable long-term demand trends remain more or less intact, but bread and butter, low-leveraged housing is where the action is.
Unfortunately, In 2007 two Apartment REITs in particular, AIMCO (AIV) and Associated Estates (AEC) were busy dumping their bread and butter, vanilla assets in places like Ohio and Indiana so they could get in on all the fun being had along the coasts and in the sunbelt states. In the process, they sold solid assets in decent markets in favor of newer, more expensive assets in the red hot “growth” markets. They also paid 2006-2007 prices using 80 percent leverage. These days, high leverage is no bueno.
AIV and AEC (among others), are now working to reduce leverage, but that primarily means selling over-bought assets into weak markets, and/or extending available lines of credit and cutting dividends (or even worse paying REIT dividends in stock). By the way, cap rates are definitely going up, so you can ignore the middle two columns:
|Leverage ratios (Now)||Leverage ratios if cap rates rise by 150 basis points|
|Company||Liquidity Leverage*||Solvency Leverage**||Liquidity Leverage*||Solvency Leverage*|
|American Campus Communities||56%||56%||68%||68%|
|Camden Property Trust||55%||55%||67%||67%|
|Colonial Properties Trust||66%||69%||78%||82%|
|Education Realty Trust||59%||60%||71%||72%|
|Essex Property Trust||47%||51%||38%||42%|
|Mid America Apartment Communities||53%||58%||63%||68%|
|Source: Green Street Advisors|
|* Liquidity Leverage ratio = book value of debt divided by estimated asset value|
|** Solvency Leverage ratio = marked-to-market value of liabilities plus preferreds divided by asset value|
Thankfully, there is a floor for apartments as people without jobs typically don’t buy homes, no matter how low prices might be.
Despite the bad news across much of the country, Zillow says 21 out of 161 markets are actually not so bad. In these areas, problems with the “shadow” rental market are also not nearly so bad. Home values in Pittsburgh, for example, were flat in 2008. In the Fayetteville, N.C. area, home values increased 6.9 percent in 2008.
For REITs, Boring is Best
Other areas experiencing steady or increasing home values include New York State (supported by upstate values in Utica/Rome, where there is a large air base, i.e. “gubmint” money), the Midwest and certain areas in the South. These more stable markets are not likely to experience the market contortions resulting from increasing supply and decreasing demand (both rapid), and the effect that will have on apartment rents and occupancies in places like Sacramento, Phoenix and Tampa.
So what does this mean? Definitely look for Apartment REITs to outperform other REIT investments in 2009, for whatever that’s worth. But it gets better: analysts see Apartment REITs posting the strongest effective rent gains in history in 2011. If you’re looking for the best performing Apartment REIT for 2009 however, look no further than Mid America Apartment Communities (MAA). MAA’s markets and assets are unexciting, just like the Company’s low levels of debt. In this market, boring is definitely the new black.