Originally published August 2022.
Did anyone notice a trend in the residential REITs’ 1st quarter 2022 earnings calls?
From a very high level, renowned C-suite executives from some of the top residential REITs across the country had very positive outlooks for 2022.
Rental rates for new and renewal leases continue to roll up;
Occupancies are hovering at almost 100%, leaving frictional vacancy;
Same-store operating metrics moved higher on a quarter-over-quarter and year-over-year basis;
Traffic is still very high as demand for housing continues with its upward trajectory;
Renovated units as well as new supply is being added by landlords to meet the demand; and
Many are seeing lower resident turnover.
At face value this seems like a prosperous time. Many executives mentioned that they continued to see these robust trends in the second quarter. Now we are almost halfway through the year and the geopolitical climate continues to heat up around the world. Anyone who has tried to buy a house or even go to the grocery store has experienced the inflationary tug at their wallets and savings accounts.
So why is it that so many C-suite executives across all of the REIT sectors have such a positive outlook? Yes, REITs traditionally are a hedge to inflation. However, the stock market has been extremely volatile and the cost to construct or renovate real estate is significantly more expensive – even the labour is more expensive and more difficult to obtain. The unemployment rate is lower, hovering around 3.6%, but it’s a different employment landscape with many people opting to work remotely and forego their daily commutes. And what if we imagine that the 3.6% unemployment rate is double or even triple what is reported, assuming you omit discouraged or marginalised employees.
Trees do not grow to the moon and we are already seeing demand cool for for-sale housing. This could be a tailwind for rental housing and it could be hitting that inflection point. Office buildings continue to experience high vacancy rates, so what are we going to do with these buildings? As gas and food prices continue to increase, spending will abate because salaries are not increasing in lock-step with the cost of living. Amazon has even given up some of its space due to the decrease in online sales.
Could we actually be on the precipice of stagflation? Stagflation is when the economy has high inflation with slowing growth and a high unemployment rate. It would seem that we could hypothesise that we are on the edge of what the US experienced in the 1970s.
“Young families are opting more for experiences than white picket fences”
However, a lot has changed in 50 years. More people are working from home and the new term that we read about is ‘ghost employees’. They were hired, but then seem to disappear. Young families are opting more for experiences than white picket fences.
To that end, how would stagflation impact the REIT space? A lot has changed in the REIT arena in 50 years as well. Because of the last downturn, REIT balance sheets are by and large better positioned than ever. They have evolved from thinly traded stocks that trade like a mutual fund, to being included in major Wall Street indices. Not to mention they are no longer lumped in with financial services and now have their own GICS code.
What about all those individuals who bought houses during the pandemic and now regret being home owners? If unemployment is higher than we suspect, then they may be locked into their money pits or do what a lot of families do during difficult times – double up. Renters who may have opted for a 2×2 may begin to opt for a 1×1, or perhaps move in with other family members. Perhaps young couples who bought a large house during the pandemic can have their parents move in with them? This allows empty nesters to downsize and helps out young families with expenses and childcare. And don’t forget the Gen Xers – many of them are or will be taking care of their ageing parents. So, if we do find ourselves in a stagflation situation, does that mean as people economise and ‘double-up’ that it will create more housing and cool housing prices to the point where the higher interest rates do not make a material difference?
At any rate, REITs and the executives at the helms of these ships will persevere as they have over the last several decades. And, what will determine their mettle are the operators – those who underwrite the real estate and secure it with credit-quality tenants. They will operate in areas with strong economic and socio-economic drivers that will allow them to ride out the storm. Unfortunately, the stories that will be broadcast are the financial engineers who ‘timed the market’ wrong and were stuck holding the bag.
CNBC, Bloomberg and Fox Business will always talk about the eye-opening headlines, like cryptocurrencies collapsing or the Elon Musk/Twitter battle, yet they don’t focus on the diamonds in the rough since REITs are ‘boring’.
Guess what? Boring is good! REITs are the tortoise in the tortoise and hare of your portfolio, so slow and steady wins the race.
