KeyBanc's Take on Apartment REITs: Incrementally Cautious; Fundamentals Still Good, but Deceleration Ahead

KeyBanc: Our Take on Apartment REITs: Marketweight

KeyBanc analyst said, "We recommend that investors reduce their exposure to the apartment REITs in 2012, focusing on lower multiple names with a higher risk profile. Following four straight years of outperformance (and outperformance in seven out of the last eight years), we suspect that Street estimates and premium valuations now fully reflect our growth outlook and the stocks will pause in 2012. Fundamentals will likely remain good for apartments in early 2012, as demand drivers seem to be intact. However, the persistent moderation seen in many markets over the last several quarters is likely to become more widespread as the apartment recovery cycle matures in the second half of the year, especially given the looming new supply expected in 2013. As market rent growth peaks in 1H12, we expect stocks with premium valuation levels to ease, keeping the group range-bound at best. The apartment REITs’ average cash flow multiple of 22.1x is 10% above the REIT average, and its 5.3% average implied cap rate is near historical lows."

"Steady NOI growth: We expect steady apartment REIT NOI growth of 6-7% in 2012. This forecast is predicated on modest job growth, low levels of new supply (for now), a stable homeownership rate and higher expense growth closer to longer term trends. We expect solid 1H12 NOI growth, with a small rebound in rent growth in the spring, followed by a more pronounced slowing of momentum later in the year."

"Estimate upside unlikely: Material upside surprises will be challenging, in our view. We suspect that Street estimates currently reflect NOI growth that is above the high end of the aforementioned range. Additionally, while rent growth may re-accelerate in the spring, harder comps, stagnant renter incomes, nascent supply and increasing expense growth could decelerate NOI growth later in the year. We are lowering our apartment REIT estimates by an average of 1% to reflect a 130 bps reduction in our NOI growth assumptions (now on average 6.5%)."

"Valuation premia likely to narrow; selective “risk on.” With premium valuation levels and maturing fundamentals, we are more cautious on higher multiple apartment REITs in 2012. We expect some convergence between the higher and lower multiple names, as investors shed higher quality REITs such as AvalonBay in favor of their less expensive peers. We recommend investors focus on value names with higher risk levels and/or below average growth expectations. Consequently, we are upgrading Apartment Investment and Management (NYSE: AIV) from HOLD to BUY, and we are downgrading UDR, Inc. (NYSE: UDR) and American Campus Communities (NYSE: ACC) from Buy to HOLD, as well as AvalonBay Communities (NYSE: AVB) from HOLD to UNDERWEIGHT."

OUR 2012 APARTMENT FUNDAMENTAL FORECAST - Modest job and household growth. We expect demand to be driven by modest economic growth in 2012, including 1.5 million new household formations and 1.3 million new jobs created. Using both job growth and household formation, we expect demand for roughly 400,000 new units in 2012, increasing to 525,000 units in 2013.

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