Investing.com -- Wolfe Research upgraded apartment REITs AvalonBay Communities and Equity Residential to Outperform from Peer Perform, arguing that expected merger synergies and attractive valuations outweigh a still-challenging but stabilizing operating environment.

The brokerage said fundamentals in AVB and EQR's core markets remain mixed, with declining apartment supply offset by weaker immigration-driven employment growth and soft demographic trends among young adults. However, rent growth appears to be bottoming, supporting low-single-digit lease spreads and earnings growth before synergies.

Wolfe expects the combined company to benefit from roughly $125 million in merger synergies, with most of the savings realized within 18 months. Factoring in these benefits, the firm estimates pro forma earnings growth could reach around 5% in 2027, placing the merged entity among the faster-growing residential REITs.

The brokerage also highlighted valuation as a key attraction, noting that the combined AVB/EQR entity trades at a discount relative to its expected growth rate compared with other residential and large-cap REIT peers. Wolfe believes the market has already priced in the sector's slower operating performance, creating an opportunity for investors.

Wolfe assigned AvalonBay a price target of $209, implying about 14% upside from recent levels. The firm estimates total returns of roughly 16% for AVB and 18% for EQR through the end of 2026, including dividends.

The research firm cautioned that risks remain, including potential political scrutiny of residential landlords, continued immigration-related demand weakness, unaccounted-for apartment supply from office-to-residential conversions, and uncertainty surrounding shareholder approval of the merger.