COVID 19 has profoundly changed the apartment industry. With the freedom to work anywhere, Americans are uprooting their homes and moving to cities with lower real estate costs, more space, lower income taxes, and a better climate. That means an exodus to Sun Belt locations like Phoenix, Dallas, Tampa, Nashville, Atlanta and Las Vegas. Multifamily landlords quickly figured out they could raise rents on Austin apartments by 20% and still save money by bringing in workers from San Francisco. Soon, all the apartment REITs were investing in the hottest real estate markets in the country, and so were everyone else. By 2023, developers with access to cheap finance have begun delivering the largest supply of new apartments in almost 50 years.
Huge new supply began to outpace still-strong demand; occupancy rates fell and rents stopped rising, and in some markets, even reversed course. Fortunately, the economy will eventually find balance. Rapidly rising interest rates cut off the tap of cheap capital, effectively making new development uneconomical. After a difficult 2023, the mantra on multifamily earnings calls became “live to 25.”
In this Industry Spotlight, we’ll examine where we currently stand in the multifamily REIT investing space. We compared market valuation relative to AFFO/share, net asset value (NAV), and Q3’24 same-store net operating income (SSNOI).
Returning in 2024
In the early days of the pandemic, astonishing rent growth spurred investor optimism and pushed apartment REIT profit multiples up by 25 to 30 times. When rent growth stalls, multifamily stock prices retreat. 2024 is a wait-and-see period, with optimism likely to return as multifamily outperforms the broader REIT market.
Multifamily REITs – 2024 Returns
S&P Capital IQ
Source: S&P Capital IQ As of January 2, 2025
market valuation
Various metrics can be applied to understand a company’s intrinsic value relative to its market valuation. At Portfolio Income Solutions, we strongly believe in Adjusted Funds from Operations (AFFO/share) metrics because they level the profitability playing field among peers. At the end of the year, the multifamily REIT sector’s AFFO/share multiples looked like this.
2MCAC, data from S&P Capital IQ
Data source: 2MCAC, data compiled from S&P Capital IQ
With P/AFFO multiples ranging from about 14x to nearly 23x, with an average P/AFFO multiple of 18.3x, the sector’s valuations are much more modest than the 25x to 30x range seen at the height of the apartment investing frenzy in 2021. With the average multiple across the equity REIT universe of 16.4x, 19.3x is a meaningful premium.
2MCAC, data from S&P Capital IQ
Source: 2MCAC, data from S&P Global Market Intelligence Compilation
As the U.S. job market continues to be strong, apartment demand and household composition are expected to remain elevated. As new supply dwindles, investors may price stocks in anticipation that landlords will regain the upper hand in rent negotiations.
Same-store net operating income
The third-quarter report showed that while demand in the multifamily market remains strong, waves of competition from new supply have dampened rental growth and occupancy rates. The result is that SSNOI growth in these industries tends to be moderate. On average, apartment REIT properties grew 0.7% in same-store cash NOI from the third quarter of 2023. Given the strong share price performance in 2024, it seems likely that investors believe profits may have bottomed out and the future is looking brighter.
2MCAC contains data compiled from company filings
Source: 2MCAC, data from company filings
net asset value
NAV is widely regarded as a useful indicator for comparing value relative to the market share price and its peers. Twelve months ago, equity REITs were trading at a discount of more than a dozen times to net asset value. Today, they trade at close to NAV valuations, which is also close to pricing in the multifamily space. In previous years, investor enthusiasm or pessimism drove stock prices to a substantial premium or discount respectively. Today, the average multifamily REIT stock price is trading at a discount of approximately 10% to consensus NAV.
2MCAC data comes from S&P Capital IQ
Data source: 2MCAC, data compiled from S&P Capital IQ
When considering net asset value, it is important to understand that the value is arrived at by using an assumed capitalization rate. As noted in the table above, the capitalization rates applicable here vary within a narrow range of 4.9% to 6.0%; the lower the capitalization rate applied, the higher the resulting NAV. Operationally, these companies are extremely diverse, so this valuation metric is just a starting point and more analysis is needed.
focus
The benefits to our economy are mixed. Employment remains very strong, which is supporting high demand for the housing sector as a whole. Employment is one of the factors in the Fed’s dual mandate, so strong employment and wage growth will restrain the pace of further interest rate cuts.
Relatively high borrowing costs will continue to inhibit new apartment development, which will help reduce new competition for apartment owners. However, many REITs are leveraged, so higher refinancing costs will put pressure on net operating income, while lower interest rates will be welcome relief.
The multifamily REITs we examine here vary in their capital structures, market geographies and demographics, and perhaps most importantly, in the skills and objectives of their management teams. This industry focus is intended as a starting point for an overview. A more thorough and detailed analysis of individual companies is necessary.
Happy investing.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
