Multi-Family REITs Building Momentum in 2012
Low levels of new-apartment construction, a stable though weak employment environment, with modest job growth in younger adult cohorts and the malfunctioning single-family housing market have supported robust multi-family fundamentals for over a year.
For the multi-family REITs, the strong fundamentals have pushed occupancies and cash-flow growth past recent highs. Development pipelines are expanding as inexpensive capital and strong investor interest in the sector often make growth via acquisitions too expensive. Construction activity is mostly limited to the REITs and we do not foresee dangerous levels of new supply for at least the next 12 months, though some specific submarkets could show some strain by 2013 unless there is meaningful improvement in employment.
The translation of underlying fundamentals into significantly improved credit metrics, by virtue of disciplined financial management and inexpensive capital, is a solid credit plus for the multi-family REITs. Leverage has been reduced to the lowest level in five years, both in terms of debt plus preferred over gross assets and debt net of balance sheet cash over cash flow (EBITDA). Fixed charge coverage is also at a five-year best, at an average of 2.4 times. The only metric not in the five-year-best category is secured leverage, which is at a four-year-best level (see the adjacent charts).
The future of Fannie Mae and Freddie Mac remain in limbo, yet they remain active in supplying capital to the multi-family sector. We do not see this lending activity abating within the next 12 months, but uncertainty remains with respect to the future of these government-sponsored entities and to government support. To this end, those multi-family REITs that heretofore have funded their activities with GSE debt have been increasingly sourcing alternative debt capital, such as unsecured notes and bank loans. Investment-grade REITs that had accessed low-cost GSE debt during the financial crisis are gradually lowering their exposure, a trend we expect to continue.
The chief risks to the sector are an acceleration of new supply, which would sap rental momentum; loss of capital access, stemming from investor and bank focus shifting towards single-family and away from multi-family; loss of government support; or a reversal of the recovery and a second recession. It is still possible that a macroeconomic shock will trigger one, most likely from a conflagration of overseas instability.