Pandemic and Demographic Shift May Slow Apartment Growth

Given the fallout of the coronavirus on the U.S. economy, we have lowered our short-term and medium-term outlook for the apartment companies we cover. As a result, we have lowered our fair value estimates to $45 per share from $50 for Aimco AIV, to $194 per share from $214 for AvalonBay AVB, to $72 per share from $78 for Equity Residential EQR, and to $273 per share from $307 for Essex Property Trust ESS. Our no-moat ratings for all are intact. Rent collection has remained relatively healthy between 97% and 98% since the start of the pandemic, only slightly off the normal collection rate, and sequential occupancy declines in the second quarter were only around 1%. However, we expect the economic impact of the pandemic to linger for a few more quarters, which will negatively pressure apartment fundamentals through at least the end of the year.

Even if the economic recession ends relatively soon, we don’t think the recovery in occupancy levels, which allows the companies to drive higher rental rates, will happen immediately. Many urban renters are starting to consider moving out of cities into suburban settings. Millennial office workers may have preferred their proximity to work, but as most companies offer increasing telecommuting options, the switch from urban apartments to suburban homes is becoming more attractive. We believe this will make it difficult for the apartment companies to quickly replace tenants who move out without offering significant rent concessions.

The one company we cover that stands to benefit from this trend is no-moat Invitation Homes INVH, whose fair value estimate we have raised to $31.50 per share from $30. Its portfolio targets starter homes in metropolitan areas with significant office and tech workers. Invitation Homes saw occupancy increase 1% to 97.5% in the second quarter, the highest level in the company’s history, which we believe is evidence of a demographic shift to the type of property it owns. As a result, we believe Invitation Homes can maintain this high level of occupancy and drive rent growth above 3% for several years.

Despite our lowered outlook, we still find the apartment names to be attractive. All four are trading at about a 20% discount to our fair value estimates. We think that the Street is too concerned about potential occupancy losses in the short term, and we believe that the management teams of these companies will be able to eventually return portfolio fundamentals to prior levels despite the headwinds. Invitation Homes trades at a more modest discount to our fair value estimate. We think that the Street recognizes the trends that will produce higher growth for the single-family rental market, but there is still some upside for investors looking for a company that trades at a discount while also producing solid growth during a difficult economic period.