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Few investors understand real estate as well as billionaire Sam Zell. When Zell makes a major real estate move, it’s a good idea to vet that move.
Zell made a major move earlier this week. Equity Residential (NYSE: EQR), a real estate investment trust Zell chairs, agreed to sell more than 23,000 apartments to Starwood Capital Group for $5.4 billion. The sale constitutes roughly a quarter of the apartments Equity Residential owns.
The Equity Residential sale is worth vetting not only for its size, but for its timing. In 2007, Zell made a major move when he sold an entire REIT, Equity Office Properties Trust, to Blackstone Group (NYSE: BX) for $23 billion. The following year, the commercial-property market collapsed: debt defaults surged, dividend payouts were slashed and REIT share prices tanked. (Interestingly, Blackstone Group recently announced it’s participating in a deal to buy a sprawling 11,200 apartment complex in Manhattan for $5.3 billion.)
Zell has a knack for selling at the top. (You have to wonder if Blackstone has a knack for buying at the top.) When you see the value that investors are bestowing on apartment REITs these days, Zell could very well be selling at the top again.
Investor enthusiasm for apartments has caused Equity Residential’s share price to double since 2010. In turn, Equity Residential’s yield has been bid down to 2.8%. Many other apartment REITs have seen a similar run up in price and run down in yield over the same period. Essex Property Trust (NYSE: ESS) and AvalonBay Communities (NYSE: AVB), for instance, have also seen their dividend yields bid below 3%.
Investor enthusiasm for apartments runs hot because rents in many major markets have run nowhere but up. Nationally, apartment rents have been breaking records almost every quarter since 2010, according to Reis Inc., a real estate data provider.
But records won’t be broken in perpetuity. The streak could end sooner than many investors expect. Reis also reports that increased apartment supply caused the rental unit vacancy rate to rise to 4.3% in the third quarter, up 0.1% from the second quarter. (The historical average is 5.5%.) What’s more, Reis reports that an additional 200,000 rental units will hit the market by year’s end.
Some analysts have attempted to assuage concerns by noting that rents can continue to rise when vacancies rise. The new units, they argue, will demand higher rents. They also argue that pent up demand from millennials (nearly half of all 25-year-olds still live at home) ensures there will be no major rent correction. Rents should remain on an upward trajectory.
Fair enough, but you have to ask if the potential reward is worth the elevated risk. And make no mistake, the risk is elevated. When investors are willing to accept less than 3% on a traditionally high-yield investment, risk is elevated because investor attitude toward risk has turned cavalier. Sam Zell might not have called the REIT market top, but I wouldn’t be surprised if he’s called the last mile.
Fortunately, there are alternatives. If you’re looking for a REIT investment, better yields and better value can be found in other segments. High Yield Wealth recommends a number of non-residential property REITs. Yields run from 5% to 10%. The higher yields are a sign these segments have yet to be smothered by investor enthusiasm, something that can be quickly ignited and just as quickly extinguished.
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