By Joe Gose
Residential real estate investment trusts have delivered investors eye-popping returns so far this year, and in some cases the San Francisco Bay Area has made a significant contribution.
Through Aug. 22, apartment REITs had generated a total return of 29.3 percent, according to the National Association of Real Estate Investment Trusts. Not only was that more than triple the total return of the Standard & Poor’s 500 Index for the same period, but it also was about 10 percentage points higher than the average total return of all equity REITs. (Total return reflects dividends and stock price appreciation.)
Residential REITs that own and operate apartments in the Bay Area, however, are profiting from some of the fastest growing rents in the country amid solid job growth and persistent demand from the millennial and empty-nest generations.
AvalonBay Communities, Inc., Equity Residential, Essex Property Trust and UDR, Inc. each has a substantial portfolio in the market, for example, and all saw net operating income in the Bay Area increase by 10 percent or more in the second quarter this year over the same 2013 period, according to their latest financial reports. Meanwhile, at least three of the four REITs in the second quarter reported a roughly 10 percent year-over-year increase in funds from operations, a key income gauge among REITs.
David Santee, COO for Chicago-based Equity Residential, told analysts at the company’s second quarter earnings call in late July that rental rates for renewals and new tenants in San Francisco had grown by about 10 percent so far this year. The new supply coming online doesn’t appear to be sufficient to meet the demand sparked by the technology boom, he added.
“San Francisco continues to be the lead market for the fourth consecutive year,” Santee said. “We see no signs of a slowdown.”
Likewise, in the second quarter, Essex reported year-over-year rent growth in excess of 10 percent in the San Francisco, San Jose and Alameda markets, according to comments by Erik Alexander, senior vice president of property operations for the Palo Alto-based company.
Essex owns more than 16,000 units in the Bay Area and recently ponied up $150 million for a 366-unit project in Milpitas. The company also is enjoying brisk leasing activity in its new communities and expansions, including Epic in North San Jose, Solstice in downtown Sunnyvale, Radius in Redwood City and Mosso in San Francisco’s South of Market district.
“This result is a testament to the strength of the San Francisco market,” Alexander told analysts, “and things should only improve for us as we begin to deliver a very nice complement of amenities.”
The REITs are designing Bay Area apartment communities with millennials in mind. Units typically feature stainless steel appliances, hardwood floors and high-end countertops such as granite or quartz, while community-wide conveniences that are geared to foster social interaction include swimming pools, fitness centers and outdoor cooking areas. Some projects provide dog- or bike-washing rooms and movie theaters.
However, REIT executives noted that in some cases they’re seeing better rent growth in the East Bay and other markets on the central business district’s periphery as the ability to substantially increase rates in pricey San Francisco becomes tougher. Renters also are increasingly looking outside the city for more affordable housing alternatives.
What’s more, executives acknowledged that they see the potential for a condominium conversion wave in San Francisco as a result of the tremendous rent growth and lack of for-sale supply. That could prompt the REITs to harvest profits by selling properties. Sean Breslin, executive vice president of investments and asset management with Arlington, Va.-based AvalonBay, told analysts last month that the company was “keeping its eyes” on the market for just such an opportunity.
“We’ve not seen it in any meaningful way at this point,” he said, comparing condo conversion activity in San Francisco to what’s happening in Manhattan and Washington, D.C. “[But] we think there may be good value there in terms of a condo exit at some point for some assets.”