The United States housing market has struggled the past 12 months, as the real estate sector severely underperformed the broader S&P 500 during this period.
Some investors, particularly those focused on momentum plays, may stick to technology stocks. However, for those who prefer to take a value approach, backed by a fundamental strategy with none of the wishful thinking, real estate may do the trick. By looking at the Vanguard Real Estate ETF, you can see how real estate now has a gap of up to 23% to fill if it wants to catch up to the rest of the market. Knowing this, strategists at Blackstone Inc. decided to plunge into the property market.
Not all properties are created equal, though, and Blackstone chose to place $10 billion into the residential sector by buying out Apartment Income REIT Corp. NYSE: AIRC. And with that move, the $155 billion private equity real estate behemoth is telling Main Street that residential property prices may rise shortly.
The Devil in the Details
It's a sizeable deal indeed, but the devil lies in the details. Blackstone paid $39.12 a share in an all-cash deal, a 25% premium to the stock's closing price on Friday, April 5.
Apartment Income's dividend yield at the time of acquisition was 5.7%, beating stubborn U.S. inflation rates and the so-called 'risk-free' yields paid by the U.S. treasury. Even after its double-digit rally, Apartment Income is still valued by its 4.7% dividend yield.
Because the Vanguard ETF only pays a 3.8% yield, the Apartment Income REIT is still undervalued despite Blackstone's premium payment. Moreover, the fund is looking to invest a further $400 million in upgrading properties and acquiring more, indicating that property prices could be compressed in today's market. This wouldn't appear to be the case, as the residential REIT sector trades at an average of 90% of its 52-week high price, so it is traditional valuation methods count here.
The residential REIT industry trades at an average price-to-book (P/B) valuation of 2.5x, and based on historical valuations, it may be due for an expansion. This expansion may be brought on by potential Fed interest rate cuts, which could be coming as soon as May or June 2024, according to the CME FedWatch tool.
Is Equity Lifestyle Properties the Next Deal?
Before interest rate cuts reach mortgage rates, which would also lower, investors may be looking for the next REIT. Equity Lifestyle Properties Inc. NYSE: ELS may offer lower dividend yields than Blackstone locked in with American Income. However, it is still worth considering. Far from its 2021 high of $88.7 a share, this REIT is still earning the market's love in its valuation. On a P/B basis, Equity Lifestyle commands an 8.0x multiple, which is 120% above the residential REIT industry.
Like Apartment Income, only the best bets can make markets pay a premium valuation. According to their February 2024 price targets, Wolfe Research analysts think this REIT could go as high as $75 a share. Seeing the potential upside for the REIT, PNC Financial Services Group decided to boost its position in the stock by 8.3% as of March 2024, representing a transaction of just over $100,000.
From a technical viewpoint, short interest in Equity Lifestyle has declined steadily since the third quarter of 2023. With a net short balance of $554 million to start, bears are currently retraced to a net balance of $227 million. Compared to worthy peers like Equity Residential and Essex Property Trust Inc., valuation trends keep favoring the smaller $12 billion market capitalization portfolio of residential properties.
The saying "It must be expensive for a reason" applies here, and as the average home price remains more than 31% higher than the pre-pandemic levels of $375,000, homebuyers may look to rent instead of buying a new home. Notably, apart from higher home prices, today's 7.3% average mortgage rates make it even more difficult for newcomers to join the wave of homeownership, making these residential properties an even stronger investment thesis for investors.
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