Role of Residential REITs in REIT Portfolios, The

Journal of Real Estate Portfolio Management, Apr-Aug 2009 by Newell, Graeme, Fischer, Franz

Executive Summary.

Residential real estate investment trusts (REITs) make a significant contribution to the overall REIT market, accounting for 13.5% of the equity REIT market capitalization at December 2007. The current housing crisis in the United States has seen an increased focus on residential REITs. This paper assesses the significance of residential REITs in a REIT portfolio over Q1:1994-Q4:2007. In particular, their risk-adjusted performance and portfolio diversification benefits are compared with the other REIT sub-sectors and to stocks, bonds, and real estate. The ongoing effect of the current U.S. housing downturn on the future outlook for residential REITs is also assessed.

Residential real estate investment trusts (REITs), comprising apartment REITs and manufactured home REITs, make a significant contribution to the overall REIT market. This sees residential REITs accounting for over $39 billion or 13.5% of the equity REIT market capitalization at December 2007 (NAREIT, 2008a). In terms of market share, apartment REITs account for 8% of U.S. apartments and manufactured home REITs account for 5% of U.S. manufactured home sites (Imperiale, 2006).

While the performance of other REIT sectors (e.g., office, retail) has received considerable attention (see Zietz, Sirmans, and Friday, 2003), the significance and performance of residential REITs has received limited attention. This research has largely focused on apartment REITs and included the portfolio implications of apartment investing (Anderson, McLemore, Conner, and Liang, 2003), apartment REIT payment of premiums (Hardin and Wolverton, 1999), linkages between apartment REIT and apartment performance (Liang, Chatrath, and Mcintosh, 1996; and He, 2000) and linkages between apartment REITs and other REIT sectors (Young, 2000; and Payne, 2006).

The investment significance of residential REITs has been further considered in light of the current residential housing crisis in the U.S. and ongoing issues regarding Freddie Mac and Fannie Mae. This has been reflected in the 45% decrease in significant apartment sales in the U.S. in the first half of 2008 compared to the first half of 2007 (Real Capital Analytics, 2008). With declining home ownership and the expected trend of home owners moving into rental this has seen increased institutional investor terest in residential REITs as a potential source liquidity and added value in the residential (Schwartz-Driver, 2008).

Given this current focus on residential and the potential enhanced role of REITs in portfolios, this paper will assess the formance of residential REITs from Ql: through Q4:2007. It will particularly highlight risk-adjusted performance and portfolio cation benefits of residential REITs, REITs, and manufactured home REITs, marked against the other REIT sectors and asset classes (stocks, bonds, and real estate). period analyses will also be performed to assess whether the investment dynamics for residential REITs have been enhanced in recent years. The strategic investment issues for residential REITs in a portfolio are identified, as well as the effect of the current housing downturn and credit crisis on the future outlook for residential REITs.

Significance of Residential REITs

Of the national stock of 18 million apartments in the U.S., the top 50 apartment owners account for 2.7 million apartments or 15% of this national stock (NMHC, 2008). Of the top 10 apartment owners (Exhibit 1), apartment REITs play a significant role, accounting for two of the top five apartment owners (Apartment Investment Management, Equity Residential) and three of the top 10 apartment owners.

Exhibit 2 details the 17 apartment REITs at Q4: 2007, accounting for over 3,400 communities and 897,000 apartments. Some of these apartment REITs specialize in university student accommodation (e.g., American Campus Communities, Education Realty Trust). Some of these apartment REITs are also amongst the world's largest REITs; this includes Equity Residential (#6 globally, #4 in U.S.) and AvalonBay Communities (#13 globally, #10 in U.S.) (Macquarie Securities, 2008). Overall, apartment REITs account for 8% of U.S. apartments.

Of the 28,000 manufactured housing communities in the U.S., this accounts for approximately 1 million home sites, including general communities and communities for those over 55 years of age (Imperiale, 2006). At Q4:2007, there were four manufactured home REITs (Exhibit 3), accounting for 504 communities and 175,000 home sites. Overall, manufactured home REITs account for 5% of U.S. manufactured homes.

The significance of residential REITs in the equity REIT market is shown in Exhibit 4. At Q4.2007, residential REITs accounted for over $39 billion in market capitalization, representing 13.5% of the equity REIT market capitalization (NAREIT, 2008a). This contribution by residential REITs has decreased from 21.0% to 13.5% over 1999-2007 (Exhibit 5), reflecting the privatizing of several major residential REITs, as well as the significant growth in the retail REIT and healthcare REIT sectors over this period.