Market Commentary | September 15, 2023


Sector Rotation

Over the last year or so, our exposure to residential real estate investment has been very limited. It’s not that business hasn’t been very good for apartment owners; from the start of 2021 through 2022, rents on lease renewals routinely jumped 15 to 20%.  The problem was that investors perceived the rent hiking trend was perpetual and bid the shares to unprecedentedly high earnings multiples. We felt the sector posed more risk than reward and stepped away.

Runaway housing costs were a major driver of the inflation experienced across the whole economy and were squarely in the sights of the Federal Reserve’s ten-rate-hike aim to kill inflation.  We are not yet certain if inflation has been defeated, but the chart below demonstrates that investor expectations have been tamed.

Sector Spotlight: Multifamily REITs – 1 year share price performance

The pace of rent growth has slowed to historic norms and share price multiples have compressed from the unsustainable 25X-30X FFO to a saner 15X FFO, on average. More importantly, the about-face of investor sentiment has been so complete as to beat some shares down to 60% of their intrinsic value. In prior cycles, these market dynamics have been followed by new waves of M&A activity.

Supply and Demand

The money for nothing credit accommodation made available to lift the economy early in the pandemic was the fuel for the construction of apartment units to meet surging demand in an ongoing housing shortage. Ten rate hikes seem now to have been sufficient discouragement to stem the supply glut of new housing inventory.

New supply is diminished, but demand remains. Higher mortgage rates have relegated would-be home buyers to remain renters. Those same high rates have compromised leveraged properties that may soon face higher financing costs.

We know the multifamily REITS in the graphic above very well.  Our present anticipation is that some of the most heavily discounted companies will become acquisition targets of those with the means and the desire to buy them. This type of merger and acquisition activity has already started to heat up in retail real estate and finance and we believe residential is now attractively priced for the same.  We plan to be present for participation.

Notes and Disclosure

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