Rental Property Stocks Get New Lease On Profits With Rising Interest Rates

This article was originally published by Motif Investing.

More than a decade ago, the housing market collapsed. The home values of 1 in 9 homeowners haven’t fully recovered from the crash, and home ownership is down to levels not seen since 1965. The housing market, however, is another story.

At least 9.3 million homeowners lost their homes between 2006 and 2014, putting millions of people into the rental housing market. Millions more Americans who came of age In the wake of the worst economic recession since the Great Depression have dropped out of the homeownership market; fewer than 4 in 10 Millennials own homes, compared to 63.5 percent of the total population. Some analysts predict homeownership rates will fall to 60.5 percent by 2025, the lowest level since the mid-1950s.

Developers saw opportunity in the wake of the Great Recession and began flooding the market with rental properties. Blackstone Group LP BX, for example, spent more than $1 billion in 2012 to buy foreclosed houses, becoming the largest U.S. investor in rental homes. Between 2014 and 2019, almost 25,000 residential housing units will be built in the white-hot Brooklyn market. And after eight consecutive months of record-setting rents, the cost of an average rental apartment in the U.S. fell $1 in September.

So is it too late for new investors to get into rental market stocks?

Rental Run-Up

Short-term investors probably should avoid the rental property market. Rents have leapt about 20 percent nationwide over the last five years. But some of the biggest markets, such as New York, San Francisco, Boston and Seattle, are experiencing slower growth rates.

“We’ve had a big run-up in rents, but I don’t think we’ll see any significant growth in the next couple of years,” David Schwartz of Slate Property Group told the New York Times earlier this year.

Sam Zell, chairman of Equity Residential EQR, sold more than 23,000 apartments for $5.4 billion to Starwood Capital Group last year, saying “it is very hard not to be a seller.” Zell, who burnished his credentials as a master of real estate timing when he unloaded $23 billion in commercial properties just before the market collapsed in 2007, is currently trying to unload properties in Berkeley and Palo Alto, Calif. Zell’s company has had to lower its revenue forecast twice in 2016.

Despite the potential for rental bargains, online real estate marketer Zillow Group, Inc. Z believes an increasing number of Millennials will buy their first homes next year, even with slow income growth and rising interest rates. The National Association of Realtors noted that the Americans who are most optimistic about the economy are high-earning, urban dwellers who are younger than 44 years old.

Buying and Holding

It’s worth noting, of course, that companies like Zillow and organizations like the National Association of Realtors make more money from people who buy homes than from people who rent them. While there are no doubt millions of Millennials who would love to buy homes, simple math suggests that relying upon the nation’s largest generation to provide much help for the housing market is going to be a long, uphill climb.

Moving Millennials into the homeownership market involves clearing two major obstacles. First, the biggest share of Millennials haven’t moved into rental housing yet; data from the U.S. Census Bureau shows 32.1 percent of 18- to 34-year-olds are living with their parents.

Even when Millennials can afford their own rental housing, a recent survey found that renters in 12 major cities would need more than a decade to save up 20 percent for a down payment, ranging from 10.1 years for a Boston dwelling to 27.8 years for a San Francisco pied-a-terre.

Statistics like those have proven to be a boon for rental property stocks. Zell’s Equity Research, for example, was trading in the mid-$60s in late 2016. Both Citigroup Inc C and Cantor Fitzgerald placed “buy” ratings on the stock, feeling it was undervalued by as much as $5 per share, and 9 of 10 analysts who cover Equity Research recommended investors either buy or hold the stock.

Likewise, Wall Street analysts generally consider Arlington, Va.-based AvalonBay Communities Inc AVB to be a bargain. The stock has been trading around $175 per share; Cantor Fitzgerald estimates it’s worth at least $188. The company also got a recent vote of confidence from the California State Teachers’ Retirement System, the largest teachers’ pension in the U.S. and the 13^th-largest such fund in the world. The fund increased its position in Avalon by 3.5 percent and now holds roughly $53.9 million worth of the company’s stock.

Analysts are also bullish on Mid-America Apartment Communities Inc MAA, a real estate investment trust that has interests in more than 100,000 apartments, mostly in fast-growing markets in the Southeast and Southwest. Both Royal Bank of CanadaRY and R.W. Baird & Co. upgraded the stock to “outperform” in December 2016. The company also recently completed its $4 billion acquisition of Atlanta-based Post Properties.