Sule Aygoren Carranza is managing editor of Real Estate Forum and editor of Multi Housing forum, from which this article is excerpted.

New York City—The CEOs of three multifamily REITs remain positive on the sector this year, but acknowledge that valuations may be full. And while they agree that most markets will continue to perform well, they don't expect 2007 will be a repeat performance of the past year, since rent growth is expected to slow in even some of the hottest areas. That was the consensus of Bank of America's recent multifamily CEO dinner, attended by AvalonBay Communities Inc.'s Bryce Blair, BRE Properties Inc.'s Connie Moore and David Neithercut of Equity Residential.

The CEOs agree demand continues to exceed supply, which should lead to same-store NOI growth of at least 5% to 7%. Infill markets on the coasts are expected to outperform other areas as the cooling single-family home and condominium market and higher levels of new supply impact conditions in the Sunbelt markets such as Dallas, Phoenix, Atlanta and South Florida. Further, low yields from acquisitions are keeping all three companies focused on development opportunities.BofA, noting that it fundamentally agrees, questions "whether an unexpected jump in new supply is a risk that the market has been underestimating, even if only from a psychological standpoint."

The strong demand, limited new supply and stretched housing affordability put Northern California, Seattle and New York City at the top of the list of best performers, the 15%-plus of last year will likely decline to 8% to 10% this year. Blair says the Washington, DC is healthy as well, despite ongoing weakness in the condominium market, and Boston, which accounts for 8% of AvalonBay's portfolio, looks promising, though its weakness is not expected to improve any time soon.

Meanwhile, the CEOs addressed the slight occupancy decline during the fourth quarter of 2006, which Reis Inc. pegged as a 40-basis-point drop to 94.1%. It's not indicative of a larger trend, they say, but rather, the result of typical seasonality.

"Additionally, though the level of traffic has slowed, the number of closings continues to increase, giving the CEOs confidence heading into the spring leasing season. New supply remains in check, but even if it increases, will it matter?" BofA asks. BofA notes multifamily starts have remained relatively steady at about 300,000 units, which the executives believe can be "easily absorbed given the healthy demand outlook for rental apartments." Neithercut predicts that even if starts rise by another 20% or 60,000 units it probably won't be enough to derail the strength in fundamentals.

Both investors and the chief executives agree that liquidity in the global markets is keeping fund flows to real estate at aggressive levels. As a result, cap rates remain low and pricing remains high. Still, while pension funds and foreign investors continue to allocate capital to the sector, "Consensus appeared to be that the money is increasingly looking for a home in global real estate, a trend we expect will continue throughout 2007," says BofA.

Meanwhile, Equity Residential's Neithercut asserts that the arbitrage between public and private companies has closed for the multifamily sector, and AvalonBay's Blair indicats that leverage of 60% or more is difficult to obtain due to low fixed-charge ratios.

The executives also discussed AvalonBay, which recently made it onto the S&P 500. While Blair did not give a direct answer as to whether his firm will issue equity into its inclusion in the index, BofA believes AvalonBay will do so and is therefore raising its estimates and target. BofA has included a $300-million equity offering in its model during the first quarter and is adjusting its 2007 and 2008 estimates upward to $4.88 and $5.25 from $4.80 and $5.18. It is also increasing its target price accordingly, from $131 to $135.

Of all three CEOs, BRE's Moore was the most optimistic for the year, which didn't surprise BofA since the company's portfolio is concentrated in supply-constrained, high barrier-to-entry markets in the West Coast. BRE expects to deliver same-store NOI growth of 7.5% to 9% this year, driven by 6% to 7% rent growth and a growth in expenses of between 2% and 3%.

"Given the wide gap between the monthly cost of owning and renting in BRE's markets, we believe expenses remain the key to the story," contend BofA analysts. "In 2006, outsized expenses were driven by an above-average increase in payroll, higher-than-expected carpeting costs due to oil prices and an appliance-replacement program."BRE also expects to ramp up its development activity, with about $250 million in development annually, a significant number for a company that size. NOI from the lease-up of new development projects this year is expected to range from $11 million to $12 million, and the development could add $1.50 to $3.00 per share to NAV once completed.

BofA continues to marketweight the multifamily REIT sector. "A more moderate near-term economic outlook, coupled with valuations that already reflect expectations of continued fundamental strength will likely limit further share price appreciation," state analysts, who peg Archstone-Smith as their favorite player in the sector. "We believe the performance of the REIT industry in 2007 will largely be driven by the ultimate growth rate of the US economy, the pricing and availability of mortgage debt, new supply growth and fund flows into commercial real estate. Our 'likely' case calls for REITs to end 2007 flat to up 5%, with total returns in the 4%-8% range including dividends." However, BofA analysts acknowledge that the downside risk is greater than the upside potential, given premium valuations.

Instant Insights /

REIT CEOs Upbeat for '07

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