Something is happening for the first time in nearly three years…
Apartment rents are falling.
Ever since the pandemic, apartment rental rates have been soaring. In summer 2021, average rents across the country jumped by 18% compared to the previous year. And then they kept going up.
There were many reasons for the sudden surge in rent – inflation, landlords making up for pandemic discounts, increasing demand to live alone, sky-high home prices, simply not enough empty apartments to meet demand…
Most of those are still issues today. But one thing has changed – there are a lot more apartments available now. And more are on the way. So renters are finally getting some relief.
Many of these new apartment units are coming from an unexpected source – formerly empty office buildings.
So while this is good news for those who rent… It could present a threat to existing apartment buildings in certain areas.
Today I’ll explain why so many office buildings are converting into apartments. I’ll also share one company whose business is insulated from this trend and is trading at a discount today.
The Problem Old Offices Are Facing
Ever since the pandemic, office owners have been struggling to get companies to rent space.
For the past few years, they have been limping along, relying on pre-pandemic leases – which often last five or more years – to keep the lights on.
But those are running out. And as companies’ leases expire, they’re looking to downsize and find newer, higher-quality offices.
So owners of older office buildings are ending up with fewer tenants.
With loans coming due and higher interest rates, they don’t have many options. So, they’re choosing to renovate… and turn those offices into other types of buildings that can attract renters.
Across the country, hundreds of old office buildings are in the process of converting into something else.
According to real estate broker CBRE, nearly half of those are going to end up becoming apartment buildings.
Many state and city governments are encouraging these conversions to bring in more tax revenue and to provide more affordable housing. Even the federal government is getting involved by offering grants and low interest loans to finance office conversions.
Apartment software and data provider Yardi Matrix expects former offices to be converted into more than 55,000 apartments this year. That’s more than four times higher than figures from just three years ago.
The large increase in supply of apartments means vacancies are now back to pre-pandemic levels. And rents are falling as more apartments come to the market.
That has led to a selloff in the apartment sector.
But there’s one company that’s being unfairly punished, creating a chance to invest in a reliable income stream at a discount…
One Company That Will Profit
Essex Property Trust (ESS) is a real estate investment trust (REIT) that owns more than 62,000 apartments.
Essex’s apartment properties are all located on the West Coast in cities like Los Angeles, San Diego, San Jose, and Seattle.
Even though many offices are turning into apartments, very few of those are happening in the cities where Essex owns properties. According to the company, it expects total housing supply in its markets to increase by just 0.5% this year.
So this new incoming supply from old offices is unlikely to affect its business negatively.
Essex expects its rental rates will keep increasing this year even as rents decrease in other parts of the country.
And here’s the best part for income-focused investors like us at Intelligent Income Daily…
As a REIT, Essex is required by law to give 90% of its taxable income to its shareholders. So those increasing rents mean more dividends in the future.
Essex is a reliable income grower and has increased its dividend 30 years in a row. In fact, it just announced another 6.1% increase in its payout last week, bringing its yield to 4.3%.
Essex shares trade at 17x adjusted funds from operations (AFFO). This financial metric used for REITs tells shareholders how much cash flow is available for dividends.
Essex has historically traded at an average of 22x AFFO. So right now, it’s at a 23% discount.
That means it’s a great time to invest in this reliably growing income stream.
Happy SWAN (sleep well at night) investing,
Brad Thomas
Editor, Intelligent Income Daily
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Source: Wide Moat Research