Neither consumers nor REITs are immune to the cost of rising crude oil prices, according to Banc of America Securities analyst Ross Nussbaum. Owners of Class-B apartments, in particular, face a modest risk exposure because they target lower-end renters and offer short-term. As a result of the oil price spike, the expectation that apartment rents would grow 3% to 4% in the second half of 2005 is now questionable.
“This [spike in oil prices] could negatively impact the ability of landlords to raise rents,” wrote Nussbaum in a research note dated Aug. 19, nine days before Hurricane Katrina slammed into the Gulf Coast states, killing hundreds, damaging oil refineries and sending prices at the gas pump even higher. In late August, the price of crude oil breached $70 per barrel compared with $43 per barrel at the end of 2004.
“Class-B rental consumers already spend a higher proportion of their disposable income on housing and other essential goods than Class-A renters,” wrote Nussbaum. “Therefore, as gasoline, home heating and other energy prices take a bigger and bigger bite of disposable income, it will be lower-end consumers who will be less and less able to tolerate expected rent increases from a recovering apartment market.” REITs with Class-B exposure include United Dominion Realty Trust, AIMCO, Camden Property Trust and Essex Property Trust.
Among other potential effects of higher oil prices on the REIT world:
• Diminished consumer spending could affect shopping center REITs in the form of a rising number of store closings in the first half of 2006. “Class-B regional malls seem the most exposed to this risk,” wrote Nussbaum.
* Office andREITs will be relatively unaffected in the near term, but reduced consumer spending could put downward pressure on employment growth and industrial production in the long-term.
Still, there may be an unexpected benefit for REITs relative to rising energy prices, notes Nussbaum, if the broader equities market begins to decline and investors becomes more defensive-minded. “If elevated energy prices do actually take a bite out of the economy, REITs’ safe-haven reputation could attract capital to the group despite current premium valuations and downside earnings risk.”