UDR(NYSE: UDR) is one of the largest publicly traded apartment real estate investment trusts (REITs) you can buy. It differentiates itself from its peers through the structure of its portfolio. Today the stock offers an attractive 4.8% dividend yield. That's roughly a full percentage point higher than industry bellwether AvalonBay Communities(NYSE: AVB). Before you buy UDR, however, you need to understand this key fact.
UDR spreads its bets around
AvalonBay is a well-run apartment REIT, showing material skill on the construction, redevelopment, and acquisition/disposition fronts. Dividend investors who want to own the industry's biggest and best names would do well to consider it. However, AvalonBay's portfolio is heavily concentrated in and around major metropolitan areas. For the most part, that means it has a coastal focus. It is only just starting to inch its way into the Sunbelt region.
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This is where UDR's more diversified approach comes in. Roughly 39% of its rents come from the Northeast, 35% from the West Coast, and the rest from the Sunbelt. That was a plus during the coronavirus pandemic when people were fleeing coastal cities in favor of more rural areas, like the Sunbelt. But, more generally, such regional diversification can help to smooth out performance over time.
UDR also has a different thought process when it comes to the quality of its properties. Roughly 44% of rents come from A-level assets, with the rest from B assets. This is something of a throwback to UDR's history, in that it has long redeveloped B assets into A assets. There's diversification in having exposure to both, but there's capital investment opportunity, as well.
Although UDR's approach to diversification should probably be seen as a net benefit over the long term for conservative income investors, it isn't always the best thing in the short term. Right now, the news isn't so great.
UDR Dividend Yield data by YCharts
The situation is changing fast
During UDR's third-quarter conference call, CEO Tom Toomey noted that the apartment landscape had changed at an "unprecedented" rate since September. That's a big statement, given that he has been in the industry for around three decades. What's happening is particularly difficult for UDR.
Essentially, new apartment construction projects begun in recent years are finally starting to hit the market. There are more to come over the next year, as well. As these buildings look to fill apartments with tenants, their owners have been increasingly aggressive with their pricing. This normally takes the form of concessions, like free months of rent. That, in turn, puts pressure on existing apartment landlords because it depresses rental rates in the surrounding areas.
The biggest effect has been on class B apartments, according to UDR. That's because most of the new properties are A assets, and the rental rates they are asking are so aggressive that they are competing with B properties. For most renters, getting into an A-quality apartment for B-quality rental rates is an easy win. For UDR, however, it is a material near-term headwind.
Not surprisingly, UDR lowered its full-year guidance when it announced third-quarter earnings. However, there is a "light at the end of the tunnel," according to UDR. While the pressure from new apartments is likely to persist into 2024, the data on new building starts suggests that 2025 will be a better year for the industry as construction slows.
No rush, but still worth a deep dive
Overall, UDR's business is probably going to lag behind its higher-quality peers for a little while. The diversification that benefited the REIT in 2020 is now constraining it. No business goes up or down in a straight line -- it is always a sine curve. But the weakness at UDR today isn't going to permanently derail the apartment landlord, and that might make now a good time to consider its above-peer yield for your dividend portfolio. Just remember that earnings might be tough reading for a few more quarters. If you think long-term, however, that probably won't be a big issue for you.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.
