3 Best Stocks for Investing in Residential REITs

By Markets Fool.com

Real estate is one of the most popular types of investments in the world, and for good reason. But owning actual rental properties isn't for everyone. With that in mind, here are three publicly traded real estate investment trusts, or REITs, that give you the benefits of owning residential real estate without the risks of individual properties.

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Large REITs can afford to buy in the most desirable markets
Equity Residential
is a large REIT specializing in apartment properties. It owns and manages almost 400 apartment properties with nearly 110,000 rentable units. The majority of the portfolio is in large metropolitan markets such as Boston, New York, Washington, D.C., and San Francisco.

Equity's strategy is to develop properties in desirable rental markets, where rents are high, jobs are being created, favorable demographics will increase demand, and there are high barriers to entry for competitors. In Equity's markets, there is less turnover, which leads to higher occupancy rates than the national average. Currently, 78% of Equity's portfolio is made up of single-occupant households or couples without children, two groups that are statistically unlikely to buy homes. In fact, Equity's apartments were nearly 96% occupied at the end of 2014.

The company's business model seems to be working. Rent is rising faster in Equity's markets than in the overall United States (6.2% versus 4.6% in 2014), and the company has been able to increase its funds from operations, or FFO -- how REITs generally measure their income -- by more than 8% per year on average since 2010.

Source: EQR investor presentation.

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A play on rising college costs
One specialized REIT with lots of room to grow is American Campus Communities . This REIT acquires, develops, and manages student housing properties located at or near major universities, and has expanded rapidly in its decade as a public company.

Source: American Campus Communities investor presentation

The trust owns 163 properties in 74 university markets with nearly 103,000 beds. However, American Campus Communities' estimated addressable market consists of more than 6.3 million students in 280 markets, based on the company's target market of public flagship institutions with more than 15,000 students.

American Campus Communties has a few competitive advantages that should help it continue to grow for years to come. First, the student housing market is fragmented. So, as the largest student housing REIT, there is a lot of opportunity to increase efficiency and save on expenses. In addition, the company's properties are "purpose-built," meaning they're specifically designed to attract today's college students with amenities that appeal to that demographic. This approach gives the trust an advantage over standard apartment communities and substandard on-campus housing.

Since going public in 2004, ACC has averaged an outstanding 97.7% fall occupancy rate, and has produced a fantastic 281% total return for shareholders (about 14% annualized). In short, American Campus Communities is the best at what it does in a growing and currently underserved market, and should continue to produce excellent returns.

A rarity among residential REITs
Silver Bay Realty Trust
is somewhat of a rarity among residential REITs. Unlike most REITs, which own large apartment complexes, Silver Bay invests in single-family houses. The company focuses on acquiring, renovating, leasing, and managing single-family homes, in order to generate both rental income and long-term growth.

Silver Bay is by far the newest REIT on the list, formed in 2012 to take advantage of a strong opportunity in rental properties. First of all, the markets Silver Bay invests in have not fully recovered from the housing crash (such as Florida, Arizona, and Nevada), and homes can be bought for significant discounts to their replacement cost. In fact, Silver Bay estimates that its average cost basis for each of its properties is about $140,000. It estimates the current average market value to be $159,000. So by simply acquiring the homes and doing some renovations, Silver Bay has immediate equity in the properties.

The average replacement cost of Silver Bay's homes is estimated at $207,000, with significant increases expected over the next several years. So there's an incredible long-term opportunity for the company to grow its equity in the homes it owns.

Source: Silver Bay investor presentation

Silver Bay owns approximately 6,800 single family homes, and it manages more than 80% of these internally. Furthermore, with its recently announced acquisition of The American Home Portfolio for $263 million in cash, the total will grow dramatically to roughly 9,200.

With an experienced management team and a disciplined acquisition strategy, Silver Bay has the potential to generate healthy returns for its investors over the next several years and beyond. Plus, shares are trading for a 18% discount to their net asset value of $19.93, so Silver Bay looks like a good opportunity right now.

Which to choose?
This isn't an exhaustive list, and simply represents what I consider to be a good overview of the residential REIT landscape. However, the point to remember is to recognize the reasons I chose these REITs (good risk management, solid income, increasing demand) and apply it to any residential REIT you may be considering.

The article 3 Best Stocks for Investing in Residential REITs originally appeared on Fool.com.

Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.