AHH - 7%-Yielding Armada Hoffler: Get Automatic Diversification

2023-12-05 12:58:14 ET

Summary

• Armada Hoffler Properties is a diversified REIT with a portfolio of retail, office, mixed-use, and multifamily properties.
• Armada Hoffler has high occupancy rates and has seen growth in same-store NOI for all three property segments.
• Armada Hoffler's development arm provides additional avenues for growth, with projects currently underway and lease-up opportunities.
• It currently pays a high and well-covered dividend yield, leaving retained capital for growth funding.

Real estate investment trusts, or REITs, have plenty of competition these days from other high-yielding alternatives, namely master limited partnerships ("MLPs"), business development companies ("BDCs"), and Treasury Bonds. It's important, however, to keep in mind that every asset class serves a different purpose, and trying to judge which one is better is like comparing apples to oranges.

That's why I hold a diversified portfolio, with REITs being one of the cornerstones of my portfolio. With many REITs currently trading at bargain valuations, it pays to take the opportunity to diversify one's portfolio even within the REIT segment, so as to not be locked into weakness in any one property class.

This brings me to Armada Hoffler Properties, Inc. ( AHH ), a REIT that holds a diversified portfolio of properties in its own right. I last covered AHH here back in August, highlighting its high occupancy ratio and healthy lease spreads. The stock has seen its ups and downs since then, with the price falling as low as $9.81 since my last piece, on fears of a "higher for longer" interest rate environment.

The share price has rallied a bit since hitting its 52-week low point in October and currently sits 4% below where I recommended it last. In this piece, I discuss why AHH remains a good bargain at present while the market remains mostly on the sidelines, so let's get started!

Why AHH?

Armada Hoffler Properties is a diversified REIT with retail, office, mixed-use, and multifamily properties that are spread across the Southeastern and Mid-Atlantic regions of the U.S. It focuses on institutional quality real estate in high barrier to entry markets with healthy population and job growth. AHH currently has a high occupancy rate of 97%, and as shown below, 45% of its NOI stems from retail, with the remainder coming from office and multifamily at 33% and 22%, respectively.

Encouragingly, AHH saw same-store NOI growth of 5.9% YoY on a cash basis during the third quarter. This contributed to a respectable 5.6% growth in same-store NOI for the first nine months of the year. This was driven by contractual rent increases on its stable occupancy and healthy renewal spreads of 14.5% and 4.9% on a GAAP straight-line and cash basis, respectively.

It's worth noting that while news headlines around commercial office real estate are scary, the underlying fundamentals for AHH are far from it. This is reflected by strong office occupancy of 96%, along with multifamily and retail at 96% and 98% occupancy, respectively. As shown below from AHH's earnings release , all three property segments saw SS NOI growth during the last reported quarter.

• Retail Same-Store NOI increased 6.6% on a GAAP basis and 6.4% on a cash basis.
• Office Same-Store NOI increased 2.3% on a GAAP basis and 8.1% on a cash basis.
• Multifamily Same-Store NOI increased 3.1% on a GAAP basis and 2.2% on a cash basis.

What sets AHH apart from its REIT peers is its multi-pronged approach towards achieving growth, not just from its multiple property segments, but also from its development arm. This includes projects that are currently underway, including a $265 million development for the T. Rowe Price ( TROW ) Headquarters building in Harbor Point, Maryland, with completion slated for the middle of next year and lease-up opportunities afterward, as shown below.

Management expects to see record development income this year, and for this to be continued in 2024, as noted during the last conference call :

Yet another major benefit comes from our construction and development operations with third-party fee income at all-time highs and an elevated level of backlog, our expectation is for 2023 to be our most profitable year ever, and we expect similar results in 2024. These earnings allow us to further flexibility and dealing proactively with potential issues elsewhere without endangering profit growth.

Risks to AHH include the potential for a recession, as this could impact tenancy in its office portfolio more than multifamily and retail. Moreover, high interest rates also pose a potential headwind, as this raises the cost of debt. However, interest rate headwinds remain muted for now, as AHH has no remaining debt maturities this year, and limited maturities next year.

Furthermore, AHH carries a BBB credit rating from DBRS Morningstar and has a net debt to stabilized EBITDA ratio of 6.2x, which is a reasonable amount of leverage. Plus, 95% of AHH's debt is either hedged or held at fixed rates with a weighted average interest rate of 4.2%. Management also expects for its 2 Harbor Point developments to enable it to deleverage its balance sheet upon completion.

Meanwhile, AHH pays an attractive 6.8% dividend yield and the dividend is well-covered by a 63% payout ratio, leaving plenty of retained capital to pay down debt and/or fund growth. AHH also remains undervalued at the current price of $11.55 with a forward P/FFO of 9.2, sitting well below its normal P/FFO of 13.1, as shown below. At the current valuation, AHH is priced for virtually no growth perpetually, but analysts estimate 4% to 7% annual FFO/share growth starting in 2025 as development projects come online.

While I see value in the common shares, more conservative income investors may want to consider AHH's Preferred Series A Cumulative shares ( AHH.PR.A ). This preferred series currently yields 7.3% and, at the current price of $23.22, trades at a 7.1% discount to its par value of $25. AHH.PR.A cannot be called until 6/18/24 at the earliest, and considering the current high interest rate environment, I would not expect for it to be called should rates remain elevated.

Dividends on preferred shares are safer than that of common shares, especially since these are cumulative (meaning that missed payments must be made up unless the company goes bankrupt). In the event that this preferred series does get called, investors still get dividend payments between now and June, and a 7.1% premium on top of today's price.

Investor Takeaway

Armada Hoffler Properties remains undervalued at its current price, and the preferred shares may be a more attractive investment for those with lower risk tolerance. Its diversified property portfolio, strong occupancy rates, and development projects provide multiple avenues for growth. With an attractive dividend yield and potential for future FFO/share growth, AHH is worth considering for investors looking to add a REIT to their portfolio for automatic diversification. Maintain "Buy" rating on both the common and preferred shares.

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