AHH - Armada Hoffler Properties: An Armada Against Market Volatility

• Armada Hoffler Properties is a diversified REIT that is trading at a discount to historical averages and to related peers.
• The company has a strong geographic presence along the eastern seaboard in top-tier commercial markets with a portfolio of Class-A properties.
• Occupancy levels are currently at record levels, and new, high-profile tenants are still being added in their key markets.
• The quarterly dividend was most recently increased by 12%. With management committed to returning the payout to pre-pandemic levels, further increases are likely in subsequent periods.
• A high degree of inside ownership provides assurance that management is aligned with shareholders.

Armada Hoffler Properties, Inc ( AHH ) is a full-service real estate company that operates as a real estate investment trust (“REIT”). Their portfolio of assets includes office, retail, and multifamily properties located primarily throughout the Mid-Atlantic and Southeastern United States. In addition to their interests in these properties, the company also provides general contracting services to third parties and invests in development projects through mezzanine lending and preferred equity arrangements.

Shares are currently trading at just 12x forward funds from operations (“FFO”), which is an attractive discount to the sector median of 15.8x , with some peers, such as W.P. Carey, Inc ( WPC ) and Alexander & Baldwin, Inc ( ALEX ) even trading at multiples of 17x and 19.7x, respectively.

AHH has also been trading in a tight 52-week range, with less than $5 separating their highs and lows. This provides investors a reprieve from the volatility displayed in the broader markets. In addition, the company provides a quarterly dividend that was recently increased by 12% and is now yielding over 5%.

Though shares are down about 6% YTD, they are still outperforming the S&P 500 , which is down 10% over the same period. Still, the stock has yet to recover to pre-pandemic levels, despite vastly improved operating results. At current trading levels, shares present upside of at least 20%, excluding dividends. For investors seeking a value addition to their diversified REIT portfolios, AHH is a strong candidate for inclusion.

Discounted To Peers, Despite Quality of Portfolio

AHH is a diversified REIT with a market cap of approximately +$1.3. This is comparable to many other names in the sector, but significantly lower than the +$17B cap of WPC, who trumps almost every other name in the sector.

Similar to ALEX, who has a strong geographic presence in one region of the U.S., the State of Hawaii, AHH also is one REIT whose operations are geographically concentrated. AHH’s operations, however, are more diverse, spanning the length of much of the eastern seaboard as opposed to ALEX, whose operations are principally in Hawaii .

Given the risk associated with operating in just one primary state, the market is still applying a valuation of 19.7x forward FFO for ALEX, which is a sizable premium to the 12x asking price of AHH. Perhaps Hawaii’s tourism-driven economy and their luxurious resorts are one reason for the diversion, but AHH's Class-A portfolio is comparable, if not better, in quality.

Record Portfolio-Wide Occupancy Levels

AHH’s portfolio is comprised of high-quality retail, office, and multifamily properties that are in the top tier of commercial properties in their markets, offering Class-A amenities and finishes. A testament to their property quality is reflected in their portfolio-wide occupancy levels, which stood at a record 97.3% at period end. This was up 90 basis points (“bps”) from three quarters ago and 20bps sequentially.

Notable tenants of AHH include Exelon Corporation ( EXC ) and Morgan Stanley ( MS ), both of whom are among AHH’s top five tenants. At 8.1% of annualized base rent (“ABR”), EXC is AHH’s largest tenant and one that is leased for the long term, with an expiration year of 2036. This provides AHH with many years of predictable cash flows with built-in escalation provisions.

Continued Opportunities In The Leasing Environment

AHH also benefits from a lease expiration schedule that is weighted more towards their retail portfolio, with approximately 35% of ABR set to expire over the next several years. This will provide an attractive mark-to-market opportunity for AHH and enable them to replace weaker retail centers with high-credit office tenants.

The re-leasing environment for retail continues to remain robust with cash spreads holding in the mid-single digits over the past four quarters. The office landscape has also shown improvement after two consecutive quarters of negative cash spreads in the back half of 2021. Together, cash spreads were up 3% and 3.5% on the quarter for office and retail, respectively, and 13.1% and 9.9% on a GAAP basis.

AHH also continues to add quality, high-credit tenants to their trophy office spaces. In July, for example, Franklin Templeton signed a new office lease at AHH’s Willis Wharf office building in Baltimore’s Harbor Point neighborhood. The signing of this high-profile lease cuts against oft-cited concerns regarding the future of office space in an era of more hybrid working arrangements.

Continuous Growth In Revenues and Earnings

In addition to their property-based rental revenues, AHH also earns revenues from their investments in development projects and third-party general contracting services. In the current quarter, AHH generated approximately +$3.2M in interest income on their preferred investments, primarily from their interests in The Interlock , which is a large mixed-use asset located in one of the hottest submarkets in the country, West Midtown, Atlanta.

And in their general contracting segment, AHH generated +$45.3M in revenues during the quarter, which represents approximately 45% of total quarterly revenues. On this, they generated an operating margin of 4.1%, up 70bps from Q1. Together with their investment portfolio, these two business lines add beneficial diversification to the company’s earnings results.

Overall, total revenues were up over 50% from the same period last year and are now running 22% higher over the first half of the year. This was accompanied by strong growth in both net operating income (“NOI”) and FFO, which exceeded expectations for the third consecutive quarter. In addition, for the second consecutive quarter, management increased their guidance range for normalized FFO to a level that represents a 10% increase over 2021 results.

Further Dividend Increases Are Likely

In addition to strong property-level metrics, AHH also has a healthy balance sheet with a manageable debt load and total liquidity of +$140M, which is sufficient to cover their capital needs over the near-medium term. With coming debt maturities largely accounted for, the company faces limited repayment risks. They are also insulated from rising interest rates due to a favorable composition of fixed-rate debt.

The flexibility afforded to them by the strength of their fundamentals enables AHH to provide a dividend payout that is currently yielding over 5% after having been recently increased 12%. With management committed to returning the payout to pre-pandemic levels, it's likely the payout will soon yield over 6% at current pricing levels. With the payout standing at about 75% of adjusted FFO, cushion does exist for future increases.

Some Risks To Consider

The geographic concentration of AHH’s portfolio exposes them to greater economic risks associated with their portfolio’s local markets. Virginia, Maryland, and North Carolina, for example, account for nearly 90% of total NOI. In addition, many of their properties are located in the Town Center of Virginia Beach and Harbor Point at Baltimore. These two locations, themselves, accounted for about 40% of total NOI.

While operations in the three locations is a key component of their business strategy that provides numerous benefits, there are unique risks that should be considered. A slowdown in the local economies of these markets that is worse than the broader national average is one such risk that could weigh on AHH operations. Potential cuts to defense spending is another, less intuitive, risk that could have a material adverse effect on the company. This is because AHH’s markets contain high concentrations of military personnel and operations. Any reduction of the military presence in the region could in-turn have a significant effect on the local economy.

Aside from geographic concentration, AHH is also exposed to the risks relating to the general retail environment, as nearly 50% of NOI is attributable to this space. In recent periods, there has been a shift of consumer spending priorities from goods to services. This has resulted in consumers spending less on retail-related items, such as clothing, furniture, and other household goods, in favor of experiences, such as restaurants and travel. Continued weakness in the retail environment could pose significant risks to AHH’s tenant base and could result in uncollected rents or increased vacancies in later periods.

At Least 20% Upside At Current Trading Levels

AHH is a diversified REIT that is trading at a significant discount to many related peers within the sector. This is despite the release of strong quarterly results that came in above expectations and included raised full-year guidance.

While shares have not materially appreciated, investors have been rewarded with generous dividend growth, the most recent being a 12% increase to current payout levels, representing a yield of over 5%. A strong management team that is highly vested in the company through inside ownership is another differentiating feature of the stock that should support a modestly higher pricing multiple.

At the end of 2019, AHH was trading at a FFO multiple of approximately 15.7x . Since then, occupancy has hit record levels and the pace of organic NOI growth from their properties continues to accelerate. Yet, shares are still trading at just a fraction of their pre-pandemic multiples, at just 12x. Even at a 15x multiple, shares would have embedded upside potential of at least 20%.

The stock has been trading in a very tight trading range. And this is good for investors when considering the volatility impacting the broader markets. The reoccurring dividend payouts also provide bond-like portfolio protection. However, given the consistent strength reflected in their past three earnings releases, it’s likely shares are due for a sustained run higher. For long-term investors, it may be of benefit to add this armada to the diversified portfolio of REIT holdings.

For further details see: