MAA - Mid-America Apartment Communities: I'm Buying The Correction (Rating Upgrade)

2023-12-20 22:39:59 ET

Summary

• MAA has been in correction territory, justifiably so. But I see brighter days ahead in the new year.
• The company continues to deliver on key metrics like rent growth and occupancy levels.
• Buying in to apartment REITs more broadly can act as a hedge against inflation.
• I continue to believe MAA is a best-in-class investment option.

Main Thesis & Background

The purpose of this article is to evaluate Mid-America Apartment Communities, Inc. ( MAA ) as an investment option. The company is a "real estate investment trust that focuses on the acquisition, selective development, redevelopment, and management of multifamily homes throughout the Southeast, Southwest, and Mid-Atlantic regions of the United States".

As my readers know, MAA has long been a favorite REIT of mine - but not at any cost. There have been multiple instances over the years when I have suggested avoiding it / taking some profits as valuations get stretched. Back in July when I last covered this REIT, that was one of those times. In hindsight, my prudent outlook was well-timed:

As I look ahead to the new year, I have opted to upgrade my rating on MAA due to this performance divergence, among other factors. I see brighter days ahead in 2024 for Real Estate more broadly, and believe this is a best-in-class way to play it. Therefore, I am putting a "buy" rating on this ticker, and I will explain the rationale behind this decision in more detail below.

The Big Story Is Yields

One of the most important (if not the most important) factors influencing my rating upgrade here is treasury yields. I noted higher Fed interest rates and correspondingly higher yields offered in risk-free investments posed a big threat to MAA in 2023. This turned out to be the case, vindicating my cautious outlook, and offered a painful lesson to investors who didn't adjust their portfolios accordingly. Simply put, higher Fed rates punished income-oriented investments as a whole. This included MAA, but was not unique to it. Other REITs, Utilities, and bonds all saw their share of pain.

But the past is the past. What matters now is where we go from here. And the good news for MAA investors is that yields have started to come back down on the backdrop of expected Fed rate cuts in 2024. This market expectation has led to a surge in bond buying (despite no actual Fed cuts yet) that has pushed treasury yields down markedly:

The takeaway here is simple. If rising yields were a headwind for MAA (which I agreed with) then declining yields are a tailwind, all other things being equal. I see yields continuing to ease and/or stay flat in the short-term, and that means that MAA's recent pop may not be done yet.

Rental REITs A Great Inflation Hedge

Another aspect I like about MAA is something I have found attractive for a long time. In fairness, it is not unique to MAA (although I will explain later why I believe MAA is one of the top ways to access this trend) as it is beneficial to most apartment REITs. This is rising rents - which most readers are probably well aware of. If you are a college student, young professional, adult renter, or supporting a dependent, you are likely aware that rents in the US have been on the upswing for a long time.

While this is not "new", what is striking about it is how rents have managed to rise well above inflation levels for a long time. There have been blips away the way, but the general trend is that rents are rising faster over time:

What I like about this reality is that it gives investors a clear way to "beat" inflation. With inflation rearing its head consistently over the past few years, finding assets that should appreciate during inflationary times is key. This can include commodities, precious metals, growth stocks, and, of course, rental REITs.

The obvious point here is that MAA has not done well recently. That is because "all other things being equal" is rarely the case. So while apartment REITs have benefited from rising rents, other headwinds have been too strong to overcome. But I see that changing in 2024 to a degree, while rents continue to rise faster than inflation. This is a favorable environment for MAA - and a host of other apartment REITs across the country - so I feel comfortable upgrading my rating here.

MAA's Vacancy Rate Beats The National Average

I mentioned earlier that MAA is one of my preferred apartment REITs. So while I am a bull on the sector as a whole, MAA has long been one of my favorites in the space (and the only one I currently own). So let's examine why that is.

A key reason why has to do with occupancy. MAA has a clear edge compared to the national averages. For example, the current rental vacancy rate, according to the US Census Bureau, is above 6%:

While not alarmingly high by any means, MAA's occupancy rate is above 95%. This has been the case for a while, meaning its vacancy rate is below the national average:

The conclusion I draw here is that MAA is an above-average operator in the rental market in terms of bringing in new renters and getting them to stay. With rental growth remaining positive due to growing populations, inflation, and tight inventory, I favor apartments REITs as a whole in 2024. With MAA registering strong numbers in the occupancy category, it serves as a reason to choose this REIT over others.

MAA's Market Presence Remains Hot

Expanding on the prior paragraph, one of the reasons for MAA's resilient occupancy levels has to do with where these properties are located. I won't go in to a ton of detail here because I have harped on this point in most of my reviews covering MAA for several years. But it is a point to emphasize again because the trend remains in place and the trend is your friend (if you own MAA).

What this centers around is where MAA does most of its business. Geographically this is the southeast and southwest, with top states being Georgia, Texas, Florida, and North Carolina, as shown below:

For those who haven't been following national migration trends this decade, you can see clearly that MAA's footprint coincides quite nicely with the states/regions that people are moving to. Similarly, the company doesn't do business in states like New York or California that have seen big outflows of residents:

The net result here is that national trends are playing right in to the hands of property landlords like MAA. The good news is this is not a trend that is slowing down or going to reverse any time soon - if anything it will accelerate in the years to come! As a former New Yorker living in the Carolinas, I can attest first-hand to the attractiveness of the southeast in comparison and it seems that every day more people are waking up to that fact. As an investor, this is central to why I believe MAA belongs in my portfolio.

If Interest Rates Stay Elevated, MAA Will be Fine

Digging in to MAA's financials, another core element that is favorable for investments is the company's debt structure. Fortunately, MAA has locked in mostly fixed-rate debt, with maturities ranging through the next decade:

This is an overall positive for a few reasons. One, it shows that MAA is properly diversified in terms of debt maturity. Two, if interest rates remain elevated (or go higher next year), MAA does not have a large percentage of its debt coming due in that timeframe. It can absorb a higher cost of borrowing on a small share of its profile - which may not even happen anyway. This shows me that management has prepared well for a higher-for-longer environment and will be able to ride it out going forward.

This helps to amplify the disconnect between how MAA has performed in the stock market and how its underlying performance has diverged. While higher rates have punished "REITs" in 2023 - sometimes it wasn't very justifiable. MAA wasn't really hurt as a company by higher borrowing costs because it had plenty of debt locked in at low, fixed-rates that wasn't due to mature for a while. Still, investors fled this sector without being as discerning as they should have been given this fact. That opens up a good buying opportunity for investors who dig a little deeper and explains why I believe a "buy" rating makes sense going forward.

Bottom-line

Real Estate as a whole has been a downer this year, but has recently begun to turn the page. Even after the recent surge in the sector, performance has contrasted widely with the S&P 500:

This signals to me some value in the broader Real Estate sector, but I still believe investors need to be more selective than just buying a "real estate" ETF. For example, I believe the office REIT sub-sector will continue to be challenged by a softening labor market and an emphasis on remote and hybrid work models. Similarly, retail REITs continue to be plagued by e-commerce and that multi-decade trend is not changing.

By contrast, apartment REITs are poised to deliver. Rent growth is strong and MAA's geographical presence exposes it to the faster growing areas of the country. As an added bonus, the Fed has likely ended its rate-hiking cycle, and that typically bodes well for REIT investors:

With history supporting the sector's outlook, a reasonable debt structure, and migration trends that favor the company, I see a buy argument to be made for MAA. As a result, I am upgrading this REIT to "buy" and I suggest that my followers give the idea some consideration as we begin 2024.

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