CA - Want A Residential REIT With A 6% Yield? Dream On

Summary

• This REIT IPO'ed in May 2022 and has not been welcomed by this market.
• We reviewed the inaugural financial results to assess what went wrong.
• It leads in terms of yield and would make a good addition to any portfolio.

Dream Residential REIT ( DRR.U:CA ) owns and manages over 16 “garden-style” properties in the United States. Their $410 million, 3,432-unit portfolio is mainly concentrated in the Sunbelt and the Midwest Regions of the country.

A “garden-style” property basically comprises several low-rise buildings, typically four floors or less, housed in one common area. Dream Residential started operations this year and at the end of June had an over 95% weighted average occupancy over its 16 properties.

Dream Residential’s IPO was in May with 9.62 million units priced at $13/unit. Perhaps not the best time to come into the market, and that has reflected in the stock price. About 80% of the proceeds from the issue funded the purchase price cash component of the 16 properties.

Dream DRR Asset Management LLC and Pauls Realty Services, LLC function as the managers of the properties, with an initial contract of ten years, and an option to renew for a further five. The base management fees are 0.25%/month of the purchase price of the properties, along with incentives tied to the funds from operation or FFO. They also receive fees related to the capital expenditures, acquisitions and any services provided for financing transactions. The two managers combined owned 21.4% of the REIT at the end of Q2. Dream Asset Management is owned and controlled by Dream Unlimited ( OTCPK:DRUNF ) ( DRM:CA ). If that name sounds familiar, it is because they had delivered one of our best performing REITs a few years back.

Performance

We compared its performance over the last few months with a few of its peers in the US, namely, Mid-America Apartment Communities, Inc. ( MAA ), BSR Real Estate Investment Trust ( HOM.U.CA ), and Independence Realty Trust, Inc. ( IRT ). We also added Boardwalk Real Estate Investment Trust ( OTCPK:BOWFF ) and Canadian Apartment Properties Real Estate Investment Trust ( OTC:CDPYF ), a couple of Canadian residential REITs to the mix. Our protagonist did not have a very great start, we must say.

Q2 Financial Results And Metrics

The inaugural FFO came in at 9 cents per unit for the two months that the REIT was in existence. The consensus analyst expectation for adjusted funds from operations or AFFO for 2023 is around 60 cents. Trading at around 12 times forward AFFO estimates, this REIT is one of the cheapest in the market compared to its peers. For example, Boardwalk is trading at 18X, while BSR is trading at 15X forward AFFO estimates. We also think the other two are relatively weaker here compared to the growth prospects from Dream Residential.

In a stroke of genius, the REIT started off with only fixed rate debt, about 18% of which matures in 2025. The weighted average term to maturity is 6 years with the weighted average interest rate coming in at 3.95%.

The management was off to a great start with that decision when we look at the risk-free rate below.

Realistically, that same debt would cost the company at least 6% today. The longer term lock helps the company navigate these troubled waters with ease.

The REIT intends to target and maintain a net total debt-to-net total asset ratio in the range of 35%-45% and was well under that in its first two months of operation.

Verdict

The dream team appeared to have done everything right while adding this residential REIT to its family and the initial months of its operations. Still the market was not too impressed, and it is trading at an over 50% discount to its $14.43 NAV. While Dream calculated this NAV using a weighted average capitalization rate (cap rate) of 4.9%, the market is nowhere close to that and is pricing it at an implied cap rate of 8% which is quite a bit more than its peers. For example, Mid-America and Boardwalk are priced around 6%. This is a huge discount for the REIT which has the lowest debt to asset ratio and pretty much no refinancings for the next 30 months. Dream is very cheaply traded and leads in the yield it provides to its investors (6%) which is the highest in its peer group. We like the management, and it always has skin in the game. Note the 18 different public market buy transactions by 6 different insiders.

If it even trades a bit higher from its current 12X AFFO to 14X AFFO or the cap rate gap closes, we get to a price of $8.40. That combined with its yield and the expectation of a reduction in cap rate, makes it a good buy for any portfolio.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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