2023-03-20 11:33:47 ET
Summary
- Independence Realty Trust owns a large portfolio of multifamily communities, located primarily in the Sunbelt Region of the U.S.
- About 75% of their portfolio is Class-B communities. These properties cater to renters across the income spectrum.
- A significant renovation pipeline provides clear visibility to future earnings potential.
- At current trading levels, shares offer prospective investors an upside potential of at least 30%.
Independence Realty Trust ( IRT ) owns and operates 120 multifamily communities totaling approximately 35,000 units.
Their operations are concentrated in the Sunbelt region of the United States, with greater exposure to markets within Atlanta, Georgia and Dallas, Texas. Together, the two regions represent over a quarter of their total net operating income ("NOI").
In 2022, the company expanded their same-store NOI margin by 160 basis points to 63.1% on the back of YOY same-store NOI growth of 13.7%. And for the year, they grew core funds from operations ("FFO") by 30% to $1.08/share.
Looking ahead, management sees core FFO landing in the range of $1.12 to $1.16/share for 2023. At the midpoint, this would represent YOY growth of approximately 5.6%. The increase is expected to be due in part to 6.5% growth in NOI at the midpoint.
Similar to other multifamily operators, IRT is down on both a YTD basis and over the past year. YTD, they are down nearly 7%. This adds to their one-year losses of approximately 40%.
The losses, which are generally on par with their peers, stand in contrast with their strong long-term track record. Over the past five years, for example, shares have returned over 70%. And over the past three, they are up about 40%. This significantly outperforms their peer set.
In a more recessionary operating environment, IRT's properties stand to gain due to their embedded value proposition that is a draw to both higher and lower income renters. Additionally, a significant renovation pipeline also figures to be a key driver for future earnings growth. Organic growth, as well as continued recycling, should also further reduce overall leverage levels. For investors, shares in IRT have pulled back to an attractive enough trading level for new initiation, in my view.
Strong Market Fundamentals
About 70% of IRT's NOI is derived from states within the Sunbelt region of the U.S. Over the past several years, these states have benefitted from favorable migration trends due in part to their lower cost of living and growing economic opportunity.
According to the U.S. Census Bureau, six states representing approximately 60% of IRT's NOI reported the highest net domestic migration gains in 2022. These states include Florida, Texas, North and South Carolina, Tennessee, and Georgia.
Furthermore, compared to both national and gateway markets, such as New York, Washington DC, San Francisco, and Los Angeles, IRT's markets have exhibited outsized population growth over the past several years.
In 2022, for example, the total population in IRT's markets, according to CoStar's ( CSGP ) 2022 data release, was 2.30% higher in relation to 2019 levels. This compares to a national average of 0.68% and a loss of 1.30% in the gateway markets. It's also worth noting that the gains in 2022 came on gains of 0.84% and 1.51% in 2020 and 2021, respectively.
In addition, IRT's markets also benefit from more favorable employment trends. In 2022, employment in their markets was up nearly 4% compared to 1.33% and a loss of 0.36% nationally and in gateway markets, respectively. The gains in the current year also follow losses in the prior two years that were significantly lower than their comparative markets.
More Affordable Housing Option
About 75% of IRT's portfolio is Class-B communities. These properties generally tend to be value driven. Compared to new apartments in 2022, for example, IRT's rent was 25% lower. This equates to about $6,000/year.
In addition, the properties cater more towards younger, middle-class residents. This includes those in their mid-30s with an average annual income of approximately $86,000. Based on current portfolio rents, this represents a rent to income ratio of approximately 22%.
During recessionary periods, therefore, the Class-B characteristic can prove to be a key competitive advantage. In a downturn, it would be more likely, and even expected, for higher-income residents to trade down as their rent burden increasingly outstrips their income growth.
Likewise, as lower-income residents move up the income ladder, they are more likely to trade up a notch from more C-Class properties. In addition, senior citizens looking to trade out of homeownership are also more likely to favor IRT's properties, due to their value proposition.
In the current market environment, the dynamics present a goldilocks scenario to IRT. For one, higher-income residents are increasingly feeling the impacts of the inflationary environment. This is causing many to trade down in goods and services. At the same time, however, lower-income workers have experienced outpaced wage growth than those in more professional sectors, causing a growing share of these workers to trade up in consumption.
Upside In The Renovation Pipeline
The Class-B nature of IRT's properties presents a sizeable value add opportunity to renovate existing communities/units where there is the potential for outsized rent growth.
In 2022, IRT realized a 24.1% return on investment ("ROI") on the renovation of over 1,400 units. This was well above their historical rate of 19.6%.
To date, the company has incurred total costs of approximately +$70M in their value-add program. Based on their historical ROI, this would represent an incremental NOI of approximately +$13.9M.
On a presumed 4.5% cap rate, this would signify about +$240M of value creation, net of their capital investment. On an assumed share count of 230M, this would be about $1.05/share in funds.
At present, the company has over 4,600 units remaining in their renovation pipeline in their current in-place program. And in 2023, they expect to start on another 2,600 units. Combined with their future pipeline, which is seen at 12,000 units, this would total about 19,000 units.
Based on historical return rates, this pipeline provides approximately +$900M of potential value creation.
Continuing Decline In Total Leverage
On December 31, IRT had approximately +$16M in unrestricted cash and about +$335M in availability on their revolving credit facility. In addition, they are consistently generating positive operating cash flows, which continues to exceed their burden for capital expenditures.
In 2021 and as late as Q3FY22, IRT was reporting net debt levels in relation to adjusted EBITDA in the 7x range. That had since fallen to 6.9x at the end of 2022, ahead of their year-end target in the low 7s.
Contributing to the declines was recent disposition activity. In Q4, for example, the company sold two properties for +$99M, representing a cap rate of 4.5%. In addition, subsequent to year-end, they locked in another sale at an expected cap rate of 4.8%, though that was pending close at the date of their release.
Overall, in 2023, IRT is expecting total leverage to be in the mid-6x range. The lower degree of leverage is due in part to no assumed acquisitions and an expected disposition volume of between +$35M and +$40M.
The lower leverage would further strengthen their balance sheet, which is already de-risked due to a high degree of fixed rate holdings and a favorable ladder with limited near-term maturities.
Final Thoughts
Though IRT reported strong growth in earnings in 2022, the company did report a notable decline in occupancy levels.
A base that is more geared towards middle-income residents was certainly one aspect of this decline due to IRT's continuous push on rents throughout the year. Part of the decline, however, was also due to downtime associated with their value-add activities. On average, their properties are offline for approximately 30 days at the start of each renovation.
Despite the occupancy decline, IRT's properties still provide an attractive value proposition. In a recessionary environment, this could prove to be a key competitive advantage as renters increasingly trade down to middle-tier properties.
For investors, there is clear upside potential in IRT. Presently, shares are currently trading at an implied cap rate of about 6.8% and are commanding a forward multiple of just 13.6x, the midpoint of their FFO range for 2023. For perspective, the company realized disposition proceeds at a cap of about 4.5% in 2022. While some expansion is expected for future disposals, valuations above 5.5% seem excessive.
The company also has a sizeable pipeline of future renovations. These projects are expected to create +$900M in incremental shareholder value. This is nearly $4.00 on a per share basis. In addition, leverage has already fallen a few turns over the past year and is expected to fall even further in 2023. The savings on future interest could provide a further boost to per share earnings growth.
At $20/share, IRT would trade at a forward multiple of 17.5x and would have an implied cap rate of about 5.8%, which is still on the high side. Yet, the share price would still indicate an upside potential of nearly 30% from current levels. At a moderate level of risk, this presents an attractive opportunity for market-beating future returns, in my opinion.
For further details see:
Independence Realty Trust: An Affordable Multifamily REIT