2023-08-04 03:05:27 ET
Summary
- Mid-America Apartment Communities is a Sunbelt multifamily pure-play.
- The company has one of the best balance sheets of all REITs and has seen a tremendous quarter with double-digit YoY growth.
- I present my buy thesis and suggest an alternative Sunbelt REIT.
Dear reader/followers,
Mid-America Apartment Communities ( MAA ) is a Sunbelt pure-play residential REIT. I've covered the company before in my article here and issued a buy rating expecting a high single-digit total return over the next three years.
Since than a couple of things have happened:
- The stock has underperformed falling by about 10% from $163 to $146
- MAA has reported Q2 2023 earnings
- And I've done a lot more analysis on the comparison between legacy markets and the Sunbelt
The conclusion I came to, is that despite the sentiment, REITs with properties in legacy coastal markets might be just as well positioned as its Sunbelt peers, at current valuations.
Today I want to clarify my thesis for residential REITs in the US and present the investment case for MAA.
Coastal markets vs Sunbelt
It's no secret that the Sunbelt has become very popular for investors over the past couple of years and has seen an influx of people and jobs moving in.
At the same though, new construction of A-Class apartments has picked up to a new all time high. Each year, inventory in the Sunbelt grows by 5%, which is more than double that of coastal markets, which add less than 2% to inventory each year.
Critically, the 5% is significantly above job and population growth which are both expected at 1.3% this year, according to MAA itself.
This leads me to believe that some markets in the Sunbelt (particularly Texas) are at risk of over-supply of A-Class apartment space. I simply don't see how the market can absorb a 4-5% annual increase in inventory with sub-2% population and jobs growth.
The situation in Coastal markets, is a little different, since new supply is low, around its historical average levels of 2% per year and is even expected to drop as completion starts between 2022 and 2023e are down 35%.
EQR Presentation, established markets means markets where EQR operates i.e. both coasts
With sub-2% new supply until at least 2025 (new starts give 2-3 year visibility), Coastal markets don't need nearly as much demand to absorb this. Using MAA's numbers, of 0.4% for population growth and 0.9% for jobs growth, it's easy to see which market is at a higher risk of over-supply.
The Sunbelt currently seems to be building about 3% more each year than it can absorb, while this number stands at just 1.5% in Coastal markets.
On top of this, consider this:
- California remains by far the #1 spot for tech with AI related investment four that of the rest of the country combined
- Recent earnings of Equity Residential ( EQR ) which is a coastal REIT, reveal that New York is currently seeing some of the highest rent increases and occupancy of all markets
All things considered, it seems that the market has got this right and currently values Coastal REITs at slightly higher multiples than its Sunbelt peers, as:
- Sunbelt REITs (MAA and CPT) trade at an average P/FFO of 16.3x
- Coastal REITs (AVB, EQR and ESS) trade at an average P/FFO of 17.6x
In conclusion, I think that the lower multiple justifies the higher over-supply risk which could somewhat negatively impact future rent growth in the medium-term. Therefore, based on the data, there's currently not a clear winner between both markets and it can make sense to diversify between the two.
Q2 Results
As for most residential REITs, second quarter results have been great, especially in terms of rent growth.
The REIT has growth its overall NOI by 8.6% YoY and maintained a 95.5% occupancy. As a result core FFO pre share has increased by double-digits YoY to $2.28.
Following a strong quarter, management has increased their guidance for NOI growth for the year by 5 bps to 6.35% at midpoint. As a result, core FFO guidance has increased ever so slightly to $9.14 per share at midpoint, which represent an 11.4% increase over 2022 numbers.
The company also maintains one of the best balance sheets of all REITs. It has an A- rating and a historically low debt to EBITDA of 3.4x. All of the debt is fixed at an average rate of 3.4%. They do have one debt maturity of roughly $350 Million in the fourth quarter of this year. Management's plan is to be patient and wait for credit markets to stabilize before refinancing. I'm ok with that strategy and generally see refinancing risk for MAA as extremely low, given their rating and $1.4 Billion in liquidity between their cash and credit line.
Valuation
From a cap rate perspective, MAA trades at about a 20% discount relative to the market with the caveat that the investment market has been very slow with only a hand full of deals. But frankly I expect the market cap rate to continue to expand for one or two more quarters.
Second quarter NOI came in strong at $340 Million which means that the stock now trades at an implied cap rate of 6.3%. That's safely above the average buyer cap rate during the quarter of 4.9% as reported by management on the earnings call.
Relative to peers, the company's P/FFO of 16.7x (15.6x on a forward basis) is reasonable. Camden Property ( CPT ) trades lower at 15.8x, but MAA likely deserves a premium due to a superior (better rated) balance sheet with less leverage.
All things considered, I don't see MAA returning to 30x FFO that we say in late-2021, perhaps ever. But I think that the company deserves to trade around 17.5x FFO, as it has on average historically since 2010.
At 17.5x FFO, if management delivers on the growth forecast, the 2025 price target stands at $170 per share, representing around 9% total annual return over the next two and a half years. This leads me to reiterate my BUY rating for the stock here at $143 per share.
Bottom line
Investing in MAA makes sense at this level, but there's one REIT in the Sunbelt, which I like more. I'm talking about a Canadian-based BSR REIT ( HOM.U:CA ) which focuses exclusively on B-Class properties in growing Texan markets. The fact that it owns B-Class is a game changer, because it means significantly lower risk of over-supply and higher demand during an economic downturn as people search for properties with cheaper rents. The investment has been discussed in great detail in High Yield Landlord.
For further details see:
Mid-America Apartment Communities: Attractively Priced With A Fortress Balance Sheet