2023-11-06 04:11:10 ET
Summary
- UDR's stock has fallen 14% YTD, underperforming its coastal apartment REIT peers as investors are concerned about its sunbelt exposure in the face of elevated supply.
- The market is concerned about UDR's exposure to sunbelt markets, but I see this headwind becoming a tailwind as new supply is set to plummet once we get beyond 2024.
- UDR trades at a significant discount to my NAV estimate and I believe it is priced to deliver 17% annualized returns over the medium term.
- With a pristine balance sheet, I consider UDR to be a very low-risk investment for long-term investors.
- Given what I believe to be an exceptional risk/return tradeoff, UDR is a top-five holding in my portfolio.
Shares of apartment REIT UDR ( UDR ) have been battered lately, falling nearly 14% year-to-date and significantly underperforming coastal apartment REIT peers like AvalonBay ( AVB ) and Equity Residential ( EQR ). While the market is concerned about UDR's greater exposure to sunbelt markets which represents 26% of NOI compared to sub-5% for AvalonBay and Equity Residential.
As we sit today, UDR trades at an implied cap rate of 6.5% which is slightly cheaper than Equity Residential (6.3% implied cap rate) and at a significant discount to AvalonBay (5.8% implied cap rate). Meanwhile while stock market investors are punishing UDR for its greater sunbelt exposure, both AvalonBay and Equity Residential have recently spent hundreds of millions to buy sunbelt apartments at a premium to their own valuations (discussed below).
With new supply set to abate once we get into 2025, a pristine balance sheet, and significant upside to my NAV estimate, I consider UDR to be an exceptional risk-reward. As such, I have made it a top 5 position in my portfolio.
Recent Results
UDR recently disappointed the market when it reduced FY2023 same-store NOI growth guidance by 0.75% to 6.75%.
UDR 2023 Full Year Guidance (UDR 3Q23 Quarterly Supplemental Report)
As shown below, the main culprit is softness in new lease growth which turned negative in some markets during 3Q23 due to new supply negatively impacting sunbelt markets (Texas, Florida, Nashville) as well as continued softness in San Francisco and Seattle.
3Q23 Rental Performance by Market (UDR 3Q23 Quarterly Supplemental )
With 26% of its NOI coming from sunbelt markets, the market is worried that continued elevated levels of apartment deliveries throughout 2024 will lead to further disappointments.
UDR Regional NOI Composition (UDR Investor Presentation)
Looking Beyond 2024
While it is certainly true that 2024 is set to see continued high levels of new supply in the sunbelt, the picture looks quite different when one looks into 2025 and beyond. New apartment permits/starts are declining significantly due to a lending pullback by regional banks (following bank failures in March/April), higher interest rates, high construction costs and limited enthusiasm by merchant developers given tough sales environment.
As shown above, Camden ( CPT ) CEO Ric Campo noted that he expects the number of apartment units developed to decline by nearly 65%:
Camden CEO Supply Commentary (3Q23 Earnings Transcript from Seeking Alpha)
Similarly, housing consultancy John Burns Research & Consulting recently shared survey results from 56 large apartment developers and investors showing a significant expected decline in new supply:
Apartment Supply Expectations (John Burns Research & Consulting)
A significant decline in supply coupled with a continuation of the long-term (50+ year) trend of sunbelt population growth is likely to lead to outsized rent and NOI growth in 2026 and 2027. Interestingly, both AvalonBay and Equity Residential acquired sunbelt apartments over the past few months. Avalon paid $275 million to buy three apartment assets in Dallas and Charlotte at a cap rate in the mid 4s (a huge premium to its own valuation & where UDR trades).
AvalonBay Property Acquisition Commentary (3Q23 Earnings call transcript from Seeking Alpha)
Similarly, Equity Residential acquired two apartment assets in the sunbelt market of Atlanta for $180 million which equates to a low 5s cap rate (again a significant premium to its own valuation as well as UDR):
Equity Residential Investment Activity (3Q23 Quarterly Supplemental )
To me, these purchases by Equity Residential and AvalonBay indicate that they believe sunbelt supply issues are temporary and better times are ahead.
Valuation
As we sit today, UDR trades at an implied cap rate of 6.5% which ranks among the cheapest of the multifamily REITs:
Apartment REIT Valuation Comparables (Company Filings; Author Estimates)
As you can see, despite deriving 74% of its NOI from coastal markets (which face limited supply), UDR trades more in line with sunbelt apartment REITs Camden and Mid-America ( MAA ) which are suffering the wrath of investors due to the near-term supply concerns discussed above.
Moreover, UDR trades at a massive discount to prices recently paid by AvalonBay and Equity Residential for sunbelt assets. Similarly all the apartment REITs are trading at discounts to a broader set of recent private market transactions. As shown below, CBRE's ( CBRE ) recent apartment investor survey shows that 3Q23 transaction cap rates for Prime Class A apartments (44% of UDR's asset base are considered Prime Class A, remainder are Class B) were sub 5% (Class B cap rates are estimated to be ~50 basis points higher):
3Q23 Apartment Investors Underwriting Assumptions (CBRE)
Assuming 3% annualized NOI growth from now until 2024-27 (lower in 2024, higher in 2026-27) and assuming a 5.3% cap rate I get to a 2027 fair value estimate of $53 per share. Taking into account dividends received (current dividend yield is 5%) along the way, this works out to an annualized return just above 17% over the assumed four-year hold period. My 5.3% cap rate assumption is a the midpoint of UDR's historical 4-6.6% range and is in line with the cap rates (takes A/B mix into account) suggested by the CBRE survey above.
I consider the 17% expected medium-term (4 year) return to be very attractive, particularly given the low level of fundamental risk here. UDR has a very strong balance sheet with a Loan-to-Value below 35%, net debt to EBITDA below 5.5x, a weighted average debt maturity of 6.3 years (at just 3.3%), and over $1 billion in available liquidity.
Conclusion
While there are nearly certain to be some ugly near-term headlines, I see UDR as an exceptional risk/reward tradeoff for long-term investors. It is a top 5 position in my portfolio.
For further details see:
UDR: Short-Term Ugly, Long-Term Beautiful