2023-09-29 07:00:00 ET
Summary
- The housing market has remained resilient despite elevated interest rates, and rents have been rising steadily.
- Apartment REITs, such as AvalonBay Communities, AIR Communities, Camden Property Trust, and Essex Property Trust, are undervalued and present good investment opportunities.
- These REITs have strong balance sheets, liquidity, and growth prospects, making them attractive for investors.
This article was coproduced with Cappuccino Finance.
Frank Williams was a Wall Street writer in the 1920s, and he was legendary for writing on the topic of speculating.
“Men and women certainly should not speculate until they have paid the landlord, the butcher, and the tailor. They should have no doctor’s bills or insurance premiums overdue.”
I like how he put the landlord first.
We all know shelter is a critical part of life, and having a head over our head is what helps us sleep well at night.
However, with the Federal Reserve’s interest rate hikes and big tech layoffs, the housing market has been jittery these past several quarters.
These uncertainties have resulted in dropping prices for stocks that are related to the residential housing market.
Some of the best companies in the sector have been suffering, and Apartment real estate investment trust, or REITs, were no exception to the trend.
Consumer Price Index for the Rent of Primary Residence from FRED
Many economists and real estate experts have been expecting the housing market to crash, however, the housing market has stayed surprisingly resilient so far in 2023.
Rents have been rising steadily , even though at a slower pace compared to the post-pandemic peak.
As the Federal Reserve has been hinting that it's close to the end of interest rate hiking era, the sentiment around the housing market has improved and is creating good opportunities for investors.
It's too early to call the end of the bearish market, but it's a great time to look at these apartment REITs that are undervalued at this point and have great prospects.
They have a strong balance sheet, capital structure, and liquidity to get through rough patches of time, and have operating ability to carry out their future growth plan. This article pairs well with our recent article on multifamily real estate.
AvalonBay Communities, Inc. ( AVB )
AvalonBay Communities is a REIT that develops, acquires, owns, and operates multifamily apartment communities in leading metropolitan areas.
They focus on the areas that historically have been characterized by growing employment of high wage sectors, higher cost of home ownership, and vibrant quality of life.
The executives of AvalonBay strongly believe their strategy has been offering, and will continue to offer, opportunities for superior risk-adjusted return over the long-term investment horizon.
During the latest earnings call , management was excited to raise their guidance for the second time this year. They mentioned that their outperformance was primarily driven by increasing revenue with the same-store revenue growing 6.3% (110 basis points above their expectation).
I expect this growth to continue well into the future, as AvalonBay is expected to deliver an additional 3,600 homes over the next 6 quarters.
With most of their development communities in early lease-up or not-yet-open stages, I have high expectations for their future earnings growth, incremental NOI growth, and NAV creation when the new developments are complete.
Additionally, their strong balance sheet (S&P rating of A-) with solid liquidity ($3 B) gives me peace of mind about their stability and ability to finish their planned projects.
Looking at their valuation metric, AvalonBay is undervalued at this point. The current P/AFFO (18.45x) and P/FFO (16.81x) are substantially lower (about 19% lower) than their 5-year average.
Also, we give AvalonBay a Buy rating with a margin of safety at 19% . It's a great time for investors to take a look at this high-quality REIT.
Their dividend (yield of 3.60%) is safe, shown by the FFO payout ratio of 62.39% and the AFFO payout ratio of 68.39%.
Apartment Income REIT Corp. ( AIRC )
AIR Communities is a REIT that owns and operates stabilized multi-family properties located in top markets (Boston, Philadelphia, Washington, D.C., Miami, Denver, Bay Area, Los Angeles, and San Diego).
Their management team aspires to create an efficient and effective way to invest in U.S. multi-family real estate through a simplified business model, diversified portfolio, stabilized apartment communities, and low leverage.
Also, they follow a paired trades strategy (disposing an older property to acquire a new property with higher growth prospects) that has greatly contributed to their portfolio and earnings growth.
Based on their latest investor presentation , the expected growth for 2024 is strong. The same store revenue growth is expected to be around mid-single-digit based on
1) earn-in from 2023 leasing activity and loss-to-lease data,
2) higher average daily occupancy,
3) improvement on bad debt,
4) incremental contribution from earlier acquisitions, and
5) contribution from capital enhancement.
Management is targeting ~5.5x Net Leverage to EBITDAre ratio by the end of 2024, and their $2.3 B liquidity is 3 times that of their peer average. Their refinancing schedule is also well spread over the next several years.
Looking at their valuation metric, AIR Communities is under-valued at this point.
The current P/AFFO ratio of 14.25x and P/FFO ratio of 13.00x are 26% lower than their historical value. It's not surprising to see we give AIR Communities with a "Strong Buy" rating with a margin of safety of 38% .
With a high dividend yield of 5.50% and investment grade balance sheet, AIR Communities presents a great opportunity for dividend-oriented investors.
Camden Property Trust ( CPT )
Camden Property Trust is a REIT that is primarily engaged in the ownership, management, development, reposition, redevelopment, acquisition, and construction of multifamily apartment communities.
They try to maximize capital appreciation of their portfolio by investing in markets characterized by conditions favorable to multifamily property appreciation. These conditions are
1) strong economic growth leading to household formation and job growth and
2) an attractive quality of life with various high-quality amenities.
Based on their latest earnings call , Camden reported core FFO of $1.70 per share, which was $0.02 ahead of the midpoint of their previous guidance.
One great contributor to this strong result was the impressive performance of Camden Tempe 2 (397-unit, $107 M community in Phoenix). Camden Tempe 2's rents are approximately 10% higher than that of pro forma, and the property is stabilizing well ahead of schedule.
Camden's balance sheet is in great shape, and their strong liquidity, well-managed debt maturity schedule, and strong credit ratings provide peace of mind for investors.
The weighted average interest rate on their debt is at 4.2%, and the weighted average maturity of their debt is at 6.1 years. Camden's credit ratings stand at A3 (Moody's), A- (Fitch), and A- (S&P).
Looking at their valuation metric, Camden's property trust is undervalued at this point. Their current P/AFFO ratio of 16.49x and P/FFO of 14.24x are 33% lower than their historical average, which presents a great opportunity for the investors.
We rate Camden a "Strong Buy" with a margin of safety at 26% .
Given their robust growth prospects, solid balance sheet, and portfolio management, I believe Camden will continue to reward their investors. Their dividend (yield at 3.90%) is safe with an FFO payout ratio of 57.27% and an AFFO payout ratio of 65.15%.
Essex Property Trust, Inc. ( ESS )
Essex Property Trust is a REIT that owns, operates, manages, acquires, and develops the apartment communities in the West Coast of the United States. Essex is a proud member of the S&P Dividend Aristocrats.
They have increased their cash dividend for 29 consecutive years, with 453% cumulative dividend growth and 4,789% total shareholder return since their IPO in 1994.
Through their disciplined capital allocation, Essex has been outperforming their peers in core metrics like Same-Property NOI Growth, Core FFO per Share Growth, and Dividend Growth.
Essex has a strong balance sheet with ample liquidity. Their debt maturity schedule is very well spread over the next several years with the weighted average interest rate of 3.3%. Their Net Debt to Adjusted EBITDAre ratio is at 5.6x, and their total liquidity is at $1.7 B.
Essex has an investment grade credit rating from Moody's (Baa1) and S&P (BBB+) with a stable outlook. This strong capital structure gives peace of mind to investors who are looking for safe investment opportunities with their hard-earned money.
During their latest earnings call , the management team raised their 2023 guidance, and they mentioned that the strong performance demonstrates the underlying strength of the West Coast economy and their operating strategy.
Reflecting the resilient of the economy and labor market that has surpassed their initial forecast, Essex management raised their expectation for average market rent growth by 50 basis points.
Essex achieved a core FFO per share of $3.77, and it was $0.08 per share higher than the previous midpoint guidance range.
With these favorable year-to-date results, management increased their full year midpoint of their same-property revenue growth by 40 basis points to 4.4%.
Looking at their valuation metrics, Essex is undervalued at this point.
Their current P/AFFO ratio of 16.64x and P/FFO ratio of 14.35x are 19% lower than their historical average. Given their solid outlook and strong balance sheet, I believe Essex's stock price will recover in the future.
We rate Essex a "Strong Buy" opportunity with a margin of safety of 28% .
The dividend yield is solid at 4.10%, and their dividend payment is safe with an AFFO payout ratio of 70.67% and FAD payout ratio of 61.29%.
In Summary
Finally, inflation has been showing signs of calming down.
It is certainly not at the level that we want (below 2%) yet, but it certainly seems like the worst has passed.
Accordingly, the Federal Reserve is hinting that the interest rate hike cycle is near the end, and, at least at the moment, the talks of severe recession are subdued.
I don't think that we are completely out of the woods yet at this point, but I certainly think that the investors can be more aggressive about picking up shares of their favorite stocks at favorable prices.
These four Apartment REITs are examples of great long-term investment at bargain prices.
They focus on markets that should produce strong long-term growth in their portfolios, and they have strong balance sheets to get them through the near-term economic uncertainties. Investors should pay close attention to these REITs!
For further details see:
You Gotta Pay The Landlord First