… Thus The Apartment REIT Rally Began


The batch of housing REITs we’re going to discuss in this article is shown below:

Symbol Company Name Subsector AFFO Multiple Div Yield Price Price to NAV
(CPT) Camden Property Trust Apartments 23.19 3.37% $98.38 0.94
(MAA) Mid-America Apartment Communities Inc Apartments 21.31 3.24% $123.32 1.06
(NXRT) NexPoint Residential Trust Inc Apartments 19.55 2.78% $45.00 1.11
(ESS) Essex Property Trust Inc Apartments 19.06 3.71% $224.03 0.87
(AVB) AvalonBay Communities Inc Apartments 18.86 4.21% $151.15 0.81
(UDR) UDR, Inc. Apartments 18.83 4.17% $34.57 0.85
(EQR) Equity Residential Apartments 18.83 4.59% $52.53 0.77
(IRT) Independence Realty Trust Inc Apartments 17.97 3.74% $12.83 1.01
(BRG) Bluerock Residential Growth REIT Apartments 15.92 7.23% $8.99 0.80
(AIV) AIMCO Apartments 14.06 6.08% $26.96 0.57
(APTS) Preferred Apartment Communities Inc. Apartments 13.04 12.99% $5.39 0.62
(CLPR) Clipper Realty Apartments 10.06 6.95% $5.47 0.36
(ELS) Equity Lifestyle Properties, Inc. MH Park 31.38 2.21% $61.93 1.02
(SUI) Sun Communities Inc MH Park 27.06 2.24% $141.20 1.05
(UMH) UMH Properties MH Park 18.41 5.08% $14.18 0.88
(RESI) Front Yard Residential Corp Single Family Rental 35.24 0.00% $13.39 1.00
(AMH) American Homes 4 Rent Single Family Rental 27.44 0.70% $28.69 1.01
(INVH) Invitation Homes Inc Single Family Rental 25.10 2.14% $28.00 0.96
(ACC) American Campus Communities, Inc. Student Housing 21.60 4.85% $38.75 0.83

Before we get into the analysis, we have a few charts for readers. We begin with the dividend and AFFO yields:

Source: The REIT Forum

Most investors aren’t familiar with using AFFO as a yield metric, so we also can present it as an AFFO multiple. With only one bar for each REIT, we can utilize the colors a little more also:

Source: The REIT Forum

Note: AIV metrics are not necessarily reflecting the full impact of their recent ex-dividend date.

We find the price to NAV is another useful metric to include:

Source: The REIT Forum

Note: In this case, the ex-dividend for AIV is 100% absolutely not included and investors absolutely should not rely on the value. Expect analysts to take a bit to update their estimates for NAV, so the consensus estimates may be a bit off for a while. This wouldn’t matter much for a normal ex-dividend date, but AIV had a huge ex-dividend this morning (11/03/2020).

Analysis

The housing REIT sector has seen a particularly rough period this year. While most of the housing REITs had at least a reasonable recovery going into June, shares have weakened again. This is most notable in the apartment REITs, especially those with more coastal exposure.

Housing REITs can be a cornerstone for any dividend growth portfolio. The sector is an excellent fit for most buy-and-hold investors. The current plunge is similar to what we witnessed during the Great Recession. Weakening rents, higher vacancy, falling estimates for NAV (net asset value), and an incredible discount in the share prices. Despite the short-term pain, the sector rebounded dramatically over the years that followed.

We expect the same trend here.

Net Operating Income Growth Forecasts

Let’s consider the expected future growth rate in same-property NOI. We’re expecting one to two years of weakness, and we already are into the first year. Consequently, we think growth in NOI could turn positive around late 2021 or early 2022. That matches the forecasts Fitch is using for credit ratings. They provided the following chart of their assumptions:

Source

While Fitch doesn’t have forecasts for all of the apartment REITs, you can see a pretty strong correlation. You also can see that Equity Residential (EQR) should take the biggest hit in their numbers for 2020 and 2021, followed by the largest bounce in 2022 and 2023. Part of that huge bounce in the later years is because the baseline is being set so low.

We also need to highlight that these are full-year projections and Q1 2020 was averaged in with pretty solid figures. Consequently, the average results for Q3 2020 and Q4 2020 should be worse than the projections shown for 2020 overall.

We appreciate having the comparison using AIMCO, Camden Property Trust, Essex Property Trust, and Mid-America Apartment Communities. The only two major ones left are UDR (UDR) and AvalonBay Communities (AVB).

EQR

The results for EQR were slightly rougher than expected. Adjusted for taking a write-off, they would’ve been missing on Core FFO per share by only $.02 rather than $.05. Our review is summed up below:

Source: The REIT Forum

We still have a very bullish outlook on EQR. Shares dipped much harder than 3% the morning after earnings, though part of that dip is driven by the broad market declines.

Note: In line with our bullish forecast, EQR had a dramatic bounce back over the last two days.

Reviewing Our Quick Take

In our note to subscribers the night earnings were released, we highlighted two metrics.

The first metric was Q3 Core FFO (or “Normalized FFO”).

We said:

Q3 normalized FFO per share of $.77 falls short of estimates for $.82 by $.05.

Sounds like a pretty big in percentage terms, but we can break it down. EQR owns apartment buildings, but several of those buildings include a “non-residential” component such as a small format retail or a parking garage. The leases on that small format retail have longer terms and EQR would normally use “straight-line” accounting. This is the proper way to record the revenue under GAAP. In this quarter they determined that some of that rent was unlikely to be collected, so they adjusted their revenue. That flows through the income statement instantly, so the negative adjustment to revenues hit in Q3 2020. This hit alone accounts for $.03 of the decline in normalized FFO per share. That’s 60% of the “miss” ($.03 / $.05 = 60%).

The following image helps to explain how the value changed compared to Q3 2019:

Source: EQR

We’ve added the red text and boxes to highlight the thing most likely to be misunderstood. That was the hit to “Non-residential same-store NOI.” That’s the result of EQR’s write-off on a portion of their rent receivables.

The second metric was gross revenues.

We said:

Revenues of $622.4 million misses by $18.81 million.

Since this adjustment flows through revenue, it’s also a major factor impacting that miss on total revenue. It helps to know that around $9 million (rough estimate) of that is tied to the adjustment. So in this case, it represents somewhere around half of the miss in revenue. These are rough numbers, pulled from reading through the earnings release tonight.

So in the first case, about 60% of the impact comes from lease accounting. In the second case, about 50% of the impact comes from lease accounting.

To be fair, the results would still qualify as a miss going beyond the impact of the lease accounting. Consequently, we adjusted the price targets down by 3% tonight. The adjustment is already live in the sheets. Shares remain in the ‘Strong Buy’ range and are still one of the strong-buy range and compete with AVB and ESS for being deepest within that range. Each is between 77.7% and 78.8% of the target ‘Buy Under’ price, representing great deals on each.

The following image brings a little more light to that discussion:

Source: EQR. Red boxes and text by the analyst.

You’ll notice in the top half of the chart that the revenue recorded for the “non-residential” space in their portfolio was down 75.5% when comparing Q3 2020 to Q3 2019. That space didn’t become worthless overnight, a combination of weaker rent today and write-offs drove the quarterly rent metric down substantially. After the pandemic ends (or is more effectively controlled), we would expect a substantial portion of that revenue to come back online.

This is a material part of why EQR is seeing weaker performance on same-store NOI and why they should have a stronger bounce back in 2022 and 2023. The non-residential space only recorded about one-fourth of the prior amount of revenue (from Q3 2019). Sure, rent could dip, but down 75% isn’t realistic.

Adding to Our Position

Following EQR’s announcement, apartment REITs took a huge hit. We took advantage of the opportunity to add another position:

Source: Schwab

There’s something beautiful about including the screenshot for the transaction, as opposed to randomly claiming to have done something. As always, we issued a real-time alert for the trade as well:

Source: Real-time alert for subscribers (paywall)

Outlook

We remain bullish on the sector. We’ve been building up our exposure to the apartment REITs while most investors have been fleeing the sector. This is a great opportunity for high-quality REITs at attractive prices. The rally over the last two days has been disappointing in a way because it reduces the incredible discounts available for growing our positions. Investors seem to finally be recognizing the great discounts available on quality REITs.

Ratings:

  • Bullish on EQR, ESS, AVB, UDR

Our method works. We know because we buy the same shares we recommend. We track our results on a real portfolio and we compare our returns with the major ETFs for our sector:

Those four ETFs are:

  • MORT – Major mortgage REIT ETF
  • PFF – The largest preferred share ETF
  • VNQ – The largest equity REIT ETF
  • KBWY – The high-yield equity REIT ETF

Sign up now. Take advantage of our November sale!

Disclosure: I am/we are long AVB, EQR, ESS, SUI, ELS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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