Mid-America Apartment Communities Continues To Outperform

Summary

MAA is up over double digits since I last recommended it and is handily beating the broader market.

The Real Estate sector has benefited from volatility and the outlook for lower interest rates, which are both trends that are expected to continue.

The median rent charged nationwide has been rising since last year, boosting profitability for landlords, such as MAA.

Main Thesis

The purpose of this article is to evaluate Mid-America Apartment Communities Inc. (MAA) as an investment option at its current market price. MAA is a stock I have consistently recommended and its performance has not disappointed. In fact, while the broader Real Estate sector has done well over the past three months, MAA continues to lead the pack, delivering above-average market returns. Looking ahead, I see reasons to remain optimistic. One, the interest rate outlook is looking increasingly more dovish, which makes the above average yield offered by MAA even more attractive. Two, rental demand remains high, and housing affordability remains a challenge, especially for younger buyers. This has slowed the annual gains for home prices, while simultaneously allowing rents to push higher in the interim. Three, the underlying asset values for rental properties continues to rise, and year-over-year gains in this sub-sector are higher than the average for the Real Estate sector as a whole.

Background

First, a little about MAA. The company is a "real estate investment trust that focuses on the acquisition, selective development, redevelopment, and management of multifamily homes throughout the Southeast, Southwest, and Mid-Atlantic regions of the United States". MAA has ownership interests in over 100,000 operating apartment homes in 17 states and Washington DC. Currently, the stock is trading at $116.90/share and yields 3.28% annually, based on its last distribution. I have been bullish on MAA for some time and continued to recommend the stock when I covered it in March. Since then, MAA is up almost 13%, which is extremely strong short-term performance. Given this large move, I wanted to reassess the company to see if there is still value in buying shares now. While I am definitely more cautious this time around, given that the stock is resting at all-time highs, I still appreciate the long-term story in apartment rentals and believe further upside is possible.

MAA Is An Outperformer

To start, I want to illustrate how profitable an investment in MAA has been in the short term. While I mentioned its total return since my most recent review, it is important to put that figure in perspective in order to gauge how strong that really is. To do so, I compiled the 3-month returns of the S&P 500, two ETFs that track the performance of the Real Estate sector, and two other related companies who are also competitors. These include the iShares U.S. Real Estate ETF (IYR), the Vanguard Real Estate ETF (VNQ), Camden Property Trust (CPT), and Preferred Apartment Communities, Inc. (APTS), which are all in the graph below, along with MAA:

Source: CNBC

As you can see, while all of these Real Estate focused options bested the S&P 500 over the past three months, MAA is the resounding winner. It has markedly outperformed the broader market as well as the Real Estate sector as a whole, which is one of the top performing sectors this year.

With this in mind, it is important to stay grounded and recognize that such marked levels of outperformance are unlikely to persist for the longer-term. However, there are some key reasons why I think this bullish momentum is not finished yet, and I will discuss those below.

Landlords Are Winning

In my last review, I discussed housing affordability and how the drop in this metric was a positive for rental apartments. This was because I saw home affordability reaching a level where many potential buyers, especially younger adults who were currently renting, were going to be kept out of the housing market. The implication of this is that rental demand would remain high, providing pricing power for landlords.

In hindsight, this turned out to be very accurate, as housing demand has softened, while rental demand remains robust. The impact on the Real Estate sector has been a sharp uptick in median rent charged, while the gains to home prices have been declining, as illustrated in the graph below:

Source: Bloomberg

As you can see, the affordability factor has been having an impact on prices, and rental landlords, such as MAA have been profiting off this reality.

My takeaway here is that I see this trend continuing. While slowing gains to housing prices will help with affordability, home prices remain high. And while the gains are indeed slowing, prices are still rising year-over-year, at a faster clip than rentals. The gap is certainly narrowing, as the graph indicated, but it is going to take a continuance of this trend before we start to see a real shift in buyer behavior. Therefore, I continue to like the longer term story behind companies who own rental properties, such as MAA.

Underlying Assets Gaining In Value

My next point also has to do with the broader apartment rental sector, and not just for MAA specifically. The trend across most of the Real Estate sector for years has been increasing asset prices, and that has continued in 2019 as well. In fact, the All-Property Index was up over 6% in April, on a year-over-year comparison, as the chart below illustrates:

Source: Real Capital Analytics

As you can see, there have been healthy gains across the space, with even retail squeezing out a gain over 2%. Importantly, the Apartment index is up around 7%, besting the average for all sectors.

My takeaway here is this is positive for the companies within the space, such as MAA. While it is true that apartment gains are less robust than they have been over the past few years, the chart shows that these gains are still above-average, helping push up the value of the underlying holdings apartment REITs own. Couple this trend with rising rents, and companies like MAA are holding on to appreciating assets, while also increasing their revenue stream. This is a win-win scenario.

Q1 Results Were Impressive

I now want to shift gears to focus on MAA’s individual performance, which looked quite good based on Q1 earnings results. The results were roundly positive, showing that MAA has done a good job improving revenues, managing expenses, and increasing rents charged. After reviewing the most recent 10-Q, which came out in early May, I compiled some important metrics in the chart below:

Metric (thousands) Q1 2018 Q1 2019 YOY Increase Rental/Property Revenues $401,178 $386,017 3.9% Property Operating Expenses $272,166 $265,148 2.6% Net Income (available to common shareholders) $65,958 $50,820 29.8% Total Same Store Revenue $375,540 $366,971 2.3% Funds From Operations (FFO) $186,404 $169,609 9.9% Metric Same Store Occupancy 95.9% Same Store Average Effective Rent (Increase) 3.1%

Source: Seeking Alpha Financial Disclosures (10-Q)

As you can see, these numbers are solid. My primary takeaways are that MAA was able to grow revenues at a higher percentage than expenses, helping to boost net income. Furthermore, while opening multiple new units over the past year, MAA was able to keep its occupancy rate near the 96% mark. This is a positive figure and helps explain how the company was able to increase rents by over 3% year-over-year, which I had anticipated due to some of the reasons mentioned earlier.

In summary, these metrics show me that MAA is managing the business well and is building properties in areas where there is strong rental demand, helping to keep the occupancy high. With the housing market still expensive for first-time buyers, I only see these trends accelerating from here.

A Dividend Play To Combat Declining Interest Rates

A final point on MAA has to do with the current dividend, which I highlighted as a very positive attribute in my prior reviews. With the appreciating share price, the yield has come down quite a bit and now sits around 3.3%. Of course, I will take a declining yield all day if that means the share price is moving higher, and that is precisely what is happening in this case. Furthermore, MAA increased its dividend by over 4% this year, starting with its January distribution. The declared dividend now sits at $.96/share, up from $.9225 a year earlier, so the company is seeing a modest level of dividend growth.

In addition, I see reasons to expect future dividend growth given the company’s strong financial position. Specifically, the cash on hand continues to increase and is up quite significantly on a year-over-year comparison, as the chart below indicates:

Source: Seeking Alpha

As you can see, the balance sheet is indicating a cash position increase over 30%, which tells me the company should have little trouble increasing the dividend going forward if it plans to use the cash that way. Notably, this cash position has been raised from multiple sources. Specifically, the company has seen growing revenues, which has, in turn, boosted overall net income. Furthermore, MAA saw a significant increase in cash from selling off some real estate assets, from the year prior:

Of course, this could be a one-time benefit, but the increasing cash balance, along with the growing revenue stream gives me a lot of comfort in the financial position of the company.

My takeaway here remains positive, even though the yield is lower than where it stood to start the year. This is primarily because there is a good chance that interest rates are heading lower by year-end, so a 3% dividend yield could look even more attractive six months from now than it currently does. Due to market volatility, slowing global growth, and escalating trade disputes, investors are now pricing in multiple interest rate cuts from the Fed by year-end, which is a marked shift in sentiment. According to data compiled by CME Group, the most likely scenario is 1-2 cuts by year-end, illustrated below:

Source: CME Group

My point here is that investors are expecting rates to go down, which means many will be looking to lock in higher yields now, whether it is in ETFs, bonds, or REITs.

In addition to the potential for investor demand, the lowering of interest rates could improve MAA’s financial position. One of the drawbacks to the company’s expansion has been increased borrowing and, in turn, higher interest expenses, as shown below:

While this is to be expected when a company is growing through expansion (and thus borrowing more), it undoubtedly pressures profits. However, MAA has a large amount of unsecured term loans, the majority of which is variable rate debt. This means the rate of interest and, therefore, the overall interest expense of these loans should decline if the Fed lowers interest rates. To put this in perspective, consider that MAA has four unsecured term loans totaling $900 million. Three of the four loans are variable rate, which makes up $750 million, as shown below:

Source: Seeking Alpha

As you can see, a drop in interest rates should impact the LIBOR rate, which will decrease the interest owed on the majority of these liabilities. This would be an overall positive for MAA.

Therefore, I continue to view MAA’s yield as attractive due to its annual dividend growth and above-average yield, expected future growth, and strong underlying share performance.

What’s The Risk?

While I mentioned that I have been bullish on MAA for some time, and I reiterate that I remain so today, it is important to recognize the risks of buying today. Specifically, MAA is trading right around its high for the year, and its Price to FFO is not cheap, at almost 19 times, as shown below:

Source: Seeking Alpha

Investors should always be a little cautious when buying in at fresh highs, although if the share price gains are justified, as I believe they are for MAA, then it is not a reason to avoid altogether. However, investing cautiously, such as incrementally, is probably a prudent move here. Furthermore, while a P/FFO of almost 19 seems high, it is not a crazy valuation compared to the market. For example, CPT, a peer of MAA, has a P/FFO of almost 21, a notable premium to MAA’s valuation.

Aside from the valuation concern, another important risk to consider is consumer demand for rentals. While I personally see future strength in this regard, I mentioned how lower interest rates are likely on the horizon. While this could benefit MAA in terms of interest expense, it could also be a headwind, as lower interest rates could help push potential home buyers into making a purchase, abandoning their rentals for home-ownership. If home affordability increases due to lower interest rates, that could spark future rental concessions by landlords like MAA, which we have seen decline over the last few years. If those concessions re-emerge, profits will be pressured, and investors will likely regret buying at the high.

Bottom line

MAA has been one of my top stock picks this year, and I believe future gains are likely. While I would not recommend going "all-in" if you don’t already have a position, I still see value in the current share price and feel now is an appropriate time to build a position. The rental market nationwide is performing well, with asset prices increasing and rents continuing to climb. With potential home buyers still facing a tough real estate market, apartment rentals will have growing demand for the foreseeable future. MAA is especially poised to capitalize on this trend, as the company operates in some of the fastest growing regions, and cities, in the United States. Furthermore, Q1 earnings figures show the company is improving its metrics year-over-year, which is always what investors want to see. In summary, I remain bullish on MAA going forward and encourage investors to give the stock a serious look.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in MAA over the next 72 hours. 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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