Dear readers,
Mid-America Apartment Communities (NYSE:MAA) is a high-quality apartment REIT which owns predominantly A-Class space in the Sunbelt, has no exposure to California, and has a strong A- balance sheet rating. The REIT has a long history (13 years) of dividend increases, with an 8.8% 5-year dividend CAGR, and yields 4.5%. As such, it can represent an interesting vehicle for income investors to get reasonably high yield and exposure to a traditional asset class (i.e. residential real estate) which could benefit from a downward movement in interest rates, which seems likely. For details regarding my thesis of falling interest rates, check-out this article.
I have covered MAA before, most recently in March in an article called Declining Rents Ahead. I discussed full year 2023 results, which were great with year-over-year NOI growth of 15% – a third consecutive year with double-digit growth. But despite good past performance, I downgraded the stock to a HOLD, because (1) NOI growth was already showing signs of slowing down on a quarter-over-quarter basis, and (2) the Sunbelt residential market seemed likely to face significant pressures from oversupply in 2024 and 2025 which had already manifested into high vacancies and declining rents in the market. Management even guided to an overall NOI decline in 2024, primarily as a result of rising OPEX showing that they clearly expect several tough quarters ahead.
Since my last article, the stock has done OK, returning 5.5% in about 3 months, somewhat above the 3.2% of the S&P 500 (SPX) over the same period. But recent data points (Q1 2024 results and fundamentals in MAA’s market) continue to point to likely disappointing results in the short and medium-term. Today, I want to try to look through the noise and into the stock’s long-term prospects, once the market works through the excess supply delivered to the market this year.
Seeking Alpha – David Ksir
Short to medium-term prospects (2024-2025)
Due to high tenant turnover, MAA’s performance is closely tied to the performance of the market it operates in. By now, it’s a well known fact that supply of new A-Class apartment space in the Sunbelt will be high this and next year, especially in comparison to Coastal markets. To put some numbers behind this claim, new deliveries in the Sunbelt are expected at 5.5% of the current stock in 2024 alone, while in Coastal markets the number stands at just 2.1% – in line with the historical (healthy) average.
Some markets, that MAA operates in, will see especially high levels of new inventory. In particular, Austin (6.4% of ABR), Phoenix (2.9% of ABR), and Charlotte (6.2% of ABR) will all see its stock grow by almost 15% over the next two years.
RealPage
Such high supply has already impacted rents and vacancies in a meaningful way. Nationwide, apartment vacancies have risen to 6.7%, and some markets in the Sunbelt have seen even higher levels of unoccupied space. Atlanta, for example, which happens to be MAA’s largest market, has seen its average vacancy head to a 12-year high of more than 8%, and in Austin, Texas vacancies of newly build properties are attacking the 10% mark.
All of this has, understandably, translated into added pressure on rents which already started to decline. In particular, Austin has been the worst performer with a 5.7% YoY decline in rents, followed by many other markets that MAA is exposed to with around 2-3% YoY declines.
CoStar
As a result of these poor fundamentals, management has been cautious in their NOI guidance and has guided towards negative NOI growth in 2024 of -1.3%, in line with guidance issued last quarter.
MAA IR
There is no doubt that 2024 will be a tough year for Sunbelt apartment REITs, and especially those that focus solely on A-Class space which is under a much bigger threat than B-Class which doesn’t get build. As long-term investors, however, our job is to look to the future and try to determine what might happen in 2025 and beyond. And here, the MAA’s prospects are much better.
Long-term outlook (2025 and beyond)
Long-term there is light at the end of the tunnel for MAA and its Sunbelt peers, because supply will drop off sharply post 2025.
We know this, because building permits, which lead deliveries by two to three years, have already declined meaningfully from the peak in 2021 as a result of rising construction, energy and financing costs. The truth is that development of new residential space is simply not a good business right now which is why very few developers are starting new projects and this is unlikely to change in the near future.
Consider this example, which comes from an actual community being developed by a close peer of MAA, Camden Property Trust (CPT). The community will have 410 units and is expected to cost $147 Million, or $359,000 per unit. To make the project interesting for any investor, it will likely have to generate an NOI yield of at least 5.5% (100bps spread to long-term treasuries to compensate for risk), or annual NOI of $19,745. With an average NOI margin of 65%, which is typical in the residential REIT space, the annual revenue required to generate that yield is $30,300 or $2,530 per month. But that is way above market rents for such properties, which only average about $2,000 per month. As a result, the project is not really worth doing unless rents increase by at least 20-25% from current levels.
This is why, going forward, I expect development activity to continue to decline, perhaps even more than is already visible from already issued building permits which imply deliveries of only 0.2% of stock per quarter by Q4 2025. That’s only 1% annualized, and way down from 5%+ this year.
RealPage
Moreover, beyond declining supply, there are also reasons to be optimistic about future demand.
Firstly, demand has been and is likely to continue to be supported by wage growth, which sits above rent growth.
MSCI Real Capital Analytics
And secondly, more and more people will likely choose to rent because of rising unaffordability of home-ownership caused by a rise in interest and mortgage rates. I estimate that the average new mortgage payment is currently more than 50% higher than rent on a comparable apartment.
And the thing is that home-ownership is unlikely to become cheaper any time soon, especially due to the lock-in effect of existing homeowners that have little incentive to sell their current homes, wiping out their low rate mortgages in the process, only to buy a new home with a more expensive mortgage rate.
FHHA, National Mortgage Database
Because of these factors, that are likely to lead to a significant supply reduction, and strong ongoing demand, I expect that substantial rent growth of 5%+ will return to the sunbelt post-2025.
Risks
Given the fact that deliveries lag building permits by two to three years, supply until 2026 is completely visible and fixed. The only risk to the above thesis is therefore on the demand side. In particular, any sort of a demographic shift away from the Sunbelt and back to legacy markets would likely have a significant negative effect on demand for rental housing. And so would a housing crisis, which could once again make homeownership a mathematically interesting alternative to renting. But these risks seem very remote and unlikely at the moment.
Is MAA a BUY, a SELL, or a HOLD?
I think that the current consensus which calls for a 4.6% decline in FFO in 2024, followed by growth of 1.1% and 5.2% in 2025 and 2026, respectively, is likely right and may even prove to be too conservative post-2025.
SA
The current implied cap rate sits at 6.7% and likely has the potential to decline from the current 230 bps spread to 10-year treasuries to at least 180-200 bps which is still a considerable premium for an A- rated company, especially when you consider that Coastal peers such as AvalonBay Communities (AVB) trade at a spread as low as 110 bps. Such spread reduction, along with consensus NOI growth and a drop in 10-year treasury yields to 4.0%, should deliver price upside of 27% over the next three years, or 9% per year.
Seeking Alpha
Add to that the nearly 4.5% dividend and you could easily make 13-15% per year under relatively conservative assumptions, and possibly more if interest rates decline more over the next three years. That is not bad at all and leads me to upgrade MAA to a BUY here at $133 per share.