How long will you wait to add some apartment REITs to your portfolio? Don’t blame it on high valuations, because these REITs are cheap. This is a sector we’ve been emphasizing lately for subscribers of The REIT Forum. We want to share part of our latest housing REIT Update.

We like this sector because it offers investors a surprisingly high implied cap rate, solid dividend yields, and solid dividend coverage.

Company Name Ticker Div Yield AFFO or Core Yield
NexPoint Residential Trust Inc. NXRT 2.85% 5.02%
Mid-America Apartment Communities Inc. MAA 3.47% 4.82%
Camden Property Trust CPT 3.71% 4.62%
Essex Property Trust Inc. ESS 4.16% 5.79%
Independence Realty Trust Inc. IRT 4.17% 5.98%
AvalonBay Communities Inc. AVB 4.31% 5.44%
UDR, Inc. UDR 4.46% 5.73%
Equity Residential EQR 4.72% 5.74%
Apartment Investment and Management AIV 4.92% 6.16%
Clipper Realty CLPR 6.21% 8.88%
Bluerock Residential Growth REIT BRG 8.74% 7.50%
Preferred Apartment Communities Inc. APTS 12.89% 9.01%

Now if you’re like me, you’re probably thinking: “You should’ve used a chart.”

That’s true, but a chart won’t link the tickers and that would make it more work for me. So, you get the table and the chart:

Source: The REIT Forum 9/29/2020, calculations use data from TIKR.com

That’s an AFFO yield, not an FFO yield. What’s the difference? Material.

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We’re using AFFO to subtract an estimated amount for recurring capital expenditures. It’s like what most REIT analysts would do, if they would do things the right way. Pretend you own a property and need to spend $8,000 on major roof repairs. Do you pocket that $8,000 or do you spend it on roof repairs? Well, roof repairs aren’t dividends, right? Right! So you need to subtract this value.

Now, if you only have one property, that gets pretty messy since it will be volatile. However, if you had a few hundred properties, you would have a less volatile number. You would simply rotate through properties each year and some repairs and upgrades would occur. You could figure out a relatively average amount and simply budget for that. Then you’d be dealing with AFFO.

So, where does that put the payout ratios?

Source: The REIT Forum 9/29/2020, calculations use data from TIKR.com

A payout ratio around 80% isn’t too concerning for an equity REIT. It’s a little bit high, but not much. When you’re looking at these values, it is important to consider that even AFFO can be influenced by unusual events. These ratios are already using estimates for AFFO that include the expected impact of the pandemic and social situation.

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Some investors are going to say that they are more attracted to buying apartment buildings directly rather than buying a REIT. That could make sense if apartment REITs were more expensive than their underlying assets. However, that isn’t the case:

Source: The REIT Forum 9/29/2020, calculations use data from TIKR.com

Many of these REITs are selling for dramatically less than the value of their real estate. We see that as an opportunity. It isn’t just highly-leveraged REITs trading at big discounts. We’ve got big discounts on several high-quality REITs. These REITs have strong balance sheets and can access debt markets at much better prices than your typical investor. That’s a big deal because every dollar saved in interest is another dollar for the owner. Would you rather finance a property at 2.75% to 3.75%? Oh, you’d like the cheaper rate? The REIT is taking care of it.

If your property is reappraised at an absurdly high price, how much would you hate having to fight with the appraising office? It’s much better to have a REIT which employs someone to do precisely that job.

Would you care for some bullish ratings? I think that sounds great! Here we go:

That’s 4 bullish ratings for you. Each of these REITs is firmly in the bullish range. We see several REITs that deserve to trade around NAV. As it stands, those NAV estimates are already down significantly to reflect lower NOI projected for 2020.

AIV is an interesting situation as it intends to split the company in a taxable event. If you’re looking to buy AIV, you may prefer to use a tax-advantaged account. Some investors are protesting the move, but we see it adding value to AIV over the long term. Management was right in their decision. They want to have two real companies (not an external manager, they aren’t stupid). One company handles the development of new apartment buildings and the other simply owns and operates apartment buildings. The one which simply owns and operates the buildings is inherently simpler because it removes the development overhead from the statements.

How Much Rent Will Landlords Miss

We previously found EQR’s total revenue would’ve been expected to be around $7/share. Using EQR for the example, shares topped out about $87 just prior to the pandemic and fell by about $36 from there. That’s about 5 times their annual gross revenue. Okay, you’re welcome to argue that rents are going to struggle and occupancy will be down. Those are both true. However, will future revenues actually decline by more than five times the annual revenues? That would be akin to setting rents 20% lower and keeping that in place for 25 years. Except, in that scenario, we would need to be discounting future cash flows because 25 years is pretty far out there.

So, what does that mean? It means the market overreacted and is still overreacting.

Bullish ratings: AVB, EQR, ESS, AIV

We’ll have more work on the REITs coming up, so make sure to follow us.

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

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Disclosure: I am/we are long AVB, EQR, ESS. 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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