Mid-America Apartment: Sunbelt Compounder At A Discount (NYSE:MAA)

Mid-America Apartments (NYSE:MAA) was not spared from the carnage in apartment REITs with shares declining 25% over the past year. Investors are likely concerned about higher interest rates, slowing rental rate growth, and fears of looming increases of new sunbelt apartment supply.

I see these concerns as temporary (discussed below) and believe that the current share price offers an attractive entry point for conservative long-term investors.

Compounding Value over the long term

As a sunbelt focused apartment REIT, MAA has been a beneficiary of the long-term demographic trends. Below is a snapshot of population numbers over the past 50 years in a selection of Sunbelt cities.

Metro Area	1970	1980	1990	2000	2010	2020
Atlanta	1,182,000	1,625,000	2,184,000	3,522,000	4,544,000	5,689,000
Austin	267,000	383,000	569,000	911,000	1,377,000	1,985,000
Charlotte	281,000	353,000	461,000	768,000	1,265,000	1,971,000
Dallas/ Ft Worth	2,025,000	2,468,000	3,219,000	4,168,000	5,149,000	6,201,000
Houston	1,693,000	2,424,000	2,922,000	3,847,000	4,976,000	6,245,000
Miami	2,141,000	3,122,000	3,969,000	4,933,000	5,518,000	6,079,000
Orlando	310,000	583,000	893,000	1,165,000	1,521,000	1,923,000
Phoenix	874,000	1,422,000	2,025,000	2,923,000	3,649,000	4,436,000
Raleigh	153,000	209,000	310,000	548,000	896,000	1,386,000
Wash DC	2,488,000	2,777,000	3,376,000	3,949,000	4,604,000	5,264,000

Click to enlarge

Source: Macrotrends

While there will be fits and starts in the short-term, the long-term trend of population migration from colder, high tax states to business friendly, warm states is undeniable. MAA has been and will continue to be a long-term beneficiary of these trends which can be seen in its historical track record below.

Like most apartment REITs, MAA will continue to grow its portfolio through development (current pipeline of ~$750 million) of new apartment assets at attractive yields (typically a 5.5-6.5% yield on cost) as well as adding value to existing assets through refurbishment as shown below. The company will continue to refurbish thousands of assets annually which will serve as an ongoing driver of NOI growth.

Current Results

Operating results for MAA were fantastic in 2022. As shown below, rent growth handily outpaced expense growth, driving same-store NOI up +17% (midpoint) for the full year.

Importantly, the strong rent growth experienced throughout 2022 sets MAA up for another record year in 2023 as already achieved rental growth will have a full year impact in 2023. On the most recent earnings call, management has guided to a 2023 embedded rental growth of 6% despite increased supply (discussed below). Additionally, occupancy remains strong at nearly 96%.

Moreover, while new lease rates are likely to stagnate in 2023 as household formation and economic growth slow, many existing tenants are paying below market rents. As such renewal rates are likely to continue to increase at a faster pace bolstering NOI growth.

Supply is a Near-term Headwind

A main concern of investors is the increase in sunbelt apartment supply coming to market in 2023. As shown below, 2023 will see an increase in newly constructed apartments becoming available in many of MAA’s sunbelt markets:

While new supply will impact the market, there are important offsetting factors to consider:

• The outlook for continued population growth in MAA’s markets remains strong. While supply will create a temporary imbalance in a few markets and exert some pressure on rents and occupancy in 2H23-2024, over the long-term, this will be (more than) offset by demand.

• As shown below, just over 60% of MAA’s Properties are Class B-Class A-. Class A- properties typically result from property upgrade program described above to modernize unit interiors and improve property amenities (gym, pool, common areas). Importantly Class A-/B properties tend to be more economically resilient than Class A. Class B properties, which are 10-30 years old and priced at a 10-25% discount to A units (and 30+% to brand new units) of comparable size. Class A-/B properties face less competition from new construction as development is ALWAYS focused on Luxury/Class A (Class A-/B would never pencil out and new Class B is NEVER BUILT).

Valuation

At $153/share, MAA trades just 17x 2023e FFO which is at the low-end of its historical range of 14-28x over the past decade. Similarly, MAA trades at an implied cap rate of 5.7% which is at the high end of not only its long-term range (3.7-6.3% over the past decade) but a discount to recent private market values in its key markets which estimated to be at in the mid 4s-low5s range.

It is important to understand that the private market represents 95% of the overall market for apartment assets in the US. The rise in interest rates has led to a pause in private market purchases of apartment assets. While we are unlikely to see apartment assets transact at ultra-low sub 4 cap rates we saw in 2H21-1Q22, the structural increase in private equity capital being allocated to real estate is shown below:

Note the significant increase in private capital allocated for real estate investment over the past 10 years. Eventually, this capital will have to be invested to allow the private equity sponsors to earn fees. Given the turmoil in office and retail, many private equity firms are increasingly focused on apartment assets.

Ultimately, I assume that valuations will revert back toward the higher end of their historical range. The logic underpinning this assumption is the significant amount of private capital chasing apartment assets. Further, inflation has driven up the replacement cost of apartment assets making the REITs increasingly attractive on a per-door basis (which represents an estimated 20-25% discount to replacement cost). Assuming a 4.5% cap rate for Mid America gets me to a NAV of just over $200 per share, which suggests 30% upside. With a 3.6% dividend yield investors get paid to wait.

Conclusion

Mid-America owns a collection of high quality, very conservatively financed apartment (Net Debt/EBITDA is just 3.9x; LTV is just 20%) assets in attractive markets throughout the US. Trading at an implied cap rate of 5.7% and a dividend yield of 3.6%, I see Mid America as an enticing investment opportunity for long-term, conservative investors.