Stagflation Resistant Real Estate On Sale: AVB and MPW Stocks

Numerous economic indicators imply that we are headed for a period of stagflation. These include inflation rates not seen in four decades, slowing economic growth, and headwinds such as the war in Ukraine, lingering supply chain issues, and geopolitical unrest in the Taiwan Straits that all combine to paint a picture of higher inflation and lower economic growth for the foreseeable future.

The real estate sector (VNQ) is quite diverse in its structure and positioning for various macro environments. For example, more defensive triple net lease REITs like Realty Income (O) and STORE Capital (STOR) are well positioned for periods of low economic growth or even economic declines, but they are not well positioned for periods of high inflation. Meanwhile, hotel REITs like Host Hotels (HST) are well positioned for periods of high inflation, but not as well positioned for weak economic environments. Fortunately, some real estate is well positioned to thrive in a stagflationary (high inflation and weak economic growth) environment like the one we currently find ourselves in. Two REITs that appear particularly well suited to the current environment are AvalonBay Communities (NYSE:AVB) and Medical Properties Trust (NYSE:MPW). In this article, we will discuss these two REITs and why we believe they are not only well suited to the current environment, but also offer investors compelling total return potential.

#1. AvalonBay Communities

The first thing that jumps out to us about AVB is that its stock price currently trades below its pre-COVID-19 levels, implying that the company has been meaningfully hurt by the pandemic, or at the very least, is currently facing severe economic headwinds.

However, this is not true at all as AVB is benefiting from strong rental growth (~20% nationwide average apartment rental rate growth since COVID-19 hit the U.S.), strong property appreciation, and portfolio growth in attractive markets like Texas and Florida. While multifamily development is booming at the moment – implying that the supply-demand dynamic may flip the other way in the coming years – supply chain logjams are currently prolonging the time for many of these developments to come to market, keeping supply suppressed relative to soaring demand.

As a result, AVB is generating outstanding performance. In Q2, its FFO per share was up 22.3% year-over-year, prompting management to increase its full-year core FFO per share guidance to $9.86 at the midpoint. This implies a P/FFO ratio of 21.1x for 2022, which is below its five-year average of 22.9x and three-year average of 24.0x, despite the company benefiting from strong demand for its apartments, soaring inflation (which benefits AVB due to its short lease structure, thereby enabling AVB to raise its rents each year), and the defensive nature of residential real estate.

On top of that, AVB offers investors an attractive 3.2% dividend yield and an expected AFFO per share growth rate of 19% in 2022 and 10% in 2023. When you combine double-digit AFFO per share growth with a 3.2% dividend yield and the possibility of a slight tailwind from multiple expansion, the total return proposition looks quite promising. When you add to that the A- (stable outlook) credit rating from S&P and its general defensive positioning as a residential REIT, you get a very attractive risk-reward profile. While the threat of overbuilding could hurt AVB in a few years, overall, the risk remains quite low, especially when compared with the total return potential.

#2. Medical Properties Trust

MPW meanwhile, is quite defensive given that it leases out defensive and mission-critical hospitals on conservatively structured and lengthy term triple net leases. While it is true that hospitals may suffer a revenue decline during a recession given that many elective surgeries are postponed during these periods, demand will likely still remain high for the real estate given that people’s health does not fluctuate wildly with the state of the economy.

However, what separates MPW from many of its triple net lease peers is that it has CPI adjustments in its leases, giving it considerable inflation protection and thereby setting it up to thrive in the current stagflationary environment.

On top of that, MPW stock is back to trading near COVID-19 lows as investors are growing increasingly worried that its tenants are financially distressed. However, we believe these fears are misplaced as its tenants have ~2.5x rent coverage at the property level, implying that these assets are highly valuable and will be in-demand even if the operators go bankrupt at the corporate level. In fact, in the event that the tenant goes bankrupt and defaults on its lease, MPW has the right to take back its properties and release them to a different tenant. Given that they are such profitable properties, it is unlikely that tenants will default on those specific leases even if they have to declare bankruptcy at the corporate level. Even if their leases are defaulted on, MPW should be able to release these attractive properties to new tenants. Again, these are highly profitable mission-critical healthcare assets in good locations. People will need to use them regardless of whether the current tenant is solvent or not.

In fact, MPW recently sold a joint venture stake in some hospitals operated by its largest tenant (Steward) – which has many of its critics concerned about a potential bankruptcy for the hospital operator – at a 5.8% cap rate. Given that this cap rate is far below that which is implied by the current MPW share price, it appears that the private and public markets have a sharply differing perspective on the true value of MPW’s properties and the safety of its leases.

In fact, when you consider the defensive nature of its leases, the high profitability of its properties, and the inflation resistance built-in to its rent escalators, its massively discounted valuation metrics make even less sense:

Metric	Current	5-Year Average
P/AFFO	10.70x	13.94x
Dividend Yield	7.91%	6.07%
P/NAV	0.80x	1.16x
EV/EBITDA	13.85x	14.43x

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As you can see from the chart above, across the board – especially on a price to NAV basis – MPW looks extremely cheap. Meanwhile, management continues to signal confidence with another dividend hike this year and analysts expect MPW to continue growing its dividend each year at a 4.4% CAGR through 2026. While MPW is not risk free or even low risk, there definitely seems to be a large disconnect between price and value here.

Investor Takeaway

With inflation continuing to rage and economic growth grinding to a halt, investors are in need of business models that balance defensiveness with inflation protection. Furthermore, they need to invest at a reasonable value in order to set themselves up for attractive long-term total returns and attractive current income.

In AVB and MPW investors can get all of these attractive qualities in their investments. AVB – as a growth at a reasonable price investment – offers very attractive double-digit growth potential along with a decent dividend yield and low risk. MPW – as a high yield investment – offers a mouthwatering current yield and significant multiple expansion potential alongside decent growth that is somewhat inflation protected. Combined, investors get a very attractive average dividend yield, average growth rate, multiple expansion potential, and inflation protection, along with a reasonably low risk profile. We rate both of these REITs as Strong Buys.