Investors looking to generate substantial risk-adjusted returns should consider backing financial real estate companies. Many firms within the real estate investment sector are heavily discounted to intrinsic value and are recovering from the recent trough. Since bottoming out at the beginning of 1Q09, Equity Residential (EQR) has bounced back for a gain of more than 265%. Put differently, a $1M investment would have been worth $3.65M in around three years.
Given how much of a star performer Equity Residential has been (it is now trading near its 52 week high), investors should consider looking into newly-formed companies. The Howard Hughes Corporation (HHC), led by esteemed hedge fund chief Bill Ackman, has delivered exceptional returns since going public: 73.3%.
Andrews Development International plc [ANDI:GXG] recently went public on the GXG Global Exchange Group. The company is meaningfully undervalued - hence the "Strong Buy" rating by equity analyst Gould Partners (click here for the report.) Andrews yields much of its profit through structuring M&A deals, helping companies go public, and securing growth financing. These services ultimately widen the differential between return on invested capital ("ROIC") and weighted average cost of capital ("WACC"). Strategically, Andrews holds a portion of the companies they back and then invests the profits in real estate with a target on emerging markets. It's a solid combination that capitalizes on a rising IPO market and global economy.
More mature companies, like Equity Residential, are still attractive. In this article, we will perform a real estate DCF model on the company and then triangulate the result against General Growth Properties (GGP) and AvalonBay Communities (AVB).
First, we need to begin with an assumption about the top-line. Equity Residential finished FY2011 with $2B in revenue, which represented a 12.2% gain off of the preceding year. Growth accelerated off of FY2010 levels. We model growth trending between 10% - 14% over the next half-decade or so.
Moving onto the cost-side of the equation, we model cost of goods sold hovering around 37% of revenue versus 2.2% for SG&A. Depreciation charges are non-cash and thus need to be added back to keep figures in purely operating terms.
Based on these projections, Equity Residential should have $1.9B worth of net operating income ("NOI") by 2015. The stock currently trades at 17x NOI. If it can trade at just 13.5x our 2015 NOI estimate, the company would be worth $25.7B for 37.5% upside.
All of this falls within the context of healthy secular trends:
[W]e continue to see strength in virtually all of our markets, actually in all of our markets, and the fundamental factors of supply and demand remain in our favor. The combined forces of demographics, household formations and the continued aversion to homeownership will ensure a strong demand for rental housing. And this is further supported by gradual improvements in job creation, especially within our younger, college-educated urban cohort for unemployment now stands at 4.1% versus 8.5% overall.
General Growth Properties similarly has strong fundamentals. Over the last six months, the stock has gained by 27.1% and still has impressive momentum. During the fourth quarter, core FFO of $0.29 was up 26% over last year. Moreover, results were above consensus and at the high-end of guidance. Core EBITDA increased 9.4% - driven by stellar leasing activity and complemented by meaningful risk mitigation on the financial-side.
Finally, AvalonBay is yet another attractive pick. FFO per share of $1.19 was up 18% over last year. This impressive result was the function of two key factors: same-store NOI growth atop 10% and a 1.8% decline in same-store expenses. Perhaps most importantly, management has showcased confidence over free cash flow by increasing the quarterly dividend 9%. As the new property developments catalyze the bottom-line, we anticipate the bull run continuing.
DISCLAIMER: The distributor of this research note, Gould Partners, is not a licensed investment adviser or broker dealer. Investors are cautioned to perform their own due diligence. We are an investor relations consultant to Andrews and have received 100,000 shares worth of equity compensation from the company for our services. We reserve the right to sell or buy at any time.
Disclosure: I am long ANDI:GXG and may initiate long positions in all of the companies mentioned in this report.