Over the past 52 weeks the REIT market, as measured by the RMZ, is up 14.11%. Reported AFFOs have not increased nearly as much so we see significant expansion in earnings multiples from an average of 14.3 in Oct. 2011 to 15.4 in Oct. 2012. One would expect this inflation to occur more or less evenly across the board, but there are some companies which have demonstrated a significant disjoint between market price and earnings performance.
Market Price 10/24/11
Market Price Now 10/23/12
Net Change in Market Price
AFFO % Change
Disparity in Bps between price and earnings change
Associated Estates Realty (AEC)
LaSalle Hotel Properties (LHO)
Ashford Hospitality Trust (AHT)
3Q not yet released
Unknown but potentially large
These companies have in fact experienced FFO multiple contraction. For these specific cases, the FFO multiple has decreased by an amount equal to the last column in the chart above. Associated Estates and LaSalle Hotel Properties are now 32.98% and 30.94% cheaper respectively in comparison to their earnings. Assuming the market normalizes and these companies return to their former multiples, the size of the disjoint between market price and performance represents the magnitude of opportunity as the market normalizes.
How do such massive disjoints happen?
1) Double accounting of aggregate statistics:
AFFO can be considered an aggregate performance statistic as nearly the entirety of a company's performance shows up in the AFFO per share result. Acquisitions, equity issuance, refinancing of debt, or just about any other event will directly affect the number that is reported with the quarterly earnings. This is where double accounting comes in. For example, when a company reports an extremely beneficial refinancing, it usually results in an increase in stock price of proportionally similar magnitude. The financial benefit of said refinance results in the company beating the quarters AFFO estimates and the stock price once again jumps. Thus, the same action affected the stock price twice, once when reported as the individual action, and again when reported as part of the aggregate statistic.
2) Skewing of information:
Investors have so many stocks to follow that often decisions are made on incomplete information. As such, there is a skewing in which the more prevalent or accessible information has a greater effect on market price as compared to its actual relevance. I believe this to be the primary cause of AEC's poor market performance. So much of the press relating to AEC has been focused on some fairly low cap-rate acquisitions. These purchases were seen by many as a poor choice, and the market price of AEC responded accordingly. However, in reality the magnitude of importance of a couple acquisitions pales in comparison to the company's overall very strong performance. Yet the prevalence of information seems to have received more weight than the importance.
3) Size of company and following:
Smaller or less followed issues are more susceptible to unjustified price swings as any given anomalous trade has a greater relative effect. With less investors following an issue there is less support for the price when it dips from small numbers of trades. For this reason, small cap issues will tend to show greater percentage pricing to performance disjoints, and the disjoints can remain for longer periods of time.
Do these disjoints represent opportunity?
Associated Estates: To reiterate, the disjoint which AEC saw was a price decline of 14.48% over the same one year period in which its earnings grew 18.5%. Trading at a price/FFO of 12.1 compared to the multi-family sector's average of 17.6, AEC is an excellent value. One of the reason's it became such a value is that it had issued equity at prices well below NAV and investors have been fearful of further dilution. A price rebound was facilitated as Jeff Friedman (CEO) assured shareholders in the 3Q conference call on 10/24/12 that equity issuance was their lowest priority for raising money behind dispositions and taking on debt. This announcement in combination with the stellar quarter results led to gains of 2.58% in AEC's price at market close on 10/24. Even after these gains it is remarkably cheap for such a strong company. In my opinion a long position in Associated Estates represents the single best play in the multi-family sector.
LaSalle Hotel Properties: LHO's disjoint came in the form of 36% earnings growth over the same one year period in which its share price only rose 5.06%. Partially accounting for the small price gains was that LHO took quite a hit in the market this past week with the announcement of its 3rd quarter earnings which slightly missed estimates. Now, a correction of this sort would make sense if there had been a price increase of proper size to reflect the estimates, but even the missed earnings showed sufficient growth to justify the market price. If we look at the results themselves, ignoring estimates, this quarter was a success for LHO with across the board progress. RevPAR growth of 5.1% and a Hotel EBITDA Margin of 35.9% culminated in AFFO growth of 36%. These numbers are not typically seen in a company trading at an FFO multiple of only 11.5. This recent price dip is a nice entry point into LHO which should give decent returns.
That being said, a potentially better opportunity awaits in the hotel sector with Ashford Hospitality Trust . Over the same 1 year period its price declined from $8.66 to $8.58. The presence of a disjoint in company performance and pricing behavior relies on its 3rd quarter earnings which will be released on 10/31. To get an idea as to what we could see in this report we should keep in mind the following:
1) RevPAR has been consistently up and maintains an upward trajectory
2) AHT has exposure to Charlotte and Tampa which provided exceptional profits from the Democratic and Republican conventions.
3) AHT also has exposure to the Washington DC area which may significantly hurt profits due to the freeze in activity from Congress.
Given these conflicting indicators, it is difficult to predict earnings, but depending on the market's reaction the 3Q release may be an excellent opportunity.
The market is not perfect: prices will frequently come out of parity with company performance. It is our job as investors to spot these situations and determine if opportunity exists. Above, I listed only a few of the plentiful times in which the market gets it wrong.
Disclosure: 2nd Market Capital and its affiliated accounts are long AHT and AEC. This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the writer.