UDR, Inc. (NYSE:UDR) is an apartment REIT that I'm not too bullish on. You could call me bearish, but I would not be foolish enough to short any equity REIT unless I saw something that would make it implode. My opinion on UDR is simply that there are better values available to investors.
In this article I'm going to focus on the debt the company uses to fund their operations and the strategy the company is employing.
Let's talk about Debt
Below is a slide I picked up from NAREIT's annual conference. It breaks down the amount of debt that matures in each year and then shows the weighted average interest rate of the debts for that year.
What do you notice from the slide above?
The first thing I notice is that the weighted average rate on 2015 is fairly high. I don't find a 5.5% rate on debt even remotely attractive in this environment. I don't know when that debt was taken out or what limitations there are against prepaying the debt, but I don't like it.
The second thing I notice is that weighted average interest rates don't follow a normal yield curve. The normal yield curve is upward sloping so the interest rates should be gradually increasing as we move towards the right. There are several reasons that it may not happen that way. For instance, the company may have taken out debts when interest rates were higher and been unable to prepay that debt when rates decreased. That would be a very valid explanation.
If you look at the far right end, you'll see that it appears green years (unsecured debts) are showing higher interest rates than blue years (secured debts), but the correlation falls apart when we look at other years. For instance, 2018 has a 2.9% weighted average interest rate but the unsecured debts are a huge portion of it.
The last thing I see is that a fairly substantial amount of the debts are unsecured. If you assume (as I do) that secured debts should generally have lower interest rates, then that seems awkward. It makes sense IF the company does not want to make a commitment to continue holding onto individual assets that could be used to guarantee the debt, but I prefer apartment REITs that rarely sell one property to buy a different one. In my opinion, it is a negative sum game. I believe the transactions costs outweigh the improvements in performance that can be gained by changing management.
Do you see something different? Call it out in the comments. I'd love to address it.
Strategy on the Balance Sheet
The following slide, pulled from the same presentation, goes over UDR's plan for managing the balance sheet.
Let's go over a few of the things from that slide:
Leverage or debt to undepreciated asset value
This is an okay metric to use, but I'd prefer to see the leverage target reflecting fair value rather than undepreciated value. I want REITs that hold onto a property for a decade or longer. I'm boring that way. I don't like excited and I don't need new transactions. I just want a boring stable return. Since I want management to hold onto the property for a time period measured in decades, I'd like to see management increasing debt as the portfolio appreciates in value.
Manage to 35% to 40% leverage
That's not bad. I would prefer more debt usage when low fixed interest rates are available. I see low interest rate fixed debt as a way to leverage returns. If I was buying an apartment complex with my own money, I would use mortgage financing to leverage my returns. If I can afford one without a mortgage, I could afford two or three with mortgages. In both of these cases, management is being a little bit more conservative than I would like, but that is no crime. In my opinion, it is better to be too cautious than too aggressive.
Investment grade ratings
The fairly good ratings on the company's debt are related to management's choice to limit leverage. I don't have access to the models I would need to project the marginal impact of additional financing. Because management is maintaining / improving their debt ratings to keep the cost of debt down, it is very possible that management is making a great decision here and deserves more credit than I'm giving them.
The "No New Equity" case
Another slide was provided that made the case for how the company would be able to grow even if no new equity was issued.
I have no problem with the slides, but it does reflect a problem for me. Despite fairly low interest rates, the company isn't increasing net debt-to-EBITDA. That value has been trending down. Meanwhile, the fixed charge coverage has been improving. The thing that I don't like here is that the level of net debt-to-EBITDA will be almost cut in half and the fixed charge coverage will almost double. In my opinion, the low interest rate environment should have allowed the fixed charge coverage ratio to improve slightly more that relative to the figures on net debt. Therefore, I feel like the company isn't taking full advantage of the current low interest rates.
The default case intends to issue more equity
I don't mind a REIT issuing equity when the share price is favorable. In my opinion, the current share price for UDR is favorable. Therefore, it makes sense for them to issue the equity. However, I believe that the choice to continue issuing equity and reducing debt is a clear signal that management also knows the current share price is favorable for selling new shares, not for buying shares.
If management was issuing new shares AND issuing significant new debts to finance new acquisitions, I could treat the entire thing as part of a balanced growth strategy.
UDR isn't a bad company, but I don't like investing at the current price. The AFFO (adjusted funds from operations) yield is at 4.28%, which in my opinion is too low relative to the growth prospects for AFFO on a per share basis. Rapid growth in total AFFO that is funded by expansion in the share base is only valuable if the increase in AFFO exceeds the increase in shares. I expect that will happen, but I don't expect AFFO/share to grow fast enough to provide enough return to shareholders to satisfy my requirements for return.
This article discussed AFFO, which is a non-GAAP measure. Non-GAAP measures should not be used in place of figures calculated in accordance with GAAP.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.