UDR: Strong Growth Outlook But Fairly Valued

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About: UDR, Inc. (UDR)
by: Ploutos Investing
Summary

UDR Inc. owns a portfolio of multifamily housing properties in top-tier cities across the U.S.

The REIT should benefit from long-term population growth trends and below national average housing affordability rates in its major markets.

UDR currently pays a growing 2.7%-yielding dividend, but its shares are fairly valued.

Investment Thesis

UDR Inc. (UDR) delivered a solid Q2 2019 thanks to robust demand and strong fundamental in its major markets. Looking forward, the REIT should continue to benefit from favorable demographic trend and strong market fundamentals in its major markets. UDR currently pays a 2.7%-yielding dividend but its shares are not cheap right now. Therefore, we think a pullback will provide a better risk and reward profile.

Chart

Data by YCharts

Recent Developments: Q2 2019 Highlights

UDR delivered a solid Q2 2019 as the company saw its same store revenue increased 3.7% year over year. Thanks to its effort to contain its operating expenses growth, the company was able to deliver same store net operating income growth of 4.2%.

Source: Q2 2019 Press Release

UDR also has a very strong start to Q3 2019. As can be seen from the chart below, its same store NOI growth quarter-to-date is 3.8%. This remains solid versus Q2 2019’s 4.2%.

Source: September 2019 Investor Presentation

Earnings and Growth Analysis

We continue to have a positive outlook on UDR for the following reasons:

A focus in top-tier cities in the U.S.

UDR has a geographically diversified portfolio of residential properties across top-tier U.S. markets.

Source: September 2019 Investor Presentation

We like UDR’s focus in top-tier markets as these markets are important markets in the U.S. Below is a chart that shows the population growth and affordability index in UDR’s top 10 markets. As can be seen from the table, these 10 markets represent nearly 86% of UDR’s total net operating income. A research report published by PwC projects that these top 10 markets will grow its population by an annualized population growth rate of 0.8% annually in the next 5 years. This will be higher than the national average of 0.7%. Residential units in these top-10 cities are also much less affordable for homeowners. As can be seen from the chart, the weighted average of these top-10 markets have a weighted average affordability index of 81.9 (the lower the least affordable). This is below the national average of 151.7. Therefore, we expect demand for residential rental units will remain strong in these cities in the next few years.

% of Total NOI

5-year annual projected Population Growth

Affordability Index

Washington DC

15.6%

0.9%

80.0

Orange County

13.8%

0.8%

57.1

San Francisco Bay Area

11.9%

0.5%

48.2

New York

10.0%

0.2%

51.9

Boston

8.5%

0.5%

112.1

Seattle

8.4%

1.1%

98.4

Los Angeles

4.5%

0.2%

58.9

Tampa

3.6%

1.1%

144.4

Dallas

3.5%

1.7%

145.4

Orlando

3.2%

1.7%

131.5

Nashville

2.9%

1.4%

142.3

Total/(Weighted Average)

85.9%

0.8%

81.9

National Average

0.7%

151.7

Source: Created by author; Emerging Trends in Real Estate 2019

Besides above national average population growth rate, total income growth in UDR’s top 10 markets are also higher than the national average. As can be seen from the chart below, the weighted average total income growth in UDR’s largest markets is 5.9% in the past year. This is higher than the national average of 5%.

Source: September 2019 Investor Presentation

Favorable demographic trend

In PwC’s latest report, the organization also observed the trend of younger generation population that seems to prefer rent to owning homes. As can be seen from the chart below, homeownership rates by age of household in the United States have gradually declined in the past two decades. We believe UDR’s residential rental business will benefit greatly from this new demographic trend.

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Source: Emerging Trends in Real Estate 2019

Limited national supply should continue to support rental rate growth

Management noted in its latest conference call that new apartment deliveries in 2019 are expected to be relatively stable-to-slightly increasing versus 2018. This is inline with the trend we have seen nationally. As can be seen from the chart below, the number of housing units for rent in the U.S. have been on a declining trend since 2009. In addition, only 4% of the anticipated 2019 national deliveries are expected to be within 1 mile of a UDR community. Therefore, the impact should be minimal.

Source: Federal Reserve Bank of St. Louis

On the macroeconomic level, the U.S. economy remains strong and the nation continues to add more jobs. This should support residential rental demand, not to mention organic population growth in its major markets. Therefore, we do not anticipate a slowdown in its rental revenue growth in the near-term.

Technology and process initiatives to deliver operating efficiency in the next 5 years

UDR has historically been active in seeking ways to grow its same store revenue and improve its operating margin. The company has a 5-year initiative program to generate efficiencies and improve its resident satisfaction. These initiatives are outlined in the table below.

Phase 1 (2018-2020)

Invest in and install SmartHome technology (e.g. keyless locks, thermostats, water leak detectors, smart switches, etc.) to enhance its revenue and to improve operating efficiency

Phase 2 (2020-2021)

Develop an enhanced suite of self-service options (e.g. resident app)

Phase 3 (2020-2023)

Analyze the internal data to better price its apartments and operate its communities

Source: Created by author; Company Reports

An investment grade balance sheet

UDR has a solid balance sheet with investment grade credit ratings of BBB+ (S&P), and Baa1 (Moody’s). The company’s total debt only represents about 32.1% of its total assets. It also has a healthy debt to EBITDA ratio of 5.4x and fixed charge coverage of 4.9x. The company has a staggered debt maturity profile with only 25.6% of its debts maturing in the next 3 years. Given the low interest rate environment we are in, refinancing the debts is not an issue. We think UDR's strong balance sheet will help support its growth projects.

Source: September 2019 Investor Presentation

Valuation Analysis

UDR expects to generate adjusted funds from operations of $1.89 ~ $1.92 per share in 2019. Using the midpoint of its guidance, UDR is trading at a price to AFFO ratio of 25.7x. This is inline with other major residential REITs that trades in the range of 24x ~ 26x.

A growing 2.7%-yielding dividend

UDR currently offers a quarterly dividend of $0.343 per share. This is equivalent to an annual dividend yield of 2.7%. The company has increased its dividend every year since 2011. As can be seen from the chart below, its dividend yield is towards the low end of its past 10-year yield range. UDR’s dividend is safe with an expected dividend payout ratio of 72% in 2019 (based on its AFFO).

Chart

Data by YCharts

Other Risks and Challenges

Macroeconomic risk

Although people always need to find a place to live, it will be challenging for UDR to raise rental rates in an economic downturn. This is because layoffs will likely result in lower demand for apartment rentals.

Elevated supply risk

Favorable long-term demographic tailwind and a lengthy period of short supply have the potential to trigger lots of new constructions. If there are a lot of new supplies coming to UDR’s markets, it may negatively impact management’s ability to raise rental rates.

Investor Takeaway

We like UDR’s high quality portfolio and its long-term growth outlook. However, its shares are not cheap at the moment. We think a pullback will provide a better risk and reward profile.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.