Preferred Apartment Community (NYSE:APTS) is the highest yielding apartment REIT out there. Currently, it offers ~7.3% dividend yield, whilst the average for its sector peers is 3.8%. Obviously, for a high current income-oriented investor, APTS causes a natural interest to explore the REIT further.
My thesis is based on three aspects, which bode well for the APTS's future in covering and even growing its already sky-high dividend payments.
While there are some potential risk areas such as exposure to retail segment and issued real estate loans, the aforementioned strengths clearly outweigh the odds of experiencing a dividend cut or a permanent loss of capital.
In almost every situation, where a stock provides above-average yield, there are some caveats that come along. APTS is not an exception. Below, you can see the offered dividend yield for each of the publicly-traded apartment REIT as of August 31, 2019.
Source: Nareit (created by the author)
Clearly, APTS leads the list by a huge margin with its yield being ~4% above the sector average.
The main reason why the market is pricing APTS's stock in such a manner is the exposure of its asset portfolio. APTS is not a pure apartment REIT compared to most of its peers. There are 7 separate segments to which the allocation is shifted:
While the four largest groups comprising ~89% of the total portfolio, generally, are not perceived to be very risky, the remaining 11% should be viewed with extra caution. Loan investments require much higher premium to account for the embedded cyclicality. These investments are much more sensitive to economic downturns, and as illustrated by valuations (and ultra-high dividend) yields of mREIT vehicles, the market indeed tends to discount their future cash flows more conservatively.
Moreover, 21.18% exposure to retail segment can also be viewed negatively. Fear of e-commerce, changing customer behavior, and looming recession risks render the asset class unattractive. For instance, Simon Property Group (SPG), the largest mall REIT with ~$46 billion in market cap, has seen its share price decline by ~14% in the last 52-week period, even though the underlying fundamentals have remained strong.
Plus, it is important to add that APTS has leveraged its balance sheet more than other apartment REIT players. Its debt ratio stands at 78.6% and debt to EBITDA ratio at 9.9x, while the corresponding sector average figures are 43.3% and 8.1x, respectively. The level of APTS's indebtedness commands greater risk premium, which pushes the valuations down and lifts the dividend yield up accordingly.
So, now, when we understand why APTS is able to offer so high dividend yield, let's explore some arguments why the probability of suffering a dividend cut is low.
Usually, when a company pays something above 5% in dividends, the current growth and its outlook are quite minuscular. However, APTS shows the opposite.
For the quarter ended June 30, 2019, APTS rental revenue increased approximately 3.4% and the operating expenses increased 1.5%, resulting in an increase in net operating income of approximately 3.9% as compared to the quarter ended June 30, 2018. The occupancy rate experienced a small hike reaching strong 95.6%.
The development of NOI marked a 7th straight increase for the Company's rental income.
Furthermore, the mid range for APTS's underlying FFO per share growth estimates for 2019 is 5%. And according to Nareit, FFO growth is projected to advance reaching 6.3% in 2020.
So, for a current income-seeking investor, especially for this level of yield, it happens rarely that a Company is able to provide some underlying growth. Essentially, the fact that APTS keeps increasing its FFO mitigates the risk of suffering dividend cuts and, ultimately, comforts investor in receiving its quarterly cash inflows.
Last but not least, FFO payout ratio for a ~7% yielding REIT is at a very acceptable level of 73.9%. AFFO payout stands at 85.0% for the trailing twelve-month period ended June 30, 2019.
The debt saturation is rather high for APTS and the corresponding interest payment coverage with EBITDA lies above the sector average. However, the management has done a remarkable job in structuring the maturity schedule. As you can see in the picture below, majority of the loans fall due in 2028 and beyond. In 2019-2020, the loan amount to be refinanced is insignificant as well.
The current level of 78% debt ratio and above-average interest coverage ratio put a constraint on the APTS's future growth. Given the sector averages, the implied additional loan capacity is low. Hence, investors should not expect a major capital appreciation here. However, the aforementioned loan maturity schedule indicates that in case of a recession, the Company should be able to refinance its loans without doing extra share offerings or liquidating its properties at considerable discounts.
So, from the lens of a dividend investor, APTS is a safe stock despite the seemingly high indebtedness.
Above, I have listed 7 individual asset groups to which APTS has exposed its portfolio. While there are some risky allocations such as real estate loans and retail, the substance of these assets and the broad allocation make the entire Company much safer.
When investing in REITs, you will look how diversified the Company's portfolio is usually within a single sector. However, APTS hits two rabbits with one shot. The portfolio allocation to 7 separate asset classes allows investors to suffer smaller drawdowns in case, for instance, one particular segment in the portfolio goes out of favour. And, secondly, the intra-segment allocation is very diversified as well - as illustrated in the picture below.
On top of the spread out investments comes asset-specific argument. Namely, the type of property and location indicates that APTS will withstand eventual crisis without eroding its underlying cash flows. Plus, APTS has a good chance to increase its rents even further.
All in all, Preferred Apartment Community REIT is a very attractive investment, especially for a high income-seeking investor. The Company's current level of dividend is well covered with strong cash flows, which are projected to increase in the coming years. Again, usually for ~7% dividend stock, this is not the case. The flexible balance sheet and non-cyclical assets come in handy for protecting the Company's cash flow going forward.
By investing in APTS, one should be able to count on receiving high level of current income and experiencing even some moderate returns from capital appreciation.
This article was written by
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.