Armada Hoffler Properties: Strong Industry Dynamics Coupled With Strong Management Indicate Upside Potential

Summary

  • AHH has a very high-quality portfolio that we believe is seen through their strong occupancy levels currently at 94.1%.
  • We believe going forward AHH's occupancy levels should continue to rise as more and more students return to school in person.
  • We believe AHH represents an attractive investment opportunity backed by decades of experience in the industry by management.
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Armada Hoffler Properties (NYSE:AHH) is repositioning its portfolio for growth and represents an opportunistic way to play a reopening trade. AHH’s diversified portfolio with high occupancy rates, coupled with strong industry dynamics and a healthy development pipeline, should result in a growing NAV and stock price. In addition, AHH’s dividend yield of 4.7% is attractive. We initiate with a BUY rating and a $17.50 price target.

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Investment Thesis

  • Armada Hoffler Properties is a self-managed REIT with four decades of experience in developing, acquiring, and managing high-quality office, retail, and multi-family properties.
  • The stabilized property occupancy rate for AHH was 94.1% as of Q2:21, which reflects AHH’s high-quality portfolio.
  • We are encouraged by a strong development pipeline which should support NOI growth. AHH expects its portfolio NOI to climb by over 40% from 2020 levels when current development projects are fully stabilized.
  • A diversified portfolio with high occupancy rates, coupled with strong industry dynamics and a healthy development pipeline, should result in a growing Net Asset Value (NAV) and stock price. In addition, the dividend yield of 4.7% is attractive.
  • The Company is poised to grow its earnings over the near to medium term. We initiate coverage with a BUY rating and a price target of $17.50.

Primary Risks

  • The Company is dependent on timely completion of its development projects. Failure to remain on schedule can lead to cost overruns, which can impact profitability.
  • The Company is dependent on external capital to fund its asset purchase. There is risk of dilution from any future equity offerings.

Investment Thesis

Armada Hoffler Properties is a self-managed REIT with four decades of experience in developing, acquiring, and managing high-quality office, retail, and multi-family properties across the Mid-Atlantic and Southeastern regions of the U.S. We view the Company’s focus on Mid-Atlantic and Southeastern regions of the U.S. positively given the favorable supply and demand characteristics and limited competition from other large, well-capitalized operators.

Armada Hoffler Properties is weathering the current environment and has maintained strong occupancy levels. The overall stabilized property occupancy rate for AHH was 94.1%, which reflects AHH’s high-quality portfolio. The development pipeline at AHH is robust and heavily weighted towards multi-family and office properties which in our opinion is positive as it will smooth NOI evenly across their three asset classes.

Looking forward, AHH’s bottom line should improve as student housing occupancy should increase with students returning to school and as new developments begin. Meanwhile, AHH maintains a sound balance sheet and a well-covered and growing dividend. The current dividend yield is 4.7% or $0.16 per share as reported in Q2:21.

We believe AHH is well-positioned to deliver solid normalized FFO growth in 2021 due to a combination of higher NOI from 2021 leasing of pandemic-related vacant space, new leasing, and tenants occupying Wills Wharf, a full-year impact of acquisitions, and development project deliveries.

We initiate coverage with a BUY rating and a $17.50 price target.

Our recommendation is based on an expectation that management can execute on their growth plan while maintaining balance sheet leverage without incurring large amounts of additional debt.

High Occupancy Ensures Cash Flow Visibility

AHH continues to weather the current environment and has maintained strong occupancy levels with a stabilized property occupancy rate of 94.1% as of Q2:21. The occupancy was strong across all assets – office at 96.5%, retail at 95%, and traditional multi-family at 97%, reflecting strength across its portfolio. The only outlier was student housing which had occupancy of 84%, but we expect that metric to increase as students return to on-campus learning this year.

The presence of tier-one tenants at Armada Hoffler retail and office properties has allowed the firm to weather the pandemic better than others. The Company’s office and conventional multifamily property portfolios maintained occupancy in the mid-90% range and rent collections were near 100% during the pandemic.

Management noted during Q2 that the leasing activity across all sectors of its core portfolio is at its highest velocity. Conventional multi-family units saw strong demand with new leases signed during Q2 seeing an average rate increase of more than 7%. The cash same-store NOI also increased 12% YOY during Q2:21. This increase suggests a strong rental desire of AHH’s assets and their locations. We expect leasing to remain strong given a shortage of housing and a migration to high-value properties in the mid-Atlantic.

Retail leasing continues to trend upward at a rapid pace. Management expects their retail portfolio to eclipse pre-pandemic NOI levels sometime early next year as occupancy rises and new tenants begin to pay rent. The office portfolio is also looking strong with activity increasing at Wills Wharf, the office building at Baltimore’s Harbor Point which was built in 2020 and had occupancy of only 59.6% as of Q2:21. This property was clearly impacted by the pandemic but is better positioned now as companies are starting to return to the office setting. Similarly, tenant activity is starting to accelerate at Wills Wharf. AHH announced two substantial leases with Transamerica and RBC during Q2:21 and has an abundance of prospects for their remaining space. We expect further leasing to occur in the building during the remainder of the year.

We note that the full impact on earnings of new office and retail leases and the rise in multifamily rents will not be reflected until 2022 but the upward trajectory of AHH’s core portfolio bodes well for the Company.

Exhibit 1: Average Occupancy Has Been Around 95% Since IPO in 2013

Source: Armada Hoffler Properties and Singular Research

Strong Development Pipeline to Support NOI Growth

The development pipeline at AHH is robust and heavily weighted towards multi-family and office which in our opinion is a positive as it will smooth NOI across their three asset classes. Currently, four projects are under development totaling nearly $250 million and are heavily weighted to the multi-family sector. Given the robust market for these types of assets in the Southeast, AHH expects to eclipse its historical 20% spread between cost and value on these facilities.

Their development pipeline includes - a $52 million 223-unit multifamily property being developed in Gainesville, GA, a $45 million 228-unit multifamily property at Harrisonburg, Virginia, a $54 million 238-unit multifamily property, Chronicle Mill, at Belmont, North Carolina, and a $95 million mixed-use project in Roswell, GA that includes 137,000 square feet of retail space and 137 apartments.

The Gainesville project is scheduled to begin pre-leasing by the end of this year with initial occupancy expected in Q1:22. Chronicle Mill is scheduled for delivery in Q3:22. Both these projects should see strong leasing based on the activity in the Atlanta and North Carolina markets. Together, with two other projects (Harrisonburg and Roswell), AHH will add nearly 700 units to its conventional multifamily portfolio, bringing the total count to over 3,000 units.

Additionally, there are two joint venture (50:50) projects under development totaling $442 million and one project in pre-development stage. The projects in predevelopment are expected to start construction late this year or early next year.

Exhibit 2: Development Pipeline

Source: Armada Hoffler Properties and Singular Research

AHH expects its portfolio NOI to climb by over 40% from 2020 levels when the current development projects are fully stabilized. Furthermore, the share of multifamily and office in total NOI is expected to increase, while retail is expected to decrease to 32% (versus 43% in 2020).

AHH’s share of the cost of the seven development projects is $440 million. The Company has already incurred $162 million of that cost as of Q2:21, leaving $278 million further to be invested. We believe that with its liquidity position of $170 million, the potential sale of non-core assets, and a strategic use of the ATM program, AHH is well-positioned to fund these projects.

Exhibit 3: Development Projects to Lead to Strong NOI Growth

Source: Armada Hoffler Properties and Singular Research

Dividend on Course for Steady Growth

AHH has a history of raising its annual dividend. The Company raised its annual dividend every year from 2014 through 2019, from $0.64 to $0.84 per share. The pandemic forced the Company to decrease their dividend in 2020. AHH suspended its dividend for Q2:20 and then lowered it to $0.11 in Q3:20 and held it constant in Q4:20.

However, prospects are beginning to look optimistic for the rest of 2021. In February 2021, the Company announced a 36% increase to its Q1:21 cash dividend resulting in a dividend of $0.15 per share. Furthermore, in May 2021, AHH announced a Q2:21 payout of $0.16 per share. This increase represented the second consecutive quarterly increase, up by 6.7% quarter-over-quarter and by 45.5% year-to-date.

The Q3:21 dividend was maintained at $0.16 per share. While the dividend did not increase, management sounded optimistic about delivering dividend increases over the next few years in their latest earnings call. The fact that the Company raised its full-year FFO guidance for 2021 suggests that the management has confidence to not just maintain its dividend but raise it over the coming quarters.

Business Overview

Armada Hoffler Properties is a vertically integrated, self-managed REIT with four decades of experience developing, building, acquiring, and managing office, retail, and multifamily properties. AHH also offers general contracting services to third-party clients. The Company currently has most of its producing assets and development projects in the Mid-Atlantic and Southeastern regions.

Armada Hoffler has 57 properties representing approximately 5.3 million rentable square feet of office and retail space, plus 2,344 multifamily units, and four properties under development. The Company has had historically high occupancy rates across all three categories. AHH’s office and traditional multi-family sectors have maintained mid-ninety occupancy and near 100% rent collection, performance that is indicative of the strength of its assets and their respective markets.

Exhibit 4: Occupancy Rates

Source: Armada Hoffler Properties and Singular Research

Retail is the largest contributor to the Company’s NOI at 49%, followed by Office at 27%, and multifamily at 23%. We note that going forward the contribution of NOI from retail will decrease relative to other sectors due to the predominantly multi-family and office make-up of AHH’s development pipeline.

Exhibit 5: NOI Contribution by Segment

Source: Armada Hoffler Properties and Singular Research

The office and retail portfolios have minimal lease expirations this year and in 2022. Only 5.3% of total office annualized rent is expiring through 2022, while 10.4% of total retail annualized rent is expiring during the same period. We believe the staggered lease expirations provide a steady stream of cash flow and mitigate vacancy risk.

Exhibit 6: Office Lease Expirations as of Q2:21

Source: Armada Hoffler Properties and Singular Research

Exhibit 7: Retail Lease Expirations as of Q2:21

Source: Armada Hoffler Properties and Singular Research

For AHH, however, the primary avenue for growth is through bringing properties online via its development pipeline and the selective acquisition of high-quality properties that are well-located in their submarkets. Additionally, the growth is also gained through increasing rental rates and high occupancy while managing/reducing costs on Company properties. We believe that AHH benefits from its construction and development expertise which provides a high level of quality control while ensuring that the projects are completed more quickly and at a lower cost than a third-party general contractor.

U.S. Real Estate Industry Outlook

The combination of a speedy vaccine rollout and a large fiscal stimulus implies a strong GDP growth rate for the U.S. this year. According to the Federal Reserve, U.S. GDP is forecasted to grow at nearly 5.9% in 2021 which should buoy stronger demand prospects across property sectors. There is a strong recovery in the multifamily, industrial, and retail property markets, while the recovery has not been as robust in the office and hotel property markets. High transmission of delta variant cases has held back the return of workers to the office setting.

According to data from the National Association for Realtors, absorption in the multifamily market is at a decade-high level, with asking rents up nearly 11% YOY in Q3:21. In the retail market, rents are up by 2% YOY, while the office market continues to experience a decline in occupancy, with 144 million square feet of office space released to the market and the average asking rent declining by about 0.5% YOY.

The labor market in the U.S. continues to remain tight. According to the Labor Department's latest monthly report, job openings were at a record high of 10.9 million as of the end of July 2021. As of August 2021, the economy has created 17 million net new jobs which are equivalent to 76% of the 22.4 million jobs lost at the onset of the pandemic during March and April 2020. In 2021, an average of 586,000 jobs has been created monthly.

Inflation has continued to accelerate in the U.S., reflecting a combination of strong demand and supply bottleneck effects. Headline inflation came in at 5.3% for August 2021. Although inflation could be a dampener, we note that the Federal Reserve expects inflation to be transient. If that is the case, real estate should continue to benefit from a solid economic outlook.

Armada Hoffler Properties is currently capitalizing on these industry trends and appears well-positioned with its office, retail, multifamily segments, and other property locations. The Company’s development pipeline is weighted towards the multifamily segment which remains the strongest out of the three.

Exhibit 8: Rising Absorption and Declining Vacancy Rates Except for Office Properties

Source: Armada Hoffler Properties and Singular Research

Management and Shareholders

The Company is led by CEO Louis Haddad. He was appointed as CEO in 1999. Under his leadership, Armada Hoffler became one of the largest commercial real estate companies in the State of Virginia. In 2013, Mr. Haddad spearheaded the Company’s initial public offering and transition into a publicly-traded REIT listed on the NYSE. He is also supported by other experienced management, including Chief Financial Officer, Michael O’Hara who has been associated with AHH since 1996.

On AHH’s most recent earnings press release, the Company reported 81.84 million shares outstanding. A summary of key shareholdings follows.

Exhibit 9: Key Shareholdings - Insiders and Institutions

Source: Armada Hoffler Properties and Singular Research

Recent Financial Results

The second quarter of 2021 reported total revenues of $65.7 million, down compared to $97.3 million in Q2:20. The decline was primarily due to lower contracting and real estate services revenue, partially offset by higher rental income. Rental revenues increased across all three segments – Office, Retail, and Multifamily. Overall, net operating income (NOI) was $30.9 million, compared to $29.4 million in the prior year’s quarter.

Stabilized operating property portfolio occupancy increased to 94.1% as of June 30, 2021. Office occupancy was 96.5%, retail occupancy was 94.7%, and multifamily occupancy was 92.2%. Within the multifamily segment, conventional apartment occupancy was 96.6% and student housing occupancy was 83.5%.

Net income was $5.6 million, or $0.07 per diluted share, compared to $11.2 million, or $0.14 per diluted share, for the three months ended June 30, 2020. Normalized funds from operations (FFO) was $23.3 million, or $0.29 per diluted share, compared to $22.6 million, or $0.29 per diluted share, for the three months ended June 30, 2020.

EPS Guidance and Estimates

For fiscal 2021, we forecast revenue of $286.7 million with rental revenues up 13% YOY at $187.8 million. We forecast net operating income (NOI) at $122.8 million, a 4.9% increase versus FY:20. This estimate is in line with management’s guidance range of $122-$123 million. We forecast normalized funds from operations at $86.8 million or $1.06 per diluted share.

For 2022, we expect revenue of $310.3 million with rental revenues up 8% YOY at $202.8 million. We forecast net operating income (NOI) at $135.3 million, up 10.1% versus FY:21. We forecast normalized funds from operations at $91.9 million or $1.10 per diluted share.

Investment Risks

  • The Company is dependent on the timely completion of its development projects. Failure to remain on schedule can lead to cost overruns which can impact profitability.
  • The majority of the Company’s properties are in Virginia, Maryland, and North Carolina which exposes AHH to geographic risks. Properties in the Virginia, Maryland, and North Carolina markets represent approximately 52%, 23%, and 14% of the total annualized base rent, respectively.
  • Morgan Stanley is the Company’s top office tenant, with 16.2% of AHH’s annualized base rents for office space. This dependence upon one tenant creates a risk for the Company should Morgan Stanley become unable or unwilling to continue leasing the space.
  • High debt remains a concern. AHH’s leverage rate (debt to EBITDA) was 6.7x as of the end of Q2:21.
  • The Company is dependent on external capital to fund its asset purchase. There is risk of dilution from any future equity offerings.

Valuation

We value AHH using industry peer companies (P/Normalized FFO multiple) blended with our Net Asset Value (NAV) valuation to derive a fair value target price for the company.

AHH trades at 12.9x 2022 Normalized FFO per share, which is at a significant discount to the peer group average of 16.4x. We believe this discount should narrow as the Company appears well-positioned to deliver strong NOI growth over the next few years. We value AHH at 14x 2022 Normalized FFO per share of $1.10. We weight this discounted multiple target to equal 50% of our price target. The multiple-based target price is $15.41.

We weight the other 50% of our target using our Net Asset Value (NAV). We value AHH’s income-generating assets (excluding contracting services) at 2022 NOI of $135.3 million using a cap rate of 5.5%. The other assets are valued on either book value or their corresponding market values. Our NAV produces a value of $19.28 per share.

The combination of $15.41 at 50% and $19.28 at 50% results in a weighted average price target of $17.35 which we round up to $17.50. Exhibits ten and eleven below summarize our peer group multiples and the NAV model.

Exhibit 10: Armada Hoffler Properties Peer Group Multiples and Price Targets

Source: Armada Hoffler Properties and Singular Research

Exhibit 11: AHH Net Asset Value (NAV) Model

Source: Armada Hoffler Properties and Singular Research

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Disclosure: I/we have a beneficial long position in the shares of AHH either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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