5% Yield And 30% Upside From Armada Hoffler
Summary
- Armada Hoffler owns mostly apartment communities and they are performing remarkably well.
- Moreover, it has a real estate construction arm that's set to profit from the boom in new real estate development.
- Despite that, it is discounted because it is seen as a complex diversified REIT. As AHH continues to evolve into a quasi-apartment REIT, we expect its valuation to rise.
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Armada Hoffler (NYSE:AHH) is an undervalued REIT that we estimate to have ~30% upside to fair value, and while you wait, you earn a near-5% dividend yield. Below, we present 5 reasons why now may be a good time to initiate a position in the company:
Reason #1: Multifamily Exposure at a Discounted Price
Today, the owners of multifamily apartment complexes are doing extremely well. This is because of the combination of three things:
- Rents are rising the fastest in 15 years.
- Cap rates are compressing to the lowest levels ever.
- Debt is cheap and abundant.
When your NOI surges all while cap rates compress and your property is 50% leveraged, you end up with substantial returns on equity. To give you an example, if you assume that:
- The NOI rises by 8%
- Cap rates compressed from 5.5% to 4%
- And you have a 50% LTV (which is the case for AHH)
Then your equity in the property becomes nearly twice as valuable. That's a near-100% return on equity in a single year.
Not surprisingly, most apartment REITs have gained significant value over the past year and many now trade at >30x FFO and large premiums to pre-covid levels. Great examples of that include Independence Realty Trust (IRT), Mid-America (MAA), and Camden Property (CPT):
Since this is now well-known to the market, it is now getting difficult to find undervalued apartment REITs.
AHH is one exception.
It is not a pure-play apartment REIT, but it is its largest property sector and its exposure to it is rising rapidly. The management has noted that 1/3 of their NOI will soon come from multifamily:
However, here it is important to remember that multifamily real estate trades at much lower cap rates than retail and office properties, and therefore, multifamily as a fraction of the portfolio net asset value is a lot higher. This is particularly true since they own some really nice multifamily properties that are performing exceptionally well:
"Apartment leasing and occupancy continue to exceed all reasonable expectations. Our 2,300 conventional multifamily units are now over 97% occupied. The same-store NOI increase of 12% on these properties, only begins to tell the story of the desirability of these assets and their locations. Rent increases and new leases signed in the third quarter averaged over 9%. With the continued migration to high-value properties in the sought after markets of the Mid-Atlantic, coupled with a shortage of housing, our expectation is that 2022 will be another strong year for these assets." AHH's CEO
Depending on the cap rates that you use, AHH's asset base is already 50-60% multifamily today, and this will rise higher as the company continues to develop new communities and/or sell retail/office properties.
"Pre-pandemic, we detailed a plan to reduce the percentage of NOI contributed from retail properties through strategic dispositions, increase the percentage of multifamily NOI through development and off-market acquisition, and decrease the volume of mezzanine loan activity. We believe this results in a qualitatively stronger income stream and higher per share asset value over the long term."
This appears to be ignored or at least overlooked by the market as AHH is priced at just 14x FFO and a 20% discount to pre-crisis levels, despite being arguably more valuable than ever (more on that in section #4).
The office and retail assets are today blurring the picture and distracting the market, but even if you gave those very little value, the stock would remain unusually cheap relative to multifamily peers. We are confident that the management will figure out a way to close the gap (more on that in section #3).
Reason #2: Valuable Construction Know-How and Services
Most REITs buy stabilized income-producing properties, but some REITs may go a step further and develop their own properties in order to achieve higher yields and create more value for shareholders.
AHH is one of the most active real estate developers in the entire REIT space. It is so active that it has its own construction crew and also provides construction services to other real estate investors. We think that this is a big advantage in today's environment because we expect a construction boom over the coming years, and with cap rates compressing lower, you want to own REITs that have the ability to develop their own assets:
Source: AvalonBay Communities (AVB)
Currently, AHH's development pipeline has an estimated value of $624 million, which is very significant for a company with a $1.2 billion market cap. For this reason, some investors (incl. SA author Dane Bowler) have categorized AHH as a "Development REIT" rather than a traditional buy & hold type of REIT. AHH operates more like a private equity firm and it is focused on creating value earlier in the life-cycle of properties. We think that these development projects will lead to significant value creation in the years ahead.
Reason #3: Shareholder-Friendly Management With a Clear Plan to Create Value
AHH often gets lumped in the same group as other diversified REITs that lack a clear focus/strategy. Most of those REITs have historically done poorly and should be avoided because they lack a clear path to market outperformance.
That's not the case with AHH. Quite the opposite: leading up the pandemic, it generated nearly 2x higher returns than the broader REIT market (VNQ) since going public:
That's because despite being a "diversified REIT", AHH actually has a unique strategy and a clear path to generating alpha-rich returns for shareholders.
First off, while it lacks a property type focus, it has a geographic focus on the mid-Atlantic/Southeast region. We often say that you cannot be a jack of all trades, and while that's true, AHH is still able to operate across all major property segments because of its geographic focus and its 40-year history of investing in this region.
Secondly, AHH isn't just buying what the market is offering to it. Instead, it is developing its own properties to earn better returns and create more value.
Thirdly, AHH can improve its profitability and growth by offering construction services to other investors, which is particularly beneficial in today's environment.
Finally, unlike most diversified REITs, AHH is managed by a team that owns 14% of the equity, representing ~$270 million of skin in the game.
"In short, we anticipate that our activities over the course of 2021 will build a solid case for expansion of our multiple and ultimately lead to higher earnings and dividends over the next several years. As the Company's largest equity holder, your management team remains committed to generating long-term value for all shareholders." AHH's CEO
All of that makes AHH different from other diversified REITs. Its management is well-aligned with shareholders and it has a unique strategy that has historically outperformed, and given today's environment, it is well-positioned to deliver more outperformance in the future.
In that sense, it makes little sense to criticize AHH for lacking a specialization by property type. Yes, that's true, but AHH has instead a specialization by geographical region and a clear focus on delivering superior results by developing its own assets and providing construction services.
I would add that if becoming a pure-play apartment REIT in the future is what would create the most value for shareholders, then I am confident that the management would go that path. Once again, the management is the biggest shareholder of the company.
Reason #4: Large Discount to Fair Value
Today, we can objectively say that AHH's properties are more valuable than ever.
Cap rates have compressed across the board, and especially so for multifamily properties. As a result, AHH's development pipeline has also become a lot more valuable.
Pre-pandemic, its NAV was estimated to be ~$18 per share. It's hard to quantify, but today's NAV would certainly be higher than that, likely in the low to mid $20s.
Yet, the share price is just $14.50 because the stock collapsed in early 2020 and failed to recover as it kept stagnating with other diversified REITs:
That's a large discount to NAV for a well-managed REIT with a track record of success and a unique strategy that is ideal for today's environment.
Based on P/FFO, AHH is currently priced at 14x FFO. The FFO growth of AHH is bumpy due to its development projects and construction services, but given the environment, we expect rapid growth in the years ahead, and more importantly, the rising exposure to multifamily real estate warrants a higher multiple.
We think that ~18x FFO would be a lot more reasonable for AHH, which is right where it traded before the pandemic. It would still price it at a large discount relative to apartment REIT peers, reflecting its lack of specialization, but it would give it credit for its large and growing apartment portfolio, its massive development pipeline, and its past track record of success.
If and when AHH rerates at 18x, it will unlock 30% upside to shareholders.
Reason #5: Generous and Rising Dividend
Most apartment REITs yield right around 2% at today's valuations.
In comparison, AHH is currently priced at a near-5% dividend yield, and best of all, the management just announced a 6% dividend hike.
Even after the hike, the dividend payout ratio remains a reasonable 64%, and given all the catalysts that the company has, we expect the dividend to keep rising higher in the years ahead.
As such, you get paid to wait, enjoy better margin of safety, and you are less dependent on the changing market sentiment of the company.
Bottom Line
AHH is not quite an apartment REIT, but it is a development REIT with a portfolio of valuable apartment communities, and resilient retail/office assets.
If you think that we are going to experience a construction boom, then this is precisely what you would want to own, and especially so at today's discounted share price. We expect 30% upside, and while you wait, you earn a near-5% dividend yield.
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This article was written by
Samuel Smith is Vice President of Leonberg Capital, he has a diverse background that includes being lead analyst at several highly regarded dividend stock research firms. He is a Professional Engineer and Project Management Professional and holds a B.S. in Civil Engineering & Mathematics from the United States Military Academy at West Point and has a Masters in Engineering.
Samuel runs High Yield Investor investing group. Samuel teams up with Jussi Askola and Paul R. Drake where they focus on finding the right balance between safety, growth, yield, and value. High Yield Investor offers real-money core, retirement, and international portfolios. The services also features regular trade alert, educational content, and an active chat room of like minded investors. Learn more.Analyst’s Disclosure: I/we have a beneficial long position in the shares of AHH; CPT; AVB 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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