Mid-America Apartment Communities: Higher Rates Take Their Toll, Opportunity Emerges (Rating Upgrade)

Summary

• I suggested caution on MAA during my last review given the macro-backdrop and the fact the stock had seen a nice run.
• With the 16% drop, that caution was clearly warranted. While not fun for holders of MAA, this weakness opens up a buying opportunity yet again.
• Be mindful of the broader headwind higher rates pose on the Real Estate sector. While MAA has mostly long-term debt, investors are not always discerning when it comes to sector sell-offs.
• The market is starting to price in a more dovish Fed starting later this year. While this may turn out to be incorrect, in the near term it provides a tailwind for income plays.
• This idea was discussed in more depth with members of my private investing community, CEF/ETF Income Laboratory. Learn More »

Bkamprath/iStock via Getty Images

Main Thesis & Background

The purpose of this article is to evaluate Mid-America Apartment Communities, Inc. (NYSE:MAA) as an investment option. The company is a "real estate investment trust that focuses on the acquisition, selective development, redevelopment, and management of multifamily homes throughout the Southeast, Southwest, and Mid-Atlantic regions of the United States".

I have been a long-term holder of MAA, starting back when I was a 20-something young professional in Charlotte, North Carolina. I was a resident of this property, as were many of my peers in the uptown/south-end neighborhoods. I saw first-hand the pricing power of these communities, not just in Charlotte but in other primary markets like Northern Virginia, Tampa, FL, and Dallas, TX, among others. Since then, roughly ten years ago, I was hooked as an investor.

Still, that doesn't mean I am a buyer at any cost. In fact, this was a REIT I suggested caution on during my last review. The price action seemed to be too optimistic, and I was concerned about an eventual market sell-off that did indeed occur. For perspective, consider MAA is down over 16% since then:

Stock Performance (Seeking Alpha)

This was a painful run to be sure. While not pleasant for holders, it has the fortunate impact of opening a reasonable entry point now. While the recent market volatility has been difficult to stomach, those are the times to be opportunistic. I see that opportunity here with MAA, and feel a rating upgrade to "buy" makes sense on this correction. I will explain the reasons why below.

Be Aware Of Macro-Forces Like Interest Rates

To begin, I will touch on one of the biggest attributes facing both the broader market, the Real Estate sector, and MAA by extension. This is interest rates - particularly the Fed's movement on rates. This is an extremely critical element because higher interest rates often take their toll on the Real Estate sector, and vice versa when rates decline.

I bring this up because it is not to be taken lightly. I mentioned this in my last review as a primary headwind facing MAA (and the broader market) and the performance since then vindicated my outlook. The Fed kept pushing rates higher on the backdrop of persistent inflation, and the market has tumbled. Income-oriented areas - such as bonds, Utilities, and Real Estate - were disproportionately hit because investors can get "risk-free" income via treasuries and savings accounts that become more competitive with what those sectors can offer. As a result, REITs are especially prone to movement in the Fed's funds rate. Ignoring this can be detrimental to overall performance, regardless of whether or not any individual company is equipped to handle it.

I say this because I made a point to emphasize MAA has mostly fixed-rate debt. I discussed this in my review that I was not worried about the long-term health of the company with respect to rates because management smartly locked in debt at a reasonable rate. Still, investors are often not as discerning when selling off a sector because of macro-headwinds like rates. As a result, MAA got caught up in the bearish wave along with the broader sector, highlighting why being blindly bullish is never a winning bet:

YTD Performance (Google Finance)

Clearly, one should have been discerning when it came to buying MAA so far in 2023 - and that is not going to change any time soon.

With this in mind, the logical question is, why am I bullish here? After all, I just spent this section explaining the macro-challenges facing REITs and why MAA got caught up in the selling regardless of the company's micro-ability to navigate the elevated rate environment.

The answer is that the market is starting to predict a less hawkish Fed going forward. With concerns over a recession heating up and inflation showing signs that it has peaked, investors are expecting (perhaps even demanding) the Fed to begin to reverse course of rates in the near future. For support, consider the dot plot, showing rates ending the year lower than where they currently are, and falling even further by 2025:

Fed Fund's Rate (Implied) (Bloomberg)

Clearly, the market does not expect many more Fed hikes going forward and has even begun to price in cuts. That is a net positive for REITs in the open market.

Now, I want to be very careful here. I personally feel the market is over-estimating a dovish Fed and is going to wind up being disappointed in the second half of the year. This is not meant to be contradictory because investor sentiment is what drives share prices. So, in the meantime, I see opportunity in MAA and Real Estate as a whole. But I would suggest readers be tactful and not to get overexposed. When the Fed disappoints, as it has done in February and March, the risk of a sell-off goes up substantially. So stay within your risk tolerance and be sure to capture short-term wins on the eventuality that this dovish outlook gets shifted when Q3 and Q4 get underway.

Apartment REITs Offer Low Vacancy Rates

I want to also discuss why I like apartments specifically going forward. This includes MAA, of course, but can also extend to other apartment REITs if one decides MAA is not the right fit for them. I mentioned above the role interest rates can have on the Real Estate sector, which is true, but we have to remember that "Real Estate" means many different things. Obviously we have residential and commercial, and within the commercial space there are sub-sectors. As stated, I like apartments REITs due to the resiliency they have during difficult times (nobody wants to be kicked out of their living quarters!), and in particular MAA's target demographic of white-collar young professionals in growing parts of the country. Furthermore, in relative terms, apartments currently have much lower vacancy rates compared to office and retail properties:

Vacancy Rates By Sector (JPMorgan Asset Management)

This makes the sector attractive in my opinion, for obvious reasons. Industrial properties look good from this metric as well, so looking for value there is certainly a straightforward play too.

However, the recent pick-up in apartment vacancy rates is something to monitor. While the rate is still below the other sectors I mentioned above, an increase is never something we want to see. But we have to remember this is the industry average, and MAA is actually beating it at the moment:

MAA's Metrics (MAA Investor Center)

In a nutshell, I see the apartment sector as a good option, and MAA as a leader within that sector. This makes it a buy to me here.

A Reasonable Income Play

Looking at MAA specifically, I do like this REIT as an income play. While the yield is going to be difficult to compete with savings accounts now that they have hit the 5% level in many cases, the dividend is still competitive. This is especially true when we consider that stocks/REITs have the potential for capital appreciation and income - savings accounts can't match that.

Aside from just offering a dividend, readers would find it useful to know the company increased the payout substantially in December. This new, higher dividend has been maintained so far in 2023 as well:

MAA's Dividend Announcement (MAA Investor Center)

If we annualize this payment, we see REIT offers a yield close to 4%:

Quarterly Dividend	Current Share Price	Current Yield
$1.40/share	$143.34	3.88%

Click to enlarge

Source: Author's calculation

I view this favorably. Is this a screaming buy signal? Of course not. But when I view MAA's recent dividend hike in addition to the share price correction, I see value in this as an income play. This is especially true if the Fed is near its peak funds rate and/or starts to cut later this year. Therefore, I see the almost 4% as supporting a buy thesis.

Southern States Lead Population Growth

My last point on MAA is to reaffirm one of my central arguments for buying this REIT years ago when I first initiated coverage on it. This is that the company is set up extremely well to capitalize on the continual trend of migration within the United States to the Southeast and Southwest. I like MAA's exposure to these regions, its lack of exposure to over-regulated markets on the west coast and in the northeast, and also its catering to white-collar young professionals that are more inflation-resilient than their counterparts.

To understand why this continues to support a bullish case, let us look at population growth figures for the last two years. States like Florida and North Carolina lead the pack, as well as other states within MAA's purview:

State Population Growth (US Census Bureau)

(Author's note: Importantly, Texas also saw a lot of population growth, but given the state's above-average population, the migration was not as large on a percentage basis).

Why does this matter? Because these are some of the states that serve as MAA's primary markets. States with the largest percentage growth in the past two years, such as Florida and the Carolinas, are top regions for the company:

MAA's Properties by Location (MAA Investor Center)

The primary takeaway for me here is that this is not a new trend, nor is it one that is going to change any time soon. This makes it a multi-year catalyst for MAA, and is central to why I pick up shares of this REIT any time there is a meaningful sell-off - such as right now.

Bottom-line

MAA continues to be one of my favorite individual names as it capitalizes on growing demand for apartment rentals, internal migration trends, and high wages amongst young, white-collar professionals. The company also has a favorable debt structure with over 95% of its debt being fixed-rate, making it less sensitive individually to rising rates than some of its peers.

However, REITs of all stripes, including MAA, are still sensitive to rising rates within the stock market. When investors rotate out of a sector, it is often a blanket move without some of the micro-thought that I presented here. Further, even if a company like MAA is positioned well, a share price can still move lower as investors get less optimistic. The point being future cash flow growth gets discounted at a higher rate as rates rise. So, even if a company has a favorable debt structure like MAA, the end result can still be lower share price valuations (pushing the stock lower, all other things being equal).

This is why being bullish at all times is not a correct assessment. I've liked the company long-term and continue to, but it was ill-advised to be a buyer after an already strong move by the stock. It is important to recognize the impact macro-forces can play, and plan accordingly. Fortunately, my past caution has paid off in that MAA has seen a 16% drop. This means anyone who has cash on hand can get a quality company at a sharp discount, and supports my opinion that a rating upgrade to "buy" is appropriate at this time.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of MAA, VOO, RSP, DIA, QQQ 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.

Comments

[tondino]

The more it dropped the more I bought. Now at 750 shares we sit and wait. One of the best priced REITs, still. Camden and UDR too in the apartment world. Remember, long term, and I've been around the States 45 years now, first as a tenant, then a landlord, rents rise. The unit I rented first for $180 in 78 now goes for $1800. Not too shabby. As long as management is good, and the above guys are pretty good.

[Dividend Seeker]

Great perspective, thanks for sharing

[mdfuller_OR]

@Dividend Seeker why multi family and not single family?

[Dividend Seeker]

Certainly a good option, I have some mortgage exposure through PDO so I don't really need more in that area

[birder]

I have recently been buying MAA.

[Dividend Seeker]

You and me both!