- Mid-America Apartment Communities' preferred stock is offering an 8.0% dividend, which is safe in my view.
- The REIT has a strong business model, with consistent growth and a healthy balance sheet.
- The investors who lock in the yield now will probably be rewarded if/when interest rates decrease.
The preferred stock of Mid-America Apartment Communities (MAA) has declined 23% since it peaked, in mid-2021. As a result, the preferred stock is currently offering an exceptionally attractive yield of 8.0%. When a stock offers such a high yield, it usually signals that the dividend is at the risk of being cut. However, I believe the preferred dividend of Mid-America Apartment Communities is entirely safe thanks to the rock-solid business model of the REIT, its positive business momentum and its pristine balance sheet. Therefore, investors should lock in this exceptional yield.
Mid-America Apartment Communities is a REIT that owns, manages and develops apartment communities in the Southeast, Southwest and mid-Atlantic regions of the U.S. It currently has ownership interest in nearly 102,000 apartment units across 16 states and the District of Columbia and has a market capitalization of $15.6 billion.
Source: Investor Presentation
Mid-America Apartment Communities is a high-quality REIT, with special advantages thanks to the superior economic growth of the Sunbelt region. Thanks to the consistent economic growth of its markets and the strong demand for its apartments, the REIT has grown its funds from operations [FFO] per unit in 7 of the last 9 years, at a 7.7% average annual rate. The consistent growth record of Mid-America Apartment Communities is a testament to the strength of its business model.
Most REITs carry a significant debt load and hence they have been severely hurt by the surge of interest rates to a 15-year high this year, as their interest expense has greatly increased. However, Mid-America Apartment Communities is one of the most resilient REITs to this headwind thanks to its healthy balance sheet.
Source: Investor Presentation
It has a leverage ratio (Net Debt to EBITDA) of only 3.5x whereas the vast majority of REITs have a leverage ratio above 4.5x. It is thus natural that Mid-America Apartment Communities is one of only 8 REITs that has an A- credit rating or better. It also has 100% of its debt at fixed interest rates, and thus it is well protected against rising interest rates.
The pristine balance sheet of Mid-America Apartment Communities is clearly reflected in its operating results. To be sure, its net interest expense has decreased 10% vs. 2020 whereas the interest expense of nearly all REITs has surged in the last 12 months. To provide a perspective, Realty Income (O) and Camden Property Trust (CPT) have seen their net interest expense surge 90% and 38%, respectively, vs. 2020. The sector-leading balance sheet and the 100% fixed debt of Mid-America Apartment Communities render it essentially immune to the headwind from 15-year high interest rates in my opinion.
Moreover, the REIT enjoys remarkably strong business momentum right now. In the second quarter, it did not show any signs of fatigue. It grew its same-store net operating income 9% over the prior year's quarter thanks to strong demand for its apartments, which enabled the trust to implement material rent hikes. As a result, the REIT grew its FFO per unit 13%, from $2.02 to $2.28, and surpassed the analysts' estimates by $0.03. Notably, Mid-America Apartment Communities has missed the analysts' consensus only in 4 of the last 21 quarters. This confirms the sustained business momentum of the REIT.
Thanks to positive demand trends, management raised its guidance for annual FFO per unit from $8.93-$9.29 to $9.00-$9.28. The new guidance corresponds to 8% growth over the prior year, to a new all-time high. It is also important to note that this REIT tends to issue conservative guidance, and thus it improves its guidance many times throughout the year.
The quality of the business model of Mid-America Apartment Communities is also reflected in its significant outperformance vs. its peers in almost any time horizon one can consider.
As shown in the above chart, Mid-America Apartment Communities has offered a superior total shareholder return when compared to its peers in almost any time horizon. This is a testament to the robust business model of this REIT and the exemplary execution of its management.
As mentioned above, the preferred stock of Mid-America Apartment Communities is currently offering an exceptionally attractive dividend yield of 8.0%. Even better, this dividend is as safe as it gets.
First of all, as shown in the second slide of the article, the preferred stock is essentially negligible in the capital stack, as it comprises only 0.2% of total capital. In addition, the REIT pays only $3.7 million per year in preferred dividends. This amount is negligible compared to the FFO of $1.074 billion in the last 12 months. To cut a long story short, the amount of preferred dividends is negligible for Mid-America Apartment Communities, which can keep paying them without any problem.
Moreover, a preferred dividend cannot be suspended unless the common dividend is completely eliminated first. However, the common dividend of Mid-America Apartment Communities is entirely safe.
As shown in the third slide of the article, Mid-America Apartment Communities has not cut its dividend for at least 30 consecutive years thanks to its reliable growth trajectory. In addition, it currently has an FFO payout ratio of 61%, which is low for a REIT and thus provides a wide margin of safety to the common dividend, particularly given the rock-solid balance sheet of the trust.
Furthermore, analysts expect Mid-America Apartment Communities to continue growing its FFO per unit over the next five years, to new all-time highs. As the REIT has missed the analysts' estimates only in 4 of the last 21 quarters, it is likely to at least meet the analysts' estimates. Therefore, it will almost certainly keep raising its common dividend in the upcoming years. In any case, the REIT is extremely unlikely to eliminate its common dividend and hence I think its preferred dividend is absolutely safe, particularly given the negligible amount of the preferred dividend.
As the 8.0% preferred dividend of Mid-America Apartment Communities is entirely safe, investors may be wondering how it is possible to encounter a safe 8.0% dividend. The only reason behind this exceptional yield is the surge of interest rates to a 15-year high. As inflation has proved stickier than initially anticipated, the Fed has maintained high interest rates for longer than initially expected.
However, interest rates are not likely to remain around their 15-year highs for many years in my opinion. Whenever the Fed restores inflation to 2.0%-2.5%, it is likely to begin reducing interest rates to normal levels. Thanks to the aggressive stance of the Fed, inflation has cooled from a 40-year high of 9.1% in June 2022 to 3.6% now. No one knows when inflation will revert to the target range of the Fed, but excessive interest rates are likely to finally take their toll on the prices of houses, which are the key factor behind the persistent inflation. Whenever the economy decelerates, the Fed will probably begin to lower interest rates. At that point, those who lock in the 8.0% preferred dividend yield of Mid-America Apartment Communities will be highly rewarded.
The only risk of the preferred stock of Mid-America Apartment Communities is the fact that it can be called from October 2026. If it is called in that month, its average annual yield will decrease to 5.8%. If it is called in 2027 or later, its average annual yield will be between 5.8% and 8.0%, depending on the time of the call.
As the cost of the preferred stock is essentially negligible for the REIT, it is hard to predict whether the preferred stock will be called, especially given the unknown path of interest rates. If interest rates remain high for years, the REIT will have little incentive to call the preferred stock. Nevertheless, investors should be aware that the preferred stock will end up offering a lower yield (5.8%) if it is called in late 2026.
Periods of multi-year high interest rates are ideal for locking in exceptionally high yields from fundamentally strong stocks. The 8.0% preferred dividend of Mid-America Apartment Communities certainly fits this description. The only caveat is the very low trading volume of this preferred stock. Therefore, the stock is suitable only for the investors who seek to initiate a small position.
This article was written by
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