At Berkshire Hathaway’s 2022 annual meeting, Warren Buffett spoke about the importance of investing in productive assets that “do something.” Buffett used the analogy of investing in apartments, he said:
“If you offer me 1% of all apartment buildings across the country and you want another $25 billion, I’ll write you a check. It is very simple.”
Of course, these numbers should be taken with great caution, but the moral of the story is this: people will always need a place to live. Additionally, the United States has a record number of singles with 4 in 10 adults between the ages of 25 and 54 unmarried or living with a partner, up 30% since 1990. These singles often don’t need a large five bedroom suburban home. . Instead, they prefer lower cost apartments in urban locations with greater flexibility.
As a property owner in the UK, I can attest to the demographic value of renting apartments. Buying a home is great, but when the average US home price has risen 19% over the past year, affordability can be an issue, especially with rising interest rates. interest. So, in this high inflation environment, exposure to rental-ready real estate makes perfect sense.
Apartment Income REIT Corp. (NYSE: AIRC), also known as Air Communities, is a real estate investment trust (REIT) that owns a diverse number of apartments in several US states. The company is led by a seasoned CEO, pays a delicious 4% dividend and is undervalued relative to its apartment REIT peers after the recent share price decline. Let’s dive into the economic model, financials and valuation to see why this stock seems like a great inflation hedge.
Modern business model
Apartment Income REIT Corp owns 77 properties and 25,384 apartments across the United States. Its properties are diverse across multiple US states and price points.
Air Communities was formerly part of Apartment Investment and Management Company (AIV), a REIT that developed and managed rental properties. However, in 2020 AIV management realized that property development is a higher risk business and therefore decided to divest 80% of the apartment ownership business to Air Communities. Personally, I think it was a good decision and should result in increased shareholder value for both companies. Air Communities can now focus fully on managing its approximately $10 billion asset portfolio and grow solely through acquisitions.
So far in 2022, management has completed two new acquisitions. One is the reservation at Coconut Point, a 180-unit luxury apartment community in Florida, which was purchased for $72 million. The luxury apartment complex includes a sparkling outdoor pool, on-site gym, club room and more.
The net operating income (NOI) should be 3.8% in the first year, with an internal rate of return (IRR) of around 8%, which is fantastic.
Additionally, they acquired Watermarc in Biscayne Bay for $211 million. This is a new 296 apartment community in Miami, Florida. This luxury apartment includes a 28-story rooftop pool and even a health and wellness “sanctuary”.
The company forecasts an NOI return of 4.1% in the first year and again expects an IRR of around 8% in the long term, which is excellent.
Management has a disciplined approach to capital allocation and expects that a deviation of at least 200 basis points from its weighted average cost of capital (WACC) can be achieved for any investment activity, as in the previous examples.
AIRC has an average daily occupancy rate of 98.1% in identical stores and has excellent reviews from tenants. The company has a “customer-centric” style of operation that emphasizes the community. Its customer satisfaction (CSAT) was 4.33 out of 5, on a slight upward trend since 2018.
Highly satisfied tenants renew twice the frequency of those who are less satisfied, so it makes sense to improve your service. A happy tenant, stays longer…it’s as simple as that. Management’s strategy is working as AIRC had a 61.3% year-over-year (TTM) retention rate as of June 2022, which is a record for the company.
Air Communities’ CEO is Terry Considine, a real estate industry veteran who founded AIV. Terry was part of the company from 1994 until its split into two entities in 2020. Today he is the CEO of Air Communities and serves as a director of AIV. Many founders tend to focus on the long term and are intrinsically motivated by the success of the business. Many great founders are already extremely wealthy and are therefore less motivated by “quick hits”. For example, in 2021, the CEO cut his own compensation by $2.5 million to help the company meet spending targets.
Air Communities has seen its net operating income (NOI) grow at a faster rate than the average for coastal peers [in blue]which is nice to see.
The company experienced a decline in revenue growth during the 2020 pandemic. However, the good news is that the REIT’s properties showed some resilience, with revenue growth down -2.4%, which was lower than the average for coastal peers. In 2021, its revenue growth was 1.7%, which is again above the coastal peer average of -1.8%, showing that the company offers greater resilience and quality by compared to his peers. For the full year 2022, management forecasts an optimistic revenue growth rate of 9.8%, which is slightly above the coastal peer average of 9.2%.
Air Communities is also demonstrating greater efficiency in its operations and recorded a same store revenue to free cash flow conversion rate of 65.3% in the first quarter of 2022. This is a slight increase from 2021 and is significantly above average for coastal peers, again representing a more efficient operation.
Funds from operations (“FFO”) per share fell during the 2020 pandemic, but has now rebounded near pre-pandemic levels, which is great to see. FFO per share was $0.57 in the first quarter of 2022 and is expected to be $2.41 in the middle of the company’s guidance.
Air Communities has a dividend yield of 4.36% with a target payout ratio of 75% of funds from operations. This is a higher dividend yield than apartment REITs such as Equity Residential (EQR), UDR (UDR) and AvalonBay Communities (AVB).
As expected with a REIT, AIRC has a fairly high debt of $3.36 billion, with approximately $1.5 billion with variable debt exposure, which is risky and higher than competitors. However, management has actively repaid or refinanced $1.1 billion of this debt, which is great to see. The remaining $400 million has been hedged at 3.99%.
Funds from operations is expected to be $2.41 per share in mid-2022. If we take this number and divide it by the stock price at the time of writing of $41/share, we get a price at funds of 17 operations. This is cheaper than other industry peers, as you can see in the table below.
|Apartment REITs||Price in FFO (P/FFO)|
|Apartment Income REIT (AIRC)||17.1|
|UDR inc. (UDR)||19.8|
|AvalonBay Communities (AVB)||20.1|
|Camden Property Trust (CPT)||20.6|
|Residential Equity (EQR)||20.8|
|Central American Apartment Communities (MAA)||20.9|
Management also showed confidence in the current stock value with $72 million in “opportunistic” stock buybacks at an average price of $44.2 per share, which is slightly above the price of $41/share at the time of writing. So I think that might be a good buy point. In addition, $500 million in share buybacks have been authorized by the board of directors.
Recession/Tenants Not Paying
Luxury apartments are nice, but when renters are pressured by a higher cost of living due to inflation in food and utility bills, cuts can start to happen. Analysts predict a “shallow but long” recession, set to begin in the fourth quarter of 2022. If businesses see their input costs reduced, they may have to lay off workers, which will mean rent payments could be difficult to perform.
Apartment Income REIT is a great company, which does exactly what it says on the tin. It offers investors exposure to the growing apartment rental industry and offers a delicious 4.36% dividend for the fun of it. The recent decline in the share price means the stock is now undervalued relative to its peers. Additionally, the veteran founder and CEO should give investors peace of mind that the ship is being steered by someone with a long-term view.