The major apartment operators have reported fourth quarter 2022 earnings and provided conservative, yet better than feared forward guidance for the coming year. These results provide an attractive backdrop for total return performance in coming quarters.
Mid-America Apartments (MAA) [1]
MAA reported a modest “beat” to 4Q earnings and initiated FFO guidance for 2023 which implies a solid 7% growth in funds from operations (FFO). Management highlighted three distinct advantages which should propel operating performance over the next several quarters and they include 1) a geographic footprint which continues to benefit from job growth, migration patterns, low resident turnover and overall value and affordability 2) exposure to secondary markets which are a buffer to high levels of regional supply 3) a portfolio price point which is 20% below the asking rents on new deliveries.
The company reported blended lease growth for 4Q22 of 5.7%, which is down notably from the full year 2022 number of 13.5%, but a deceleration in operating metrics has been well telegraphed by MAA and their peers. The stabilized portfolio ended the year at 95.7% occupancy. Fourth quarter same store operating metrics were strong with revenue, operating expense, and net operating income growth (NOI) of 13.6%, 7.9% and 16.8%, respectively.
The transactions market remained muted in 4Q22 as high financing costs, uncertainty over economic conditions in coming quarters and a general difference of opinion between buyers and sellers hindered the closing of transactions. MAA does not expect the acquisitions market to improve much until late in 2023. The company did manage to complete roughly $355 million in dispositions for 2022, mainly selling 20+ year old assets at an average internal rate of return (IRR) of 17.7%. On the development front, MAA had approximately $729 million under construction at year end with a majority of its new units skewed towards Texas and North Carolina.
MAA’s guidance for 2023 of $9.08 per share (at midpoint of range) was largely in line with consensus expectations and driven by what appear to be conservative operating level growth assumptions. Portfolio revenue, operating expenses and income are all expected to see growth in the 5-7% range and occupancy is expected to remain flat in the range of 95.5-96.0%. The biggest drivers of operating expense growth in 2023 will be property taxes and insurance. The company’s balance sheet is industry leading, having ended 2022 with a debt/adjusted EBITDA ratio of 3.7x and liquidity in the form of cash and access to undrawn credit totaling $1.3 billion.
UDR Inc. (UDR) [2]
The company generated 4Q22 funds from operations (FFO) growth of 13% and full year 2022 growth of 16%. While 4Q operations moderated from prior quarters, the company was still able to achieve a robust 14.5% growth in same store net operating income (NOI) driven by a 12.1% rise in quarterly revenue and a 6.8% jump in operating expenses. Management and the board of directors were also confident enough in their 2023 outlook to raise the dividend by a bold 10.5%. Initial 2023 FFO guidance equates to 8% year over year growth at the mid-point of the given range which is impressive given the growth achieved in 2022. Both revenue and operating income growth for 2023 are projected to be roughly half that achieved in 4Q22, as fundamentals for the industry continue to moderate and we see a return to more traditional seasonal leasing patterns. Demand has been healthy since the start of the year with strong traffic and little evidence of renter fatigue. There are modest concessions being offered in a few markets such as Austin, Dallas, and Denver, all of which have also seen an uptick in supply over the past few quarters. Rent-to-income levels remain healthy, and wages are supportive of current rents, especially when compared to the cost of home ownership in UDR markets.
While there is a plethora of unknowns associated with the broader economy at the start of this year, the company is confident in the current and longer-term fundamentals of the rental housing industry. They note the historic resiliency of the industry along with the structural impediments to housing supply in the U.S. which favor predictable rent growth for the foreseeable future. They have also maintained a strong and liquid balance sheet which enables them to be opportunistic towards potential investments in rental assets.
Essex Property Trust (ESS) [3]
Essex Property Trust (ESS) is the only pure-play west coast apartment REIT in our universe and as such represents a real and perceived litmus test for all things California. The California markets were last to come out of the pandemic shutdowns and in several instances are still feeling the lingering effects of the pandemic with eviction moratoriums still in place for Los Angeles and Alameda Counties even though employment has rebounded to well in excess of pre-pandemic levels.
ESS reported 4Q22 results which were at the high end of company guidance driven by strong revenue growth across all three major markets along with operating expense growth of 4%, which was well below inflation, to generate 13.3% operating income growth in the period. 2023 earnings guidance was shy of consensus by approximately 4% as operating results will be negatively impacted by bad debt expense, or residents who have stopped paying rent and remain in their units without the remedy of eviction. Higher interest expense from shorter term financings will also have an impact on this year’s results.
Aside from the anticipated drag on revenue from bad debt expense, the company was encouraged by a pick-up in demand across their markets in the typically slow months of December and January. This improvement has been met with moderating concessions or inducements upon new lease signings and the portfolio has thus far proven to be resilient in light of the numerous technology industry layoff announcements which have made national headlines. ESS is quick to point out that many of these layoffs are coming from “satellite” technology hubs away from the San Francisco and Seattle cores.
AvalonBay Communities (AVB) [4]
The company reported results that were in line with expectations and punctuated by strong yet moderating operating results including an 11.3% increase in operating income. Keeping with the trend of conservative guidance forecasting, the firm’s 2023 outlook was modesty shy of consensus expectations and is expected to be negatively impacted by higher interest rates on debt and a dearth of activity from transactions and other capital markets items. AVB noted exceptionally strong 4Q performance from its Seattle, Boston, and metro NY/NJ portfolios, while California lagged. AVB stood apart from peers in that it was relatively active on the investment front in the quarter and for the year. This was primarily a function of portfolio repositioning which has been several years in the making as the company pivots from a bi-coastal strategy to one that includes “expansion markets” in higher-growth sunbelt markets including Denver, Dallas, southeast Florida, and North Carolina. Expansion market exposure stood at 7% at the end of 2022 with a goal of getting to 25% over the next 5-7 years.
AVB will likely continue to differentiate itself as an active developer in the apartment industry. It had $2.3 billion of active construction at the start of the year and anticipates starts of $900 million in 2023. The company takes a conservative approach to funding development, raising a majority of the required capital before the start of construction. In terms of return on investments, the company notes that yields on development are approximately 150 basis points (bps) above prevailing cap rates for stabilized assets, so yielding low-6% returns on development compared to mid/high 4% yields on stable assets.
Equity Residential (EQR) [5]
EQR is the largest of the coastal apartment REITs and continues to be the industry leader in the area of managing expenses and driving operating margins, a critical attribute in the current environment where inflationary pressures remain a key hurdle to success. The company reported 4Q results and provided 2023 guidance that met expectations and is underwriting 6.5% FFO growth in 2023. Revenue growth will be negatively impacted by elevated bad debt from California, yet operating expense growth projected to be 4.5% (at mid-point) will be industry leading. EQR also continues to have one of the strongest balance sheets in the REIT sector finishing 2022 with a net debt/EBITDA ratio of 4.4x. 4Q22 operating results were in-line with peers as revenue jumped 9.1% and operating income improved by 10.9%.
Management is highlighting a larger degree of uncertainty for 2023 relative to a typical year given the balancing act playing out with monetary policy as the Federal Reserve continues to try and rein in inflation. This said, every indication is that EQR’s renter base of predominantly college educated white-collar workers in professional/business service and technology jobs are holding up well. This dynamic could change as the year progresses and if the long list of high-profile layoffs in the technology sector continues unabated. Management also points out the continued high cost of homeownership across their markets even with the recent softening in home price appreciation. Apartment supply is expected to peak in 2023 and while markets such as Austin, Dallas, and Denver will see a disproportionately high level of deliveries in coming quarters, this supply is partially offset by the overall shortage of housing. This implies that with single-family supply at extremely low levels, homeownership becomes less of an alternative to apartment living, thus keeping more potential homeowners in the rental pool.
The company also highlighted the current state of the job market in relation to the January employment report and the upcoming spring/summer leasing season. Jobs are the single most important variable for rental housing, and the stronger the job market remains going into the heavy leasing season, the better operating results will be for the year. 2023 forecasted guidance is calling for occupancy to remain strong at over 96% with blended lease rate growth of approximately 4%. The best markets in 2023 are anticipated to be New York and Boston with San Francisco and Seattle not too far behind. The latter two however are expected to see some rent concessions as a result of supply in those markets.
Camden Property Trust (CPT) [6]
CPT reported fourth quarter results which were in line with their previously disclosed guidance and consensus expectations. Unlike MAA however, CPT released initial 2023 guidance which was materially below consensus expectations. CPTs operating results for 4Q22 were solid with revenue, operating expense, and NOI growth of 9.9%, 8.1% and 10.9%, respectively. Occupancy at year-end was 95.8% and blended lease growth for the period was strong at 6.1%. CPT management commentary on price discovery echoed that of MAA stating that the bid/ask spreads on transactions were “the widest they could recall” and they do not see this getting resolved in the short term.
Each quarter, CPT provides letter grades ranking their markets from best to worse. The outlook for 2023 is impacted by approximately 200,000 units of supply which will be coming online across their markets over the course of the next year with many markets seeing an average 10-20,000 units. Several of the highest ranked markets in the CPT portfolio for 2023 include Orlando, Southeast Florida, Tampa, Charlotte, Raleigh and Nashville, all ranked A+ or A. The lowest ranked markets are Houston, Los Angeles and Orange County with ratings of B/B-. Overall, a ranking of A- has been assigned to the total portfolio with a moderating outlook and guidance for revenue growth of 5.1%, operating expense growth of 5.5% and NOI growth of 5.0%.
CPT’s FFO forecast for 2023 of $6.85 per share (at the midpoint) was not well received by the market as it represented a 4% “miss” relative to expectations. The company outlined the components of FFO with the key negative offsets to growth coming from higher interest expense on short term debt, the assumption of a 100bp rise in vacancy over the course of the year and higher operating expenses driven by property taxes and insurance. The company also assumes no external growth upside with $250 million of acquisitions/dispositions during the year. Despite the negative impact on forward guidance coming from short term debt exposure, CPT’s balance sheet remains in good shape with year-end debt/adjusted EBITDA of 4.1x and liquidity of $1.2 billion.
Conclusion
With the major apartment REITs having now reported 4Q22 earnings and 2023 guidance, the stock market responded with a collective sigh of relief and appears to have been pleasantly surprised by the results as demonstrated by the NAREIT Apartment REIT subsector achieving a +2.85% total return for the month-to-date period through Monday, February 13th. This compares to a +0.10% total return for the broad FTSE/NAREIT Equity REIT Index over the same period. [7]
The apartment industry has done an admirable job of communicating the pending normalization in operating fundamentals following a year of unprecedented performance for the segment. As we look ahead to 2023, expectations are calling for rent growth to moderate further with Q1 and Q2 offering up high single digit growth before decelerating to low single digit growth in the latter half of the year. Many companies were encouraged to see traffic and leasing demand rebound materially in January after what appears to have been a November/December tough. It also appears that coastal apartment owners are finally starting to “close the gap” with their sunbelt brethren as equilibrium ensues and some of the strongest drivers of jobs and migration to sunbelt markets moderate. In our opinion, supply will also act as an equalizer in 2023 as peak deliveries of new units will be most impactful in the sunbelt. We further anticipate that the east coast will outperform California in 2023 as bad debt expense remains a headwind to growth for Los Angeles and Oakland landlords.
In the final analysis, we believe the key variable to the sector’s overall performance will come down to jobs and whether the current environment remains strong with unemployment levels close to all-time lows, or Federal Reserve policymakers will be forced into an even more aggressive stance toward tightening economic conditions and drive-up unemployment in the process.
As of 2/23/2023, the Armada Residential REIT Income ETF’s (HAUS) holdings include 9.25% MAA, 7.26% UDR, 5.72% ESS, 9.18% EQR, 9.10% AVB, and 4.64% CPT. For current holdings click here. Holdings are subject to change.
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Glossary Terms:
Basis Point (BPS): A basis point is a common unit of measure for interest rates and other percentages in finance. Basis points are typically expressed with the abbreviations bp, bps, or bips. One basis point is equal to 1/100th of 1%, or 0.01%.
EBITDA: Earnings Before Interest, Taxes, Depreciation and Amortization.
FTSE/NAREIT Equity REIT Index -A free-float adjusted, market-capitalization-weighted index of U.S. equity REITs.
Funds From Operation (FFO): The most commonly accepted and reported measure of REIT operating performance. Equal to a REIT’s net income, excluding gains or losses from sales of property and adding back real estate depreciation.
NAREIT: National Association of Real Estate Investment Trusts.
NOI: Net operating income (NOI) is a calculation used to measure the profitability of income-generating real estate investments. NOI equals all revenue from the property, minus all reasonably necessary operating expenses.
REIT: A REIT (Real Estate Investment Trust) is a company that owns, operates, or finances income-producing real estate.
Blended Lease Growth: weighted average growth in lease rate coming from new and renewal leases
Armada ETF Advisors LLC serves as the investment sub-adviser to the Fund.
The Fund is distributed by Foreside Fund Services, LLC. Foreside is not affiliated with the sub-adviser.
Footnotes:
[1] Mid-America Apartments: 4Q22 Financial Supplement and Webcast
[2] UDR Inc.: 4Q22 Financial Supplement and Webcast
[3] Essex Property Trust: 4Q22 Financial Supplement and Webcast
[4] AvalonBay Communities: 4Q22 Financial Supplement and Webcast
[5] Equity Residential: 4Q22 Financial Supplement and Webcast
[6] Camden Property Trust: 4Q22 Financial Supplement and Webcast
[7] FTSE Nareit U.S. Real Estate Index Series Daily Returns: February 10, 2023
