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We’re reviewing Mid-America Apartment Communities (NYSE:MAA) Q4 2023 earnings with a potential investment in mind, but we’re cautious given the current economic landscape. We find the current valuation attractive already but would like to see another dip before initiating a position.
We anticipate MAA facing tougher challenges compared to other housing REITs due to excess supply. New supply is particularly high in markets where rental rates surged post-pandemic, driving increased construction activity.
Even though MAA is guiding for a material increase in interest expense, it ends up being a tiny headwind on a per share basis. The major headwind is MAA’s transaction plans.
Transactions
MAA is guiding for external growth in 2024, but they currently trade at a material discount to consensus NAV estimates. When pulling these numbers, the current estimates were at $155.40 while MAA was trading at $131.80. This puts them at a price to NAV of 0.85. When REITs are trading at significant discounts to NAV, we usually don’t want them to be aiming for external growth.
Between acquisitions and developments, they are projecting spending between $600 to $800 million. Management stated that it’ll be funded by debt financing and internal cash flows.
After deducing the dividend from consensus AFFO estimates, MAA has about $264 million cash flow to fund the transactions. That would leave about $236 to $436 million to be funded by debt. Securing financing for $236 to $436 million at a 5.5% interest rate would result in an annual interest cost of $13 to $24 million, equating to approximately $0.11 to $0.20 per share. This would be the transaction having a significant impact on driving interest expense higher.
MMA predicts that the upcoming deals will initially reduce the 2024 Core Funds From Operations (FFO) before enhancing it post-stabilization, expected by 2025. We agree with this assessment.
Why engage in further development spending?
MAA is currently working on five development projects, with $391.6 million already allocated and an additional $255.6 million required for completion. Finishing these projects is logical, with completion expected between 2024 and 2025.
As a result, an expenditure of approximately $255.6 million is anticipated for development over the next two years, though the precise schedule for these expenditures remains unclear.
What we don’t want to see
We are concerned about MAA starting new development projects amid the high costs of financing and construction. The announcement that MAA allocated $48 million during the fourth quarter of 2023 towards ongoing and forthcoming projects, including predevelopment activities, has not been well received. This funding decision is part of a broader plan to initiate four to six multifamily development projects within the next 18 to 24 months, raising eyebrows over the strategic direction amidst current economic conditions.
A closer examination of MAA’s financial commitments reveals that the majority of the $48 million expenditure was directed towards the progression of five ongoing projects, with a notable increase in development spending from $346.3 million to $391.6 million.
This implies that a minor portion, less than $3 million, was allocated for predevelopment activities related to future projects. We argue that MAA’s current development endeavors, potentially requiring capital commitments ranging from $400 to $900 million, do not represent the most judicious use of resources. We would suggest that MAA reconsider these projects. We prefer allocating non-dividend cash towards share buybacks and the completion of existing constructions, or debt reduction. Despite the allure of a 6.5% average stabilized NOI yield on recent developments, this metric may not fully account for the cost-effective nature of past projects, indicating a possibly inflated projection of returns.
Current valuation
At the time of writing, MAA shares traded at $131.80 with a consensus 2024 AFFO of $7.98. This is a 16.5x multiple. MAA’s valuation is near its ten-year low.
Our CPT discussion noted analysts see rising supply and its challenges and future benefits. A further look at MAA suggests overly optimistic growth forecasts for both REITs from late 2025 to 2028.
Forecasts for 2025 seem too high. The debt issuance pace, new supply, and MAA’s focus on development over buybacks make a 3.9% FFO increase and a 3.2% AFFO rise unlikely between 2024 and 2025. The forecasted 2024 FFO is $8.92, $0.04 above the $8.88 guidance.
Summary
MAA’s FFO and SS NOI guidance for next year wasn’t surprising. We anticipated this a year in advance. We expect supply issues to last into 2025, with possible improvements in 2026. This is later than MAA’s mid-2025 optimism. The one negative surprise was MAA’s choice to continue developments now, a strategy we find misaligned with optimizing risk-adjusted returns.
Management expects leasing recovery by 2026, matching project completions. But this doesn’t fully justify their strategy. Redirecting capital to buybacks or redevelopments, or buying discounted projects from defaulting developers, could offer better returns.
The company’s strategic choices in capital allocation will likely lead to a slight downward adjustment in our targets. While investing in new developments is not equivalent to misallocating funds, there are certainly more favorable options that MAA could pursue.
MAA’s solid development track record puts it in a good position to bid on and finish projects, using its capital and expertise effectively.
