Sunbelt Region Apartments: Bellwethers Provide Insights Into 2023

Earnings Recap – The Tale of the Tape

Sunbelt apartment companies Mid-America (MAA) and Camden Property Trust (CPT) each reported fourth quarter 2022 earnings late last week, providing the first glimpse into what lies ahead in 2023. This, following a banner year for operating performance of the rental housing industry in 2022, although one would not have noticed if just focused on stock price performance, which was abysmal.

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. ^[1]

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. We note that renewal lease growth was materially stronger than new lease growth in 4Q and we expect this will be a trend seen across the rental housing industry in 4Q22 and into 2023. 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. ^[2]

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. The company’s forward guidance is assuming external investment in 2023 of approximately $700 million and this activity will be funded by asset sales, cash flow and short-term borrowing. ^[3]

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%. ^[4] 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. ^[5]

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. Trends toward normalization in operating activity will continue through 2023 making what will be a good year overall seem a bit underwhelming compared to 2022. ^[6]

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 on line 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%. ^[7]

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 100 basis point (bp) 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. ^[8]

Not All Blue Chips are Created Equal

While MAA and CPT are both terrific organizations with exceptional management teams, portfolios and balance sheets, the representative weightings within our Residential REIT Income ETF, HAUS, are quite different. As of 02/01/2023, MAA is the Fund's largest holding with a weighting in excess of 9%. CPT is currently weighted at roughly half the size of MAA at approximately 4.5%. As recently disclosed per fourth quarter earnings reports for both companies, lease rate growth is expected to moderate for both companies to a level that is much more indicative of historic trends. We believe this metric will likely hit a low point in the 1Q period, before rebounding as we approach the spring/summer leasing season. It is noted that lease growth is expected to remain positive (year over year) for the entirety of 2023, testament to the expected strength of the market, even in light of difficult comparisons and an abundance of supply in many regions. A divergence starts to take hold as we examine the expected operating performance of the two sunbelt names. MAA is forecasting revenue and income growth of over 6% for 2023^[9], while CPT is expecting growth much closer to 5.0%.^[10] The primary drivers of outperformance for MAA are associated with better occupancy, less of a drag from interest expense and fewer onetime items as a temporary drag on performance. The net result is an expected 7% FFO growth rate for MAA compared to a more modest 4% for CPT.^[11] Both companies are currently providing in excess of 3.0% yields on their dividends,^[12] but with MAA’s outsized earnings growth potential, we anticipate strong total return from current levels and the likelihood for upside earnings surprises if the economy in general and employment more specifically do well in 2023.

Definitions:

EBITDA – Earnings before interest taxes depreciation and amortization; a widely used measure of core corporate profitability

Basis points – one hundredth of one percent, used chiefly in expressing differences of interest rates

Footnotes:

^[1] Mid-America Apartments: 4Q22 Earnings Conference call

^[2] Mid-America Apartments: 4Q22 Financial Supplement

^[3] Mid-America Apartments: 4Q22 Financial Supplement

^[4] Mid-America Apartments: 4Q22 Financial Supplement

^[5] Mid-America Apartments: 4Q22 Financial Supplement

^[6] Camden Property Trust: 4Q22 Earnings Conference Call

^[7] Camden Property Trust: 4Q22 Earnings Conference Call

^[8] Camden Property Trust: 4Q22 Financial Supplement

^[9] Mid-America Apartments: 4Q22 Financial Supplement

^[10] Camden Properties: 4Q22 Financial Supplement

^[11] Mid-America Apartments and Camden Properties: 4Q22 Financial Supplements

^[12] Mid-America Apartments and Camden Properties: 4Q22 Financial Supplements