Mid-America Apartment: No Reason To Wait For Supply Demand Inflection Point, Buy Now (MAA)

peeterv My previous article on Mid-America Apartment Communities, Inc. (NYSE:MAA) was issued right after the publication of its Q1 2024 earnings report. I indicated that MAA is still a clear buy despite short-term headwinds on the supply end. The overall idea was that the decreased construction starts, restrictive financing for households to buy new homes, and MAA’s solid balance sheet should lead to a significant value creation as the current oversupply issue gets gradually resolved. Since the publication of my latest piece, MAA has delivered total returns of close to 15%, which also marks a slight outperformance of the market. Relatively recently, MAA circulated its Q2 2024 earnings deck, which, in my opinion, includes several messages and data points that still render MAA’s bull case active and relevant. Let me now elaborate on why I think so. Thesis review What is quite interesting is that even though the assumption for 2024 was that MAA will register a slight drop in its cash generation due to the abovementioned supply issue, the actual results have turned out a bit different. The expectation was that MAA will exhibit a significant pressure on the rent front (i.e., prices coming down) and that there will be a decrease in occupancy level due to consumers switching to more affordable units. However, in Q2 2024, MAA reported core FFO of $2.22 per share, which exceeds the mid-point guidance for this quarter by $0.03 per share. The key driver here was the improved cost base, where $0.02 per share came from an optimized same-store expense profile ~ $0.01 per share from a combination of a reduced SG&A and lower interest expense. Looking at the top-line level, we will notice some consequences of the currently unfavorable supply and demand dynamic (albeit the demand is very high). Most importantly, the new lease pricings on a lease-over-lease basis landed at negative 5.1%. Yet, what was the offsetting factor here were the renewal rates that went up by 4.6% on a lease-over-lease basis. As a result of this, the lease-over-lease pricing on a blended basis actually increased by 70 basis points. An additional element that helped push the cash generation higher was the improvement at the physical occupancy end, where MAA registered an uptick of 20 basis points to 95.5%. So, all these factors allowed MAA to capture same-store revenue growth of 0.7%. Finally, in terms of the growth momentum, the blended pricing for rents continued to go up in July, increasing by 0.3% from the prior month. Plus, new lease pricings have improved now each month since March this year. Speaking of the longer-term prospects, we have to pay some attention to the MAA’s M&A and organic growth activities. In this regard, the Q2 2024 could be deemed a rather strong quarter with increased momentum across the board. For instance, MAA initiated two new construction starts, bringing the current organic CapEx construction pipeline to 2,617 units at an estimated cost of circa $870 million. These two new projects are projected to generate first cash flows in mid-2026 with an initial stabilized NOI yield of ~ 6.5%, which is in line with the yield level of the remaining pipeline. The pre-development work, which covers projects that have not yet received final investment approvals, has increased to 11 projects (with ~ 3,100 additional units that emerged during Q2). During the quarter, MAA deployed about $80 million towards these organic growth opportunities, which represents only a fraction of the total expected CapEx spend. Finally, MAA also managed to commit some of its internal cash generation towards funding of nearly 1,700 interior unit upgrades. This enabled it to capture quick wins on the rent increase front — i.e., growing the net rents on these refurbished units by ~ 8%. On the M&A or external growth side, MAA was actually quite active this quarter. Namely, in Q2 2024 MAA acquired 306 unit suburban property for about $81 million, which was 15% — 20% below its replacement costs with an occupancy of 62%. The plan here is to upgrade the property and then attract new tenants. In parallel to this acquisition, the Management announced that it is in the late stages of acquiring two additional properties, which together with the previous one should generate a stabilized NOI yield of circa 6%. By listening to the recent earnings call, we can clearly observe that the growth environment for MAA has finally started to improve. The new supply deliveries across MAA’s markets have peaked or are close to it, which will then be followed by a period of a sharp supply decline due to the construction (or development) halts during COVID-19 and increasing interest rate period. The comment in the Q2 2024 earnings call by Tim Argo — EVP, Chief Strategy & Analysis Officer — provides a very solid and encouraging color on MAA’s growth prospects from here: It varies by market, but on average, new construction starts in our portfolio footprint peaked in mid-2022 and we have seen historically that the maximum pressure on leasing is typically about two years after construction start. While supply remains elevated, the strength of demand is evident as well. Absorption in the second quarter in our markets was the highest of any quarter since the third quarter of 2021. Wage growth remained strong with our rent to income ratio in the second quarter dropping a bit to 21%, the lowest level in three years. Additionally, we saw resident turnover continue to decline in the second quarter, and we expect it to remain low with fewer residents moving out to buy a home. A theoretical caveat in this context could be that MAA does not have a strong enough balance sheet or sufficient financial capacity to fully capitalize on the emerging growth opportunities. However, there are two things to consider. First, MAA’s leverage is clearly in line with the investment grade requirements — i.e., net debt to EBITDA of only 3.7x, which for such an inherently defensive REIT as MAA is very low. Second, given that we have now observed that MAA’s cash generation has been improving despite the supply and demand conditions being still relatively unfavorable, we can assume that on a go-forward basis, MAA will manage to expand its EBITDA. This, in turn, should accommodate incremental financial capacity to sustain growth sustainably. The bottom line After digesting Q2 2024 earnings report, the conclusion is clear — MAA remained a solid buy even despite the recent increase in the share price and currently unfavorable supply and demand conditions. The Company has managed to strengthen its cash generation by boosting the same store NOI figure and growing the occupancy level, even though the elevated supply dynamics continued to depress rent growth. Meanwhile, MAA has also stepped up its M&A and organic growth game, which should position the REIT in a better place to capitalize on the opportunities once the market conditions reverse (i.e., when the supply side starts to get constrained due to the historical periods of underinvestment). Considering the above and the fact of a robust balance sheet, I remain bullish on Mid-America Apartment Communities.

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