Armada Hoffler Properties: 7% Dividend Yield With Strong Coverage (NYSE:AHH)

Armada Hoffler Properties (NYSE:AHH) is one of the best investment opportunities in the equity REIT space. The REIT is currently trading hands for a 9.14x multiple to the midpoint of guidance for normalized funds from operations (“NFFO”) of $1.21 to $1.27 per share for fiscal 2024. This would represent growth of 3 cents at the top end over NFFO of $1.24 per share realized in 2023, the midpoint would mean flat year-over-year growth. AHH multiple reached as high as 14x in 2022 with Seeking Alpha placing the REIT at a B+ valuation grade versus its REIT peers.

The commons have dipped by 8% year-to-date to push the dividend yield to a near-record as adjusted for the effects of the pandemic. AHH last declared a quarterly cash dividend of $0.205 per share, hiked 5.1% sequentially and $0.82 per share annualized for a 7.2% dividend yield. The hike has come against a dividend winter for equity REITs burdened by the dual impact of the Fed’s fight with inflation and market angst over commercial real estate.

AHH is a diversified property equity REIT, with a portfolio split between retail, office, and multifamily properties. Retail forms its largest rental revenue segment at 41.4% of $61.88 million in fiscal 2024 first quarter rental revenue. Office was at 35.3% and multifamily was at 21.2%. Rental revenue for the first quarter was up 10.1% over its year-ago comp, with AHH generating first quarter NFFO of $0.33 per share, growth of 3 cents over its year-ago comp. This diversification has been bittersweet for the REIT with its current multiple a strong reflection of deep market anxiety over the future of office properties. While AHH is up since my last coverage, the upside is still significant on the back of the low multiple and the decent outlook for NFFO growth. The preferreds (NYSE:AHH.PR.A) have stayed flat.

Occupancy And NFFO Growth

Total revenue for the first quarter was $193.48 million, up 34.2% over AHH’s year-ago comp and a strong beat on consensus. This came as AHH’s weighted average portfolio occupancy at 94.7% dipped sequentially from 96.1% in the fourth quarter. This drop was led by retail occupancy falling by 270 basis points to 94.7% from 97.4%. Office occupancy at 93.6% fell from 95.3%, and multifamily occupancy at 95.1% dipped from 95.5%. So dips all around, but the REIT’s construction business performed strongly against its $343 million backlog.

Commercial lease renewal spreads were up 11.5% on a GAAP basis and 3.7% on a cash basis during the first quarter, with AHH generating total property net operating income (“NOI”) of $41.35 million. This was up 9.26% from NOI of $37.85 million a year ago. AHH is guiding for full-year 2024 NOI to come in between $166.6 million and $171 million. The REIT also closed 21 lease renewals and 3 new leases spread across 115,549 net rentable square feet during the first quarter. Critically, AHH is covering its hiked dividend 151%, a 66% payout ratio that opens up the prospect of another near-term hike.

Credit Profile, Liquidity, And The Fed

AHH’s total debt at the end of the first quarter stood at $1.4 billion, with roughly 90% of this at fixed interest rates or hedged with interest rate swaps. Total debt has been rising since the fourth quarter of 2022, but AHH’s net debt to total adjusted EBITDAre dipped sequentially during the first quarter to 7.4x from 7.5x. Total debt-to-enterprise value sits at around 54%. The REIT’s leverage is showing some signs of stress, with a continued dip in the weighted average years to maturity of its debt set against a leverage ratio that is sitting above management’s 40% target.

AHH’s low multiple and elevated dividend yield is a function of a stock market that has soured on REITs in the interim. This sentiment will change on the back of pending rate cuts, with AHH well-placed to see its multiple expand due to strong coverage and its elevated dividend yield. REITs have been one of the worst-performing sectors since the Fed funds rate was raised to a 22-year high at 5.25% to 5.50%. Further, initial dovish expectations at the start of 2024 of at least three rate cuts have dipped to a single rate cut at the upcoming November or December FOMC meeting according to the CME FedWatch Tool.

AHH’s office occupancy sits far above the occupancy rate implied by the national office vacancy rate of 18.8% at the end of April. This rate was up 210 basis points year-over-year. REITs are sensitive to the Fed funds rate due to the significant leverage they take on to fund their asset purchases. So they have positive duration risk. We can see this by the dip in the price-to-free cash flow of respective office REITs from early 2022 when the Fed’s fight with inflation kicked off.

The discounting of office REIT is reflective of this zeitgeist, whether this at some point is stabilized against rising office-to-residential conversion and the collapse of new office construction is an uncertainty. AHH’s diversified portfolio, extremely safe dividend, and high occupancy rates mean the REIT deserves a higher multiple to NFFO. This will likely only come once the Fed starts cutting rates. I’d expect the timeline for this re-rating to happen in the back-end of 2024 and early 2025 with the FedWatch Took pricing in this period as the highest probability for rate cuts. This would be the base scenario if inflation resumes its descent, with a worst-case scenario placing rate cuts further away from investors into an uncertain period beyond 2025.