Mid-America Apartment Communities: Long-Term Buy Despite Limited Near-Term Growth (MAA)

A couple of months ago, before the release of Q3 2023 earnings, I issued an article Mid-America Apartment Communities (NYSE:MAA) assigning a buy rating.

It was really a combination of two fundamentally important factors that made the investment thesis rather attractive – i.e., one of the safest balance sheets in the sector with a very healthy NOI and FFO growth.

Since then, MAA has remained somewhat flat (even on a total return basis) despite the massive recalibration in interest rate expectations and quite solid Q3 2023 performance.

Considering the changed dynamics in the monetary policy and new data points from Q3 results, it is worth revisiting the previous thesis and see whether a buy rating is still justified.

Synthesis of Q3 2023

All in all, MAA delivered stable results across the board as it was expected given the defensive characteristics of the underlying business.

During the third quarter, one of the most important metrics – same store NOI – increased by 3.7%, which is a testament of MAA’s ability to keep the top-line growing despite holding quite conservative stance on its capital structure and new M&A.

Having said that, even though in aggregate the same store NOI continued to climb higher, we could notice two potentially concerning elements:

1. The rate of change in NOI de-accelerated compared to the previous quarters, landing significantly below the YTD NOI growth figure.
2. The overall expenses increased at a higher rate than the revenues, which (if not changed) could render future growth of NOI more difficult.

In terms of the other critical metrics, MAA remained at a sound territory: e.g., resident turnover was down in the third quarter by 4% and the occupancy improved a bit by 1 basis point from already healthy level of 95.6%.

The state of balance sheet remained at historically sound levels with the debt to EBITDA at 3.4x and 100% fixed debt for an average maturity profile of just over seven years. The average interest rate stemming from the assumed borrowings stood at 3.4%.

An important activity in the context of MAA’s capital structure was the refinancing of $350 million debt that was made utilizing mostly cash and to some extent commercial paper program. This did not only reduce further the financial risk in MAA’s books, but also served as an indication of how MAA views the overall capital allocation: i.e., focus on keeping the balance sheet strong and not assuming incremental leverage.

Finally, in the context of future growth, MAA is still in a conservative mode. For example, according to Clay Holder – Senior Vice President & Chief Accounting Officer (as per recent earnings call), the investment amount over Q3 period was quite shallow:

During the quarter, we invested a total of $19.7 million of capital through our redevelopment repositioning and smart rent installation programs. Those investments continue to produce strong returns and add to the quality of our portfolio. We also funded just over $47 million of development costs during the quarter toward the completion of the current $643 million pipeline leaving $296 million remaining to be funded on this pipeline over the next two years.

From the aforementioned quote, I would just underscore the fact that MAA has only ~ $300 million of unfunded pipeline over the next two years, which, again, implies two important elements:

1. MAA is in a position to further deleverage its balance sheet unless attractive M&A opportunities emerge.
2. The external growth factor, which in general for REITs is a notable source of growth, will likely be muted in the foreseeable future.

Brad Hill – Executive Vice President & Chief Investment Officer – painted a somewhat similar picture in the recent earnings call:

And so and we’re still seeing cap rates in the low 5% range for those well-located assets. I would expect to see pressure on cap rates. But really it’s going to depend on how that liquidity shows up for those assets to bid on them. But certainly given the severe movement that we’ve seen in the 10-year. And agency debt today is in the 6.5%, 6.75% range, we would expect some upward movement in cap rates but to what degree is going to depend on the liquidity picture, the fundamentals of the properties locations things of that nature. So it’s really hard to say where that goes from here.

With that being said, while the prospects of future growth are relatively weak and unattractive, MAA continues to remain well-positioned in terms of being able to act opportunistically in case the market environment considerably improves.

As we can see in the table above, MAA could already be considered a very conservative REIT, where the underlying financials are stronger than average (on top of the inherently durable sector exposure).

Based on the aforementioned dynamics on the external growth front, it is highly likely that MAA will manage to enhance most of these KPIs even further.

Just to give you a context of the benefit of the current level of core FFO payout. Assuming ~62% in FFO payout, MAA is able to retain ~$400 million per year that could be put at work for either funding the CapEx program or bringing down part of the existing borrowings. Against the backdrop of relatively muted pipeline, I see a great potential of MAA to refinance only a relatively minor part of the 2024 maturities (~399 million) as the retained cash flows could be channeled towards repaying a notable chunk of these maturities; thereby avoiding higher interest costs (from refinancing at higher rates) and reducing the debt burden.

The bottom line

We have to appreciate the fact that it is highly unlikely that MAA delivers outstanding growth or excellent results in the foreseeable future as most of the focus is put towards strengthening the balance sheet even further and not venturing into sizeable M&A or internal CapEx transactions. Plus, given the already robust financial characteristics of MAA and the low-duration profile of its top-line, MAA will not be able to benefit much from the normalization of interest rates.

Nevertheless, MAA remains a great vehicle through which to assume a wait and see stance. When market conditions become more interesting (e.g., cap rates increasing or cost of capital going below overall cap rate levels), we should see MAA making considerable moves utilizing its fortress balance sheet. Until it does not make sense to conduct aggressive growth strategy, MAA as an investment offers quite an attractive dividend yield at ~4.5%, which is underpinned by conservative payout and improving balance sheet.