Continued Price Weakness Offers Great Opportunity To Pick Up Shares Of Preferred Apartment Communities

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Summary

GAAP accounting rules forced APTS to incur a $0.07 per share hit when in reality it was a great investment.

Revenue growth, and expansion, continues its torrid pace, reaching 39.2% YoY.

Shares are still cheap at these levels considering the underlying metrics and growth.

An investment in APTS yields 6.9%.

What Happened?

The last time I wrote about Preferred Apartment Communities (APTS), it was just coming out of its 6-iteration multiple bottom last summer. Shares were trading at $15.17 at the time of publication. Since that day, shares soared to $18.50 before coming crashing down to $15.08, where we are now. Post-earnings report, there was a 12% drop which was both unwarranted and a great opportunity. I doubled my position at the ridiculous price of $14.01. The price recovered just a few hours later to a more reasonable $14.48 and while the recovery continued for a while, it has since come back down to extreme value levels.

Image from finviz.com

As I will point out later, the sell-off does not make sense to the fundamental investor. The highlights of the bull thesis are all still present:

-Ridiculously high YoY revenue growth, most recent quarter up 39.2% YoY.

-Diversification of holdings into Residential, Office, Grocery/Retail and Student Housing.

-High and just-increased dividend that yields 6.9%.

-Peer-best average age of properties (5.3 years) leads to lower capital expenditure on repairs and renovations.

-Unique capital structure of preferred shares and project-level mortgage loans create fixed rate borrowing rates with which APTS has easily surpassed.

-Lower home ownership trend across the country means demand for apartments is high.

Growth

Q3 FFO of $0.28 (missed by $0.09) and Revenue of $104.23M (up 39.2% YoY)

Q3 earnings caused a 12% intra-day drop, mainly due to the $0.07 hit to GAAP FFO from the early termination of a loan. Headline traders, trading algorithms and people unable to pour through the finer details panic-sold shares on the news. The loan is no longer a source of recurring revenue so it lowers FFO, but the company still managed to record a 12.9% IRR on the loan. Most of the time I criticize companies for hiding bad performance behind Non-GAAP reporting, but in this case it was GAAP reporting that caused the misconception. FY 2018 guidance was revised lower by about $0.04 to make up for the termination of the loan, so it stands now at $1.39-1.42.

Image from Seeking Alpha

Portfolio Composition and Strategy

A criticism of APTS is that it is not a pure-play apartment REIT, instead opting for opportunistic investments in apartments, retail (typically grocery-anchored) and office properties. Some theorize that at some point in the future the retail and office arms of the company could be spun off. I enjoy having my investment eggs in different baskets because it should smooth out performance and allow management flexibility to create shareholder return.

Here are some of the most recent acquisitions:

July 31st – APTS buys Wells Fargo Capitol Center, a 559,591 square-foot, 29-story office tower in Raleigh, North Carolina. Fixed-rate 30-year mortgage of 4.27%.

September 28th – APTS buys a 300-unit multifamily complex in Tampa, Florida. Fixed-rate 30 year mortgage of 4.32%.

November 15th – APTS buys a 200-unit multifamily complex in Charlotte, North Carolina. Fixed-rate 30 year mortgage of 4.51%.

APTS’ push into Raleigh and Charlotte makes a lot of sense because population growth, high demand and low supply of office space, retail space and multifamily properties will ensure the ability to increase rents in the future. I’m a big fan of buying into an up-and-coming secondary markets rather than chasing superheated, overpriced markets. The following graphs support the decision to hitch a ride on the market trends before they become the next Seattle or Denver.

Image from LoopNet

Image from LoopNet

Image from LoopNet

Another trend that I see as a positive for apartment REITs is the trend of fewer and fewer Americans owning their own home. With housing prices skyrocketing and wage growth relatively flat, renting makes more sense for many. 30-year fixed mortgage rates are close to 5% nowadays, which puts a damper on younger generation’s ambition to buy a home. This is helping keep demand high enough to swallow the increasing apartment supply nationwide.

Image taken from Hoya Capital Real Estate’s article

Big, Covered Dividend

Compared to its peers, I think that APTS offers the best risk-adjusted dividend yield. Lower-growth pureplay apartment REITs such as Essex Property Trust (ESS) or AvalonBay Communities (AVB) have yields of 2.88% and 3.15%, respectively. APTS’ covered dividend yield of 6.9% fairly compensates you for the risks of the sector. Average dividend growth rate of 14.4% since the 2011 IPO shows a commitment to shareholder returns.

Image from author, with data coming from Seeking Alpha

Past nine-month dividend coverage comes in at a very respectable 74.5%. The temporary FFO hit mentioned earlier makes the future of the dividend look uncertain to the cursory glance. But in reality, once new acquisitions and redeployed capital contribute to the bottom-line, the FFO should return to prior levels. If management didn’t have confidence in its ability to fund the dividend, it probably wouldn’t have just raised it to $0.26 a quarter.

Summary

For investors who are seeking income, growth or both, this stock is a gem. With 84% fixed rate mortgages and preferred share sales funding growth, the company can drum up huge amounts of capital and deploy it into undervalued growth regions such as North Carolina. Revenue growth and dividend growth continue to go up and to the right, and by timely adding shares on dips, you can generate sizable returns.

Disclosure: I am/we are long APTS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I doubled my long position in APTS on November 6, 2018, at a price of $14.01.

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