High Quality Multi-family REITs - EQR, CPT, ESS, AVB

[Gregmal]

This sounds like the kind of thing people wait around years or decades for and during which, rack up really sub par returns. If it comes, great, but baselining something like this is a sure fire way to not make money. Flip side is if it does, you don’t need much spare change to make life changing long term investments. 

[thepupil]

I don't know. that's a lot of rhetoricals and not a lot of tickers. what companies under what I'll term the Learning Machine Pet Theory Radically Higher Cost of Capital (LMPTRHCOC) scenario do you like at today's prices? 

 

what's the LMPTRHCOC Portfolio look like?

[LearningMachine]

4 minutes ago, Gregmal said:

This sounds like the kind of thing people wait around years or decades for and during which, rack up really sub par returns. If it comes, great, but baselining something like this is a sure fire way to not make money. Flip side is if it does, you don’t need much spare change to make life changing long term investments. 

 

You don't have to wait around.  You can be in those companies today, and actually earning FCF yield, money being returned to shareholders, not some hypothetical on the company being able to sell something at a high price in the future.

Edited March 27, 2023 by LearningMachine

[Gregmal]

2 minutes ago, LearningMachine said:

 

You don't have to wait around.  You can be in those companies today, and actually earning FCF yield, money being returned to shareholders, not some hypothetical on the company being able to sell something at a high price in the future.

I know we talked a bit back, and I actually like some of the names you mentioned quite a lot given my real estate and housing skew….but…. doesn’t this sort of kinda teeter along the edge of buying economically sensitive cyclicals? Which is then making a bit of a timing call. If rates go 10% I think washer dryer sales plummet. Am I missing something? 
 

I got intrigued enough with your obsession probably two years ago, that I looked through some stuff that met the thresholds, but they largely fit that above criteria or had tons of debt. I did find quite a lot of value if I lowered the 10% FCF figure moderately though.

[thepupil]

9 minutes ago, LearningMachine said:

 

You don't have to wait around.  You can be in those companies today, and actually earning FCF yield, money being returned to shareholders, not some hypothetical on the company being able to sell something at a high price in the future.

 

It's not clear to me that there are securities that wouldn't be drastically lower in price under LMPTRHCOC. So if you use LMPTRHCOC as a base/reasonably probably downside case, I'm not sure what you could own. If there are some, I'm very interested.

 

I think maybe my royalty trusts (unlevered and hydrocarbon cost linked) may do okay, but who knows. their success will depend on hydrocarbon px and volume of production on their land. 

Edited March 27, 2023 by thepupil

[RedLion]

4 minutes ago, thepupil said:

 

It's not clear to me that there are securities that wouldn't be drastically lower in price under LMPTRHCOC. So if you use LMPTRHCOC as a base/reasonably probably downside case, I'm not sure what you could own. If there are some, I'm very interested.

 

I think maybe my royalty trusts (unlevered and hydrocarbon cost linked) may do okay, but who knows. their success will depend on hydrocarbon px and volume of production on their land. 

 

Short term t-bills and probably short term TIPS would do well under a scenario where rates go to 10% with 7% + on the 10 year treasury no? I would think almost everything else would selloff, and even the good businesses will probably sell off with the rest due to the prevalence of indexing. 

 

I'm not a real estate expert, but didn't residential real estate do OK during the rising interest rates of the 70s and 80s?

 

I know this isn't a security, but you can get 30 year fully amortizing non-recourse multifamily financing on a Fannie Mae Small balance loan today as low as a 5.2% fixed rate with 55% LTV if this link is correct.  https://selectcommercial.com/fannie-mae-loans-small-rates.php  I think the max loan size is only 6 or 7 million, but there are other longer term loans available on multifamily as well. Anyway, if you can buy an apartment building at 55% LTV with a 5% CAP rate with fixed rate 5.2% financing and rates actually go to 10% (because of persistent HSD inflation), then it seems like the cashflow growth would be very attractive even if CAP rates expanded. Also, the small balance loans are assumable, so if rates go up that would bolster the value of the property to some degree if you did want to exit during a high interest rate period. 

[LearningMachine]

21 minutes ago, thepupil said:

 

It's not clear to me that there are securities that wouldn't be drastically lower in price under LMPTRHCOC. So if you use LMPTRHCOC as a base/reasonably probably downside case, I'm not sure what you could own. If there are some, I'm very interested.

 

I think maybe my royalty trusts (unlevered and hydrocarbon cost linked) may do okay, but who knows. 

 

22 minutes ago, Gregmal said:

I know we talked a bit back, and I actually like some of the names you mentioned quite a lot given my real estate and housing skew….but…. doesn’t this sort of kinda teeter along the edge of buying economically sensitive cyclicals? Which is then making a bit of a timing call. If rates go 10% I think washer dryer sales plummet. Am I missing something? 
 

I got intrigued enough with your obsession probably two years ago, that I looked through some stuff that met the thresholds, but they largely fit that above criteria or had tons of debt. I did find quite a lot of value if I lowered the 10% FCF figure moderately though.

 

 

 

Similar to royalty trusts, oil companies are still making money hand over fist, and buying back stock at low P/E and trading at high unleveraged FCF yield. 

 

Now, imagine, the price of your product was guaranteed by a cartel of governments to keep track of inflation (with some lag). 

 

Imagine what happens in the event of a calamity that causes our democratically elected politicians to print even more money. 

 

If you believe a bank is not going to get a bank-run with high degree of certainty, some of those banks are making more and more money as interest rates go up.   In some specific cases, it can be almost like you owning multifamily buildings, where rental yields are going up, and you have financed the multifamily building with almost zero interest rate, and you have high degree of certainty that you won't have to refinance at rates much higher than zero for at least some portion of your financing for some of the apartments that are on longer term leases and that people giving you money are going to have to leave some of the money there. You ended up renting out some of apartments at longer term leases, while vast majority are at short-term lease.  Mr. Market is running around saying those apartments you rented out at longer term low-rental-rate leases should be marked to market so that you lose 30-50% of the value of those apartments.   Imagine now you could buy these rights at P/E of 8, i.e. 12.5% earnings yield today, and imagine the entity has been showing history of buying back its stock at low P/Es. 

 

 

 

 

 

Edited March 27, 2023 by LearningMachine

[LearningMachine]

Imagine what happens when those apartment leases come up for renewal, where you were charging $2500 per month (2.5% interest rate), and now the going rate is $7000 to $10000 (7-10% interest rate).  You'd make a killing. 

 

You bought it at P/E of 8 when they were renting out at $2500 per month.

 

And, now they are renting out at $10,000 per month. 

Edited March 27, 2023 by LearningMachine

[thepupil]

I'd think that dramatic of a move in rates zombie-fies the whole banking system given that the move to date basically killed 80-90% of capital. now the system collectively doesn't have to "mark to market", but I don't think i'd love being invested in banks if they went to like 4x their equity into theoretical insolvency, nor do i think capital return would be happening. 

 

I'm not a bank doomer; in fact I don't think there's evidence we are in a "crisis" that is widespread or important.. But I'd be a bank doomer if I thought rates went to 7-10% quickly. 

 

as for energy, I don't know. I own some. no idea where prices going.

 

Sort of in line with what @Gregmal was saying, being so concerned w/ rise in cost of capital does push you into lower multiple sectors that have other different risks.

 

Time will tell. But for the record, I think a 2 handle 10 year is more likely than a 7 handle . And a 1 handle  more likely than a 9. given we're at 3.5%, I think most would agree. doesn't make it right of course. 

 

 

 

Edited March 27, 2023 by thepupil

[CorpRaider]

Tryin to catch a fill on Clippah.

[LearningMachine]

2 hours ago, thepupil said:

I'd think that dramatic of a move in rates zombie-fies the whole banking system given that the move to date basically killed 80-90% of it. now the system collectively doesn't have to "mark to market", but I don't think i'd love being invested in banks if they went to like 4x their equity into theoretical insolvency, nor do i think capital return would be happening. 

 

I'm not a bank doomer; in fact I don't think there's evidence we are in a "crisis" that is widespread or important.. But I'd be a bank doomer if I thought rates went to 7-10% quickly. 

 

as for energy, I don't know. I own some. no idea where prices going.

 

Sort of in line with what @Gregmal was saying, being so concerned w/ rise in cost of capital does push you into lower multiple sectors that have other different risks.

 

Time will tell. But for the record, I think a 2 handle 10 year is more likely than a 7 handle . And a 1 handle  more likely than a 9. given we're at 3.5%, I think most would agree. doesn't make it right of course. 

 

 

 

 

Indeed, you can't look at what other people are saying.

 

You've to do your own thinking and have confidence that anytime in history, if a bank had a bank run, they wouldn't have been able to give 100% of depositors their money. 

 

It is analogous to when Buffett was asked what would happen to the country if oil prices went down, and he answered it beautifully that short-term people will try to mark-to-market the reduced FCF on oil companies, resulting in a lot of short-term thinking that low oil prices are bad for the country, even though longer-term we all know low oil prices will be better, but the effect will be positive slowly. 

 

Similarly with banks with sticky deposits, you know long term, if they can rent out those deposits at 7-10% instead of the current rents of 2-3%, they will be better off.  Now, if you start walking into other kinds of thought patterns that what if they have to liquidate now, you can talk yourselves out of it.  While the thought pattern of liquidating your assets might apply to some specific banks, it doesn't apply to other specific banks.  You've to be really good at assigning probability ranges to thought pathways, and decide which pathways to thought patterns to cut off for specific bank situations. 

 

 

Edited March 27, 2023 by LearningMachine

[thepupil]

So I kind of loaded up today and ended up with 7% each in MAA/CPT. Sold my 29 year TIP at 1.6% real, CLO AAA at 6 and change yield to buy these pups at 6.5% CR and like a 6% AFFO yield,

 

in conjunction with my ESS/NEN/CLPR/parts of JBGSFRPH got like low 20’s in multi family which seems reasonable to me. Lots of supply but starting with well below pvt mkt basis and leverage will (hopefully) help.

[HalfMeasure]

On 3/24/2023 at 2:34 PM, Spekulatius said:

Reits are not bonds. Some like NNN are very much like bonds or even office Reits with long duration leases often are, but others like MF reits that reprice yearly clearly are not.

 

For example since the 1990's, I believe commercial property as a group traded at higher Cap rate than the 10year risk free treasury. However, in the 70's, commercial property actually traded a lower cap rate than the 10 year treasury. Why - because commercial property owners could generally raise rent with increasing inflation, so there was an inherent inflation protection build in which of course was appreciated by property owners.

 

Reits as an asset class did not exist yet in the 70's as far as i know, so we can't look at that part of the stock market history.

Agree with this line of thinking. Building on this, if a REIT's underlying assets have supply constraints and demographics on their side (hypothetical for now), and thus likely has inflation protection built in, isn't it more comparable to a TIPS-type security vs. a nominal bond? Further, if the REIT has a well termed out cap structure with reasonable leverage, they're effectively short nominal bonds while their underlying that they are long behave more like inflation-protected bonds. It's a very attractive structure with the right assets, cap structure, and management.

Edited March 27, 2023 by HalfMeasure

[Dinar]

5 hours ago, LearningMachine said:

 

Thanks @thepupil for doing the exercise with 10% interest rates :-). 

 

Just so that I understand fully, what did you mean by "1%/yr each headwind"?  That weighted average interest rate goes up by 1% each year? 

 

Regarding net cash from operating activities, I see it was $744.7M in 2022. 

 

For 2023, assuming we believe their midpoint FFO per share, at 106,700,488 shares, FFO would be $747M for all shares in 2023. 

 

Taking $215M of interest from 747M would be $532M.

 

At that point, if the market prices CPT at 7-10% leveraged yield (in line with unleveraged risk-free 7-10% treasuries at the time), CPT market cap would be $5.3B to $7.6B.

 

That said, CPT would have an edge over treasuries to be able to increase rents. 

 

you are subtracting interest twice, ffo is post interest

[thepupil]

He’s not, $215mm is the incremental interest expense at his 10% refi rate (which I think is absurd, but likes of MAA/CPT could handle)

[Spekulatius]

Kind of an interesting world where risk free interest rates are at 10% and rents don’t rise, while at the same time BAC gets 10%+ on loans while still paying nothing on deposits.

 

I would like to see what loan losses in this world would be like and why deposits rates don’t rise or how Mr Market and depositors  look at the ~ MTM losses of their ~$880B in 2.3% yielding debt securities in addition to MTM on fair value of their loans. My guess is that at 10% the MTM loses on their security will be many times the equity ($172B tangible equity), so technically we would be look at a zombie bank here.

[LearningMachine]

54 minutes ago, Spekulatius said:

Kind of an interesting world where risk free interest rates are at 10% and rents don’t rise, while at the same time BAC gets 10%+ on loans while still paying nothing on deposits.

 

I would like to see what loan losses in this world would be like and why deposits rates don’t rise or how Mr Market and depositors  look at the ~ MTM losses of their ~$880B in 2.3% yielding debt securities in addition to MTM on fair value of their loans. My guess is that at 10% the MTM loses on their security will be many times the equity ($172B tangible equity), so technically we would be look at a zombie bank here.

 

I'm not saying rents won't rise at 10% per year, taking more than 7 years to double. 

 

If interest rates go to 10% in a few years, all the additional rent increase is eaten up by additional interest and some more, and that additional interest is going into BAC's pocket. 

 

As long as no-one forces them to liquidate that $880B, they can lend the other $1+ Trillion at 10% interest rate, which is $100B in interest income on $1T alone, and wait to rent that $880B at 10% as it matures. 

 

 

[thepupil]

37 minutes ago, LearningMachine said:

 

I'm not saying rents won't rise at 10% per year, taking more than 7 years to double. 

 

If interest rates go to 10% in a few years, all the additional rent increase is eaten up by additional interest and some more, and that additional interest is going into BAC's pocket. 

 

As long as no-one forces them to liquidate that $880B, they can lend the other $1+ Trillion at 10% interest rate, which is $100B in interest income on $1T alone, and wait to rent that $880B at 10% as it matures. 

 

 

 

if rent and expenses grew by 10%/yr, NOI would grow by 10%/yr. (NOI - Interest) would grow at roughly the same rate.

 

Under this scenario, the additional rent would by no means be eaten up by additional interest.  there is $1B of additional NOI and $183mm of additional interest. Under this scenario Interest goes from 15% of NOI to 17% of NOI over 7 years.

 

Does that surprise you? 

 

What matters is the relative growth between rent and operating expenses (or interest or maint capex etc). For example, if rents grew 7% but all other expenses grew 10%, then NOI would only grow 4%/yr over a 10 year period and margins would be declining (and your mcapex as % of NOI is probably increasing too). if the opposite (10% rents, 7% expense growth, then you get 12% NOI growth.

 

What will happen will probably be like 4 and 3 or 3 and 4. (2-5%) but just entertaining the crazy high numbers for your benefit. 

 

Edited March 28, 2023 by thepupil

[Spekulatius]

33 minutes ago, LearningMachine said:

 

I'm not saying rents won't rise at 10% per year, taking more than 7 years to double. 

 

If interest rates go to 10% in a few years, all the additional rent increase is eaten up by additional interest and some more, and that additional interest is going into BAC's pocket. 

 

As long as no-one forces them to liquidate that $880B, they can lend the other $1+ Trillion at 10% interest rate, which is $100B in interest income on $1T alone, and wait to rent that $880B at 10% as it matures. 

 

 

This assumes that they pay nothing for deposits and that loan losses remain low in this scenario. Both assumption are unlikely to hold.

[LearningMachine]

21 minutes ago, thepupil said:

 

if rent and expenses grew by 10%/yr, NOI would grow by 10%/yr. (NOI - Interest) would grow at roughly the same rate.

 

Under this scenario, the additional rent would by no means be eaten up by additional interest.  there is $1B of additional NOI and $215mm of additional interest. Under this scenario Interest goes from 15% of NOI to 17% of NOI over 7 years.

 

Does that surprise you? 

 

What matters is the relative growth between rent and operating expenses (or interest or maint capex etc). For example, if rents grew 7% but all other expenses grew 10%, then NOI would only grow 4%/yr over a 10 year period and margins would be declining. if the opposite (10% rents, 7% expense growth, then you get 12% NOI growth. What will happen will probably be like 4 and 3 or 3 and 4. (2-5%) but just entertaining the crazy high numbers for your benefit. 

 

 

Thanks @thepupil, I agree it depends on how fast interest rate is going up for CPT, and for that, the most important figure is CPT's weighted average maturity.  I'm curious how you built your WA Rate column?  Is it based on their maturity schedule on page F-20 in the 10K at https://www.sec.gov/ix?doc=/Archives/edgar/data/906345/000090634523000008/cpt-20221231.htm ?

 

CPT's 10K says weighted average maturity is 6.4 years.  Is CPT the REIT with the highest weighted average maturity, or you have found another with a higher weighted average maturity? 

 

Also, not sure how your starting point is 852M for NOI - Interest for 2023.  Regarding net cash from operating activities, I see it was $744.7M in 2022.  For 2023, assuming we believe their midpoint FFO per share, at 106,700,488 shares, FFO would be $747M for all shares in 2023. 

 

 

[LearningMachine]

4 minutes ago, Spekulatius said:

This assumes that they pay nothing for deposits and that loan losses remain low in this scenario. Both assumption are unlikely to hold.

 

I wasn't saying $100B + $88B = $188B in net income. 

 

I was saying that as interest income. 

 

Sure, they might have to pay a little more for some portion of their deposits if they really want to keep them.   If the inflation keeps going, deposits will start going up again too at some point. 

 

Regarding losses, really depends on how fast the interest rates go up.  Basically, the question is do the banks take so much money from people and companies that they have nothing left and have to go under, or can they just keep on increasing how much they are charging just upto the point that there aren't widespread losses. 

[thepupil]

I built it using their capital structure. I assumed that at maturity debt gets refi'd at x% (in this case 10%) and then that calculates a pro-forma total interest expense. Just a very simple excel exercise.

 

NOI and FFO and CFO, EBITDA, etc. are not at all the same thing. NOI is Revenue - Property operating expenses. It does not include G&A, interest, mcapex, etc. FFO subtracts g&a and interest, but does not include maintenance capex, CFO is cash from operating activities and may include many different other things. there are many different metrics or ways of looking at things. 

 

For example for 2023, using JPM estimates, CPT's estimated NOI is $1B its, its FFO $6.9 / share ($760mm) and AFFO $6 / share ($660mm). the delta between NOI and FFO is $60mm ish of g&A and $135mm ish of of interest and some "other expense plug that I honestly don'd know what that is. then there's an implied $100mm of mcapex ($1,600/unit/yr). 

 

However you want to look at things, the general principle is that if rent and whatever expense line item is growing at same rate, then whatever you're looking at will grow a that rate.

 

If something is growing faster (and it's on the expense side) that's a problem. If CPT had to refi at 10%, all else equal their interest expense would grow about 12%/yr over the next 7 years. 

 

if you want to make a case that all expenses and capex will rise more quickly than rents (causing NOI/FFO/AFFO growth to lag inflation), AND we'll see cap rate expansion then you can make that case, but rising interest rates alone are unlikely to be a problem for a REIT with such low leverage and well staggered maturities. 

 

CPT's maturity profile is very typical for blue chip REITs (7.5 years appears to be the market average). Some REITs are longer like PLD and KIM IIRC. Some are shorter.  you can read more about it here 

https://www.reit.com/news/blog/market-commentary/solid-balance-sheets-prepare-reits-rising-interest-rates

 

 

 

 

Edited March 28, 2023 by thepupil

[LearningMachine]

Thanks @thepupil, for net cash from operating activities, I was going by what they have in the 10K on page F-8 at https://www.sec.gov/ix?doc=/Archives/edgar/data/906345/000090634523000008/cpt-20221231.htm#ic3d0808623a844d5be74a512380237cd_121 . 

 

 

Indeed, what's helping CPT survive here is low leverage and well staggered maturities to be able to withstand 10% interest rate scenario. 

Edited March 28, 2023 by LearningMachine

[thepupil]

everyone has their own way of doing things. I look at numerous ways of valuing something like CPT.

 

1) what would a sovereign, Blackstone, MAA, EQR pay? NAV today. how fast is NAV growing, how does that NAV and NAV discount change in numerous environments. 

 

2) Perpetual constant multiple going concern metrics (dividend + growth, AFFO yield) etc

 

there are numerous folks who calculate NAV. Consensus NAV is $140 ish at a low 5's cap. stock is at $100. so that's a good start. Now how reasonable is the low 5's? How levered is the NAV? has this mgt team historically created value? what if cap rates go to 4%? what if they go to 7%? what does that all look like. What if NOI is 20% lower in 3 years because of recession / too much supply? etc. 

 

I won't claim to have modelled everything out precisely. I kind of think of something like CPT as having a mid to HSD perpetual return (call it 7-9% / yr, 4% divvy +3-5% growth) which for 25% levered RE seems pretty damn good to me.

 

Or you could say "at some point in 10 years, someone will pay me NAV, I think NAV is $140 because I agree with the consensus assumptions and I think NAV will grow 3% / yr), so if I get paid NAV in 10 years, I'll make  a little more than 10.5%/yr ($188 NAV 4% divvy) or if I get paid NAV in 5 years, I'll make 15%/yr  ($162 NAV + divvy)...or If NAV doesn't grow for 10 years because of some combo of bad stuff and it still trades at same discount I'll clip the divvy (4%/yr) or any number of permutations. 

[thepupil]

Anyways back to MF. for those who didn’t see this, large landlord  (CEO of 26K unit owner) tweeted this today and said the posted cap rates were not representative of the market and were unrealistically HIGH. while we sit here and wonder if 6.5% is going to 8%, private market still in the 4’s and 5’s, with maybe even high 3 handle here and there.

 

that’s basically the opportunity/disconnect.

 

https://twitter.com/MRossG199/status/1640338388459876352?s=20

Edited March 28, 2023 by thepupil