Description

Summary

I have been investing in multifamily via the public markets for over a decade now, this is one of the best set ups for a multifamily REITs if you have a 2-3 year time horizon. I try not to make this too complicated. This thesis is like telling people to buy FANG stocks in the past (ok, not as high upside). This idea is simple and easy. That's it. You just need the patience to wait it out. It's a boring investment. The Fed may cut rates this year, it may not. I don't know. But if you have a 2-3 year time horizon, you do fine. If you're a pod shop, I can't help you. 

Mid-America trades at roughly 6.8% cap rate which was unimaginable back in 2021. The company owns over 100,000 apartment units in a dozen Sunbelt cities. The company currently pays 4.4% dividend which is on par with the US 10 year treasury. But MidAmerica pays out less than 70% of its free cash flow after all corporate G&A, maintenance cap ex, interest expenses etc. So the free cashflow yield is actually closer to 6.5% to 7.0% that should grow over time. Thus owning Mid-America will likely beat owning the 10 years US Treasury by a wide margin over 10 years. The EBITDA covers interest expense 8.4 time. This is unheard of in the private markets. This is very safe by all standards. The 6.8% cap rate is very cheap. One has to go back to the early 2000s to get to this level of valuation. Just a few years ago, it was commonly accepted that buying a multifamily building at a 4.5% cap rate was safe and a good capital allocation. I think investors will double their money in 5 years with dividends reinvested. While this may not jump out at you. It is a great risk adjusted return that sits somewhere between a bond and an equity. Lastly, these are pretty much all stabilized assets. Private real estate investors generally earn 15-20% return when they increase the project's risk profile by taking on value-add or ground up development risk or by using high leverage.

Affordability 

Across the portoflio, the average tenant pays 22% of their income towards rent to MidAmerican. 

Balance Sheet 

3.6x net debt/EBITDA with well laddered maturity 

The Development Model is Broken 

For the past 10-12 years, real estate GPs have been trying to develop to a 6% unlevered yield from the ground up and try to sell at a 4.25 to 4.5% cap rate.  

The increases in interest rate has rendered this 20% levered IRR model broken. Builders will finish buildings, but very few new projects are being greenlit. Over time, little supply will be delivered. Rent growth will likely be strong in 2026 and last for 2-3 years at the minimum. 

This benefits MidAmerican and the incumbents as new supply will be sparse in 25 and beyond. 

Optioanality

Mid-American's balance sheet is pristine. They can increase debt by another $3.3 bn and acquire additional multifamily building this cycle. The longer that interest rates stay high, the more accretive deals Mid American will be able to do. 

Valuation 

Current stock price $132.72 

At 5% cap rate - $197 or 49% upside 

At 6% cap rate - $158 or 20% upside 

In 2027 @ 5% cap rate - $218 or 64% upside, add on $23.50 in dividends and $13-16 of cash build that may be revinested in new acquisitions.  

Total upside is 93% by year end 2027 or 18% gross IRR over 4 years

Key Risk 

There is a lot of supply being built which results in weak rent growth in 24. Most of the new delivery will be absorbed in 2024. This has shown up as muted rent growth and even rent declines in certain markets. We believe the supplies will be absorbed in 2024. Financing is not an issiue. MidAmerican issues 10 year fixed rate unsecured corporate bonds at 5% in Jan of 2024. 

The company has guided to a -2.8% to -0.2% same store NOI growth in 2024. 

Historical Performance 

While past performance isn't indicative, Mid-American has a pretty good history. 

Catalyst

Catalysts

Blackstone bought Air Communities, a multifamily REIT that owns one of the oldest vintage portfolio of buildings at around 37 years. The implied cap rate is 5.9-6.0% cap rate and Blackstone paid a 25% premium. Blackstone venturing back to the public markets signals two important messages. 1) The buyout optionality is now back on. 2) Blackstone is likely the smartest or at least has the biggest pockets in PE and they are signaling that buying at a 6% cap rate is smart. Most multifamily REITs rallied about 5% today on the news. 

https://www.wsj.com/real-estate/blackstone-making-10-billion-multifamily-purchase-going-on-the-real-estate-offensive-f3126928?mod=Searchresults_pos1&page=1

If the Fed cuts rates, watch out!