Mid-America Condo: No Reason to Wait for Supply Demand Tipping Point, Buy Now (MAA)

My previous article on Mid-America Apartment Communities, Inc. (NYSE:MAA) was issued immediately following the release of its Q1 2024 earnings report. We indicated that MAA is still a clear buy despite short-term supply headwinds Ending. The general idea was that the decline in construction starts, the restrictive financing for households to buy new homes and the strength of the MAA. balance sheet should lead to significant value creation as the current oversupply problem is gradually resolved.

Since publishing my last piece, MAA has delivered total returns of nearly 15%, which also marks a slight market outperformance.

Relatively recently, MAA released its Q2 2024 earnings package, which in my opinion includes several messages and data points that continue to make MAA’s bull case active and relevant.

Let me now elaborate on why I think so.

Revision of the thesis

What is quite interesting is that while the assumption for 2024 was that MAA would see a slight decline in its cash generation due to the supply issue mentioned above, the actual results turned out to be a bit different.

The MAA was expected to exert significant pressure on the rent front (ie, falling prices) and that there would be a decline in occupancy due to consumers moving to more affordable units.

However, in Q2 2024, MAA reported core FFO of $2.22 per share, which is $0.03 per share above the midpoint guidance for the quarter. The key driver here was the improved cost base, where $0.02 per share came from an optimized same-store expense profile ~ $0.01 per share from a combination of lower overhead and lower interest expense .

Looking at the top level, we will see some consequences of the current unfavorable supply and demand dynamics (although demand is very high). Most importantly, new lease prices on a lease-over-lease basis reached a negative 5.1%. However, the offsetting factor here was renewal rates which increased by 4.6% on a lease over lease basis. As a result of this, the lease price over lease on a mixed basis actually increased by 70 basis points.

An additional element that contributed to the increase in cash generation was the improvement in physical occupancy, where MAA saw a 20 basis point increase to 95.5%. So all these factors allowed MAA to achieve same-store revenue growth of 0.7%.

Finally, in terms of the pace of growth, the composite price for rents continued to rise in July, increasing by 0.3% from the previous month. In addition, new rental prices have now improved every month since March this year.

Talking about the longer-term outlook, we have to pay some attention to MAA’s M&A and organic growth activities. In this regard, Q2 2024 could be considered a fairly strong quarter with increased momentum overall.

For example, MAA initiated two new construction jobs, bringing the current CapEx organic construction pipeline to 2,617 units at an estimated cost of approximately $870 million. These two new projects are expected to generate first cash flows in mid-2026 with a stabilized initial NOI yield of ~6.5%, which is in line with the yield level of the remaining pipeline. Pre-development work, which covers projects that have not yet received final investment approvals, increased to 11 projects (with ~3,100 additional units coming in Q2). During the quarter, MAA allocated approximately $80 million to these organic growth opportunities, which represents only a fraction of total estimated CapEx spending.

Finally, MAA was also able to commit some of its internal cash generation to finance nearly 1,700 indoor unit upgrades. This allowed it to make quick gains in terms of rental growth, i.e. increasing net rents for these renovated units by ~8%.

In terms of M&A or external growth, MAA was actually quite active this quarter. Namely, in Q2 2024, MAA acquired 306 units of suburban property for about $81 million, which was 15% — 20% below its replacement costs, with 62% occupancy. The plan here is to upgrade the property and then attract new tenants. In parallel with this acquisition, Management has announced that it is in the late stages of acquiring two additional properties, which together with the previous one should generate a stabilized NOI yield of around 6%.

Listening to the recent earnings call, we can clearly see that the growth environment for MAA has finally started to improve. New supply deliveries in the MAA markets have reached or are close to a peak, which will then be followed by a period of sharp decline in supply due to construction (or development) shutdowns during COVID-19 and the growth period of the interest rate.

Commentary from the Q2 2024 earnings call by Tim Argo – EVP, Chief Strategy & Analysis Officer – provides very solid and encouraging color on MAA’s growth outlook here:

It varies by market, but on average, new construction starts in our portfolio have peaked in mid-2022, and we’ve historically seen peak leasing pressure typically about two years after construction starts. While supply remains high, the strength of demand is also evident. Second-quarter absorption in our markets was the highest of any quarter since the third quarter of 2021. Wage growth remained strong, with the second-quarter rent-to-income ratio falling slightly to 21%, the lowest level in recent years three years. Additionally, we saw resident turnover continue to decline in the second quarter and expect it to remain low with fewer residents moving to purchase a home.

A theoretical caveat in this context could be that MAA does not have a strong enough balance sheet or sufficient financial capacity to fully capitalize on emerging growth opportunities. However, there are two things to consider.

First, MAA’s leverage is clearly in line with investment grade requirements – namely, net debt to EBITDA of just 3.7x, which for a REIT as inherently defensive as MAA is very low.

Second, given that we have now seen MAA’s cash generation improve despite still relatively unfavorable supply and demand conditions, we can assume that on a going forward basis MAA will be able to expand its EBITDA. This, in turn, should accommodate incremental financial capacity to support sustainable growth.

The bottom line

After digesting the Q2 2024 earnings report, the bottom line is clear – MAA has remained a solid buy even despite the recent rally in the share price and the current unfavorable supply and demand conditions.

The company was able to strengthen its cash generation by increasing same-store NOI and increasing occupancy, even as high supply dynamics continued to depress rent growth. Meanwhile, MAA has also stepped up its M&A and organic growth game, which should position REITs in a better place to capitalize on opportunities once market conditions reverse (ie, when the supply side begins to be constrained due to historical periods of underinvestment).

Given the above and the fact that there is a solid balance sheet, I remain bullish on Mid-America Apartment Communities.