My Oh My, 2 Strong Buys: Residential REITs That Help Me Sleep Well At Night

This article was coproduced with Leo Nelissen.

One of the biggest trends in real estate is unaffordability. Since the pandemic, home prices have accelerated along with inflation, in general. Then, the Fed hiked rates to combat inflation. However, it didn't achieve lower home prices as higher rates kept people from selling their homes, keeping supply low.

As a result, the Wall Street Journal reported that the financial gulf between purchasing a home and renting one is at its widest since at least 1996.

Analysis from CBRE reveals that the average monthly mortgage payment now surpasses apartment rent by 52%. Such a disparity hasn't been observed since the prelude to the 2008 housing crisis when a peak of 33% was recorded in the second quarter of 2006.

According to the Wall Street Journal, someone securing a 30-year mortgage on a $430,000 home with a 10% down payment would face monthly payments of approximately $3,200, which is 60% higher than three years ago.

60%!!!!!!

In comparison, rents have risen by a more moderate 22% over the same period. The surge in house prices makes it difficult for renters to save for a down payment, let alone afford higher mortgage costs.

Having said that, Bloomberg reported that the one factor that has shielded the housing market from soaring interest rates is the significant disparity between prevailing rates and the rates at which many homeowners locked in their mortgages.

While the average 30-year mortgage rate stands at 7.89%, the effective rate for existing borrowers remains significantly lower, around 3.6% to 3.7%. This gap is a crucial factor in maintaining price stability. After all, it keeps people from selling their homes.

Unlike during the 2007 housing crisis, homeowners in 2023 are showing a greater commitment to preserving their home equity, even when facing financial challenges.

This shift in payment priorities may contribute to the stability of the housing market despite rising rates. I believe the biggest risk to housing is rising unemployment as it could trigger forced home sales and increasing supply, which pressures prices.

For now, however, these risks are subdued.

Also, as Bloomberg reports, the increase in homeowners aged 65 and older, now at 33%, contributes to inelastic supply, as they're less likely to sell. Even a recession with substantial job losses may not significantly boost supply, given the infrastructure for mortgage modifications and forbearance measures in place to prevent foreclosures.

In other words, it's very likely that housing affordability remains a big issue, which favors landlords with healthy balance sheets.

That's where our top-tier REIT plays come in. They are both Strong Buys!

Sun Communities (SUI)

Affordable Manufactured Housing

Manufactured housing is one of my favorite REIT segments.

Why?

Because modern MH communities offer high-quality amenities and affordable prices.

Sun Communities has a $13 billion market cap. It generates roughly half of its revenue from its 354 MH communities, which cover 118,000 sites with an occupancy rate of 95.3%.

SUI is the largest operator of MH communities. It's also the only MH operator with exposure beyond North America, as it owns 55 holiday parks in the U.K., making it the second-largest operator in that country.

30% of its revenue is generated in the RV business as it owns 182 RV communities with 59,000 sites.

Its remaining money is made from marinas, which is a segment that benefits from declining supply due to new housing projects on the coast (mainly in Florida). It owns 48 thousand dry storage spaces and wet slips. 84% of its marinas have a waitlist.

Unlike a few decades ago, MH communities have a much better reputation. Compared to single-family homes, they're much cheaper.

• The price per square foot is more than 50% cheaper.
• The square footage is often bigger!
• The average rent is $1,261 per month, which is well below the average SF of almost $2,100.

On top of that, SUI comes with tremendous stability.

• Last year, the average weighted rate increase was 5.0%.
• It has a consistent occupancy rate, currently at more than 95%.
• More than 90% of its sites have rents tied to the market or CPI (inflation protection).
• Over 4,000 sites are available for occupancy gains.
• More than 1,000 expansion and development sites are expected to be delivered this year, which supports the company's high internal growth.

It also helps that the company has a terrific balance sheet.

As of June 30, the company has a net leverage ratio of 6.2x. 82% of its debt has a fixed rate. 77% of its debt is unencumbered.

It also has no major maturities until 2026, when 11.7% of its debt is due. In the 2023-2025 period, roughly 5.3% of its debt is due. As a result, the company has a BBB credit rating, which is an investment-grade rating.

The company currently yields 3.5%. This dividend is protected by a 57% 2023E adjusted funds from operations ("AFFO") payout ratio. Over the past five years, the company's dividend has been compounded at an average annual rate of 5.6%.

During the Great Financial Crisis, SUI did not cut its dividend.

It's also attractively valued.

After dropping 27% year-to-date, SUI is now trading at 16.6x AFFO. As we can see below, the company did not see a decline in its AFFO during the Great Financial Crisis. While it's not expected to see growth this year, it also will likely be able to avoid contraction. Next year, AFFO is expected to grow by 6%.

If the company returns to its normal valuation of 20.2x AFFO, it could return 16.4% per year through 2025. While this is a theoretical value, it shows how attractive this company is thanks to a lower price and consistent AFFO growth.

The current consensus price target is $148, which is 42% above the current price.

We give the stock a Strong Buy rating.

Camden Property Trust (CPT)

Reliable Multifamily Income

Camden has it all. The company has a top-tier business model, a healthy balance sheet, a well-protected and steadily rising dividend, and a good valuation.

Camden became a publicly traded company in 1993. It currently is one of the few REITs in the S&P 500. The company owns 172 communities in nine states. Almost all of its exposure is in the highly desired Sunbelt, with roughly 10% California exposure.

Its 172 communities cover close to 59,000 apartments with an average age of 15 years. Just like Sun Communities, Camden has a 95% occupancy rate.

Most of its homes are low-rise apartments in suburban locations.

Furthermore, Camden isn't just a random landlord. In addition to having top-tier Sunbelt assets, the median age of its tenants is 31. The average annual household income of new move-ins in 3Q23 was $120,000, which brings the rent-to-income ratio to 20%. This is well below the average numbers we discussed in the first part of this article.

On top of that, despite its focus on a high-demand market, supply growth in CPT markets is below the nation's average, with both starts and completions having come down to pre-pandemic levels. This supports rent growth as demand hasn't come down to pre-pandemic levels.

As of August 2023, same-store renewal rates were +4.9%. That's on top of 11.1% growth in August of 2022.

Hence, the company expects to grow net operating income by at least 4.0% this year.

It also has a terrific balance sheet. One of the reasons is its capital recycling program to generate value. Since 2011, the company has sold apartments worth $3.5 billion with an average age of 23 years. It has bought $2.7 billion worth of new apartments worth $2.7 during this period, with an average age of just four years.

During this period, Camden spent $4.2 billion on value-adding developments.

Camden currently has 1,553 apartments under development and a pipeline of another 3,350 homes. 60% of this pipeline already is funded.

With that said, going back to its balance sheet, the company is protected against elevated rates. It has an A- credit rating, making it one of the very few REITs with an A-range rating.

• The weighted average interest rate on all of its debt is just 4.2%.
• 77.4% of its debt has a fixed rate.
• More than 90% of its debt is unsecured.
• The weighted average maturity of its debt is 6.1 years.
• It has close to $700 million in available liquidity.
• Its net leverage ratio is just 4.2x.
• It has no maturities in 2023.

In other words, I believe that if interest rates come down over the next 1-2 years, the company will be one of the first places real estate investors put their money.

After all, I believe the stock has suffered too much.

CPT shares are currently 48% below their all-time high. As a result of this steep sell-off, CPT is now underperforming the S&P 500 over the past 10 years. Before the sell-off, the stock was able to keep up with the market. On a side note, SUI shares are still outperforming.

As a result, CPT shares are trading at just 15.4x AFFO. The long-term normalized valuation is 20.6x. A return to that valuation by 2025 could result in an annual return of more than 23%.

The current consensus price target is $120, which is 31% above the current price.

It also helps that the company is not expected to see a falling AFFO. This year, AFFO is expected to grow by 4%. That number is expected to remain consistent in 2024, followed by a potential surge of 6% in 2024.

The company comes with a 4.3% dividend yield. This dividend has a 2023E AFFO payout ratio of 66%.

The five-year dividend CAGR is 5.2%. On Feb. 2, the company hiked its dividend by 6.4%.

Given the safety and growth opportunities it brings to the table, CPT is a fantastic REIT for the next decade, especially in light of significant rent-over-buy tailwinds.

Takeaway

In today's real estate landscape, the unaffordability gap between owning and renting a home is at its widest since 1996.

Home prices have surged, making it increasingly challenging for renters to save for a down payment or afford higher mortgage costs.

Despite rising interest rates, stability prevails thanks to the disparity between prevailing and locked-in mortgage rates. Homeowners in 2023 are determined to preserve their home equity, contributing to housing market stability.

This environment favors landlords with strong balance sheets.

Two top-tier REITs, Sun Communities and Camden Property Trust, stand out as promising investments.

SUI offers manufactured housing with affordable prices, excellent stability, and growth potential. CPT, focused on the thriving Sunbelt, boasts a solid balance sheet, favorable rent growth, and a promising outlook.

These REITs present compelling opportunities for investors, offering stable income and growth potential in a shifting real estate landscape.

Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: Written and distributed only to assist in research while providing a forum for second-level thinking.

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