Camden Property Trust: Priced For A 9% Total Return (NYSE:CPT)

Dear readers/followers,

There seems be a debate among REIT investors regarding the future prospects of Sunbelt states. The main worry is that supply has picked up significantly and with completions expected to peak in 2024 at 200,000 units that year, it is natural that investors are asking themselves whether the market can absorb this. While I think that job and population growth will be able to roughly offset this new supply and will likely lead to a balanced market, we are unlikely to see the high double-digit returns recorder over the past two years again.

In this article I analyze the Sunbelt market from a supply and demand perspective and look at the fundamentals of Camden Property Trust (NYSE:CPT) to try to determine whether it makes a good investment and can be reasonably expected to deliver safe alpha.

Multifamily in the Sunbelt

Sunbelt states have seen a surge in popularity during the pandemic with Texas and Florida being the biggest population gainers in 2020, according to the US Census Bureau. As a result of lots of people moving in, apartment REITs that operate in the region have experienced unprecedented rent increases and low vacancy. Now that the pandemic is over, investors should ask themselves if this was a short term phenomenon or if these markets are going to outperform going forward. Let’s have a look at some data points and try to determine if the popularity of Sunbelt states can last.

First let’s have a look at the reasons that drove people to the South.

• work from home
• better housing affordability (compared to legacy markets such as NYC)
• lower population density
• more favorable tax laws
• better weather

I’d argue that most of these are here to stay, perhaps with the exception of long-distance work from home. My view is that eventually we will keep the hybrid working model where people can work from home, but need to come to the office from time to time. This will make it impossible to live in a different city or state than you’re employed at and any work that will be fully remote will likely be outsourced overseas. Luckily urban centers located in the Sunbelt are expected to see the highest number of new jobs added over the next two years, providing enough opportunities for people already there and attracting new ones.

Jobs are likely to attract new people so migration and population growth are expected to go hand in hand with employment growth. In particular, the population of main urban centers in the Sunbelt is expected to grow by about 1.5 Million by 2024. A large portion of people moving are likely to rent at least for a couple years leading to a lot of new demand for apartment REITs. In addition most of the newcomers are likely to be young, say below 35 years old. This age group has the lowest homeownership rate nationwide at just 39%. Because of this I estimate that up to 50% of newcomers will rent. I think this high percentage will be reaffirmed by the current difficult economic situation as move-out rates for home purchases dropped by 50% compared to the peak just a few years ago. People are uncertain of the future so they’re likely to rent until the situation gets better. With an average of 1.7 occupants per apartment, 450 ths. additional units will be needed by 2024 to house the new arrivals.

On the supply side, completions have been hot. Many on the Sunbelt cities have been among the top 10 hottest metros for construction in 2022. To make things worse, It is estimated that completions will not peak until 2024, when they will reach about 25% above 2022 levels. Analysts expect that over 500,000 units will be delivered to the Sunbelt markets between 2022 and 2024. This seems like a huge number, but when compared to the 450 ths. units I estimate will be needed for the new arrivals (driven by population growth) things don’t seem that bad.

Let’s have a look at a couple of key markets:

Note: For supply I will assume a 25% growth in deliveries between 2022 and 2024. For demand I will assume that 50% of new arrivals rent with an average of 1.7 occupants per apartment. Numbers below are totals for the period 2022-2024.

• Dallas: supply = 79,500 units, demand = 56,000 units
• Austin: supply = 61,500 units, demand = 42,000 units
• Houston: supply = 60,000 units, demand = 75,000 units
• Phoenix: supply = 54,000 units, demand = 60,000 units
• Atlanta: supply = 43,200 units, demand = 54,000 units

It’s easy to see that some markets might experience oversupply and others not. But overall I think that demand driven by population growth will offset the increased supply over the next two years, resulting in a relatively balanced market. Based on this, I would conclude that the period of very high rent growth in Sunbelt states is likely over, but I don’t see over-supply as a major threat to the market and don’t expect rents to decrease significantly because of it. I think investors should continue to invest in the Sunbelt but lower their return expectations.

Camden Property Trust

Camden Property Trust is an apartment REIT with properties located exclusively in the Sunbelt. It operates 172 communities (low rise – 60% and mid-rise – 28%) and has an occupancy of 95.8%.

Financials

The REIT has delivered great results in 2022. FFO increased by 22% YoY to $6.59 per share, driven primarily by a 14.6% YoY increase in same store NOI. While this was a great year for CPT, based on my market analysis, we shouldn’t expect nowhere near the same level of growth going forward. As far as guidance, management expects FFO to reach $6.85 per share in 2023 (just 4% growth), driven by a 5% same-store NOI growth, new acquisitions and increased interest expense. This seems quite conservative and should be achievable.

The company has an active development program that has built 38 communities with a total of 11,000 units over the past 10 years. This has allowed the company to create $1.5 billion of additional value for shareholders as it is able to build the properties cheaper compared to buying existing properties. Though currently management has slowed the pace of new development in the midst of increase market supply. In Q4 2022, CPT delivered only one community, located in Florida and worth $100 Million (already 87% occupied). In 2023, the company expects to deliver another two communities with a total of 800 units and worth $220 Million. In addition to new construction, the company also focuses on improving their existing portfolio as it has remodelled nearly 40,000 units to date, updating kitchens, bathrooms and flooring. With an average remodelling cost per unit of $14,500 and a $129 rent increase per month, these remodels generate a solid 10% cash-on-cash return for the REIT.

CPT has an A- rated balance sheet with about $3.7 Billion of debt – 85% of this debt is fixed-rate resulting in a total weighted average interest rate of 4% (slightly above the 10-yr treasury yield of 3.8%). The company has significant debt maturities of $250 Million and $550 Million in 2023 and 2024, respectively. The company will likely be able to refinance, but there’s always a risk that this will result in higher interest expense – management has already reflected this in their 2023 FFO guidance as a $0.21 per share deduction. The company has very little cash but has a $1.5B unsecured credit facility to cover any liquidity needs.

Finally, the company pays a reliable dividend of $4.0 per share which translates to a yield of 3.3%. The dividend is very well covered with a payout ratio of 61% and personally I wouldn’t expect it to grow any faster than the expected FFO for 2023 of 4%.

Valuation

CPT has fell over 30% from its peak, but still isn’t exactly cheap. On a relative valuation basis, the company currently trades at 18x FFO, mostly in line with its historical average of 18.70x. A return to the average over a three year period represents a multiple expansion return of just 1.7% per year.

Peers trade at the following multiples: AvalonBay – 18x, ESS – 16,3x, BSR Real Estate – 17,3x. I would say that CPT deserves a premium compared to ESS because of its exposure to Sunbelt markets which should grow faster than the West coast. It also deserves a premium relative to BSR Real Estate, because although both operate in the Sunbelt, Camden has an active development division which generates additional value for shareholders. So overall I would conclude that CPT is fairly valued here based on its P/FFO multiple.

On an NAV basis, the company generates annual NOI of $924 Million. With a market cap of $13.2 Billion and outstanding debt of $3.7 Billion, the market is pricing it at an implied cap rate of 5.5%. According to CBRE, as of the end 2022 fair market cap rates for multifamily were still below 5%, but they argue that the increase in cap rates has been outpaced by borrowing costs, creating a situation that’s unsustainable in its current state. Because I don’t expect the Fed to u-turn any time soon, I won’t assume a lower cap rate to value CPT and will stick with 5.5% which I believe is conservative enough to reflect a prolonged period of higher rates (one to two years). The risk in this case is that rates stay above 4-5% for many years – in that case cap rates would most likely have to increase as well and stock price would likely tumble.

So with that said, what can we reasonably expect from CPT going forward?

• 3.3% dividend yield (growing at 4% per year)
• 4% FFO growth for the next two to three years
• 1.7% multiple expansion return as the company returns to 18.7x FFO
• -> total return of 9% per year (basically in line with expected market return)

Remember how I generate alpha:

1. start with a thesis why a given industry/sector should outperform
2. stay overweight in those sectors for as long as the thesis is valid
3. look for companies with sound fundamentals that are either undervalued or fairly valued with exceptional growth prospects
4. if a company becomes overvalued, trim the position and rotate into another stock/sector that is still undervalued
5. if a company becomes increasingly undervalued and the thesis is still valid, add to the position
6. generate alpha and repeat

My total return then comes from the dividend yield, EPS growth and multiple expansion as the valuation normalizes over time. I always target a total return in excess of market returns (>8%) to generate alpha.

What things do I look for when selecting individual stocks to buy?

1. strong and safe fundamentals
2. good management teams with a track-record of caring about shareholders
3. healthy EPS growth
4. well-covered dividend
5. discount relative to peers and/or historical fair multiples
6. other catalysts

Verdict

The Sunbelt market’s glory days are likely over and while over-supply likely won’t be an issue thanks to strong job and population growth, we are unlikely to continue to see double-digit rent growth. With that said the market is likely to be quite balanced and rents will probably continue to grow, but at a more modest rate of 4-5% per year.

Camden is well positioned within the Sunbelt region and represents a safe investment. With a relatively low dividend yield of 3.3% and a total expected annual return of 9%, the company will likely deliver solid market level returns. Because of that, I rate CPT stock as a “BUY” here at $120 per share with a PT of $140 per share. Personally though, I would only consider adding shares to my portfolio if the price returns to the recent lows as I try to beat the market and generate alpha.