We bought shares of Essex Property Trust (NYSE: ESS) today. I don’t usually send alerts from the public side on the same day, but I decided it would be appropriate this time. Sharing the occasional article right away is nice because it means my comment and my images will always be perfectly up to date.
I’ll start by sharing our review of our subscriber portfolio update (note: paid link).
Wallet Update Commentary
I would like to add to our position in Essex Property Trust. I think equities have been hit too hard lately. However, I also monitor the dynamics of the sector. We don’t have enough cash to make more than 1-2 purchases (of significant size) and there are several bargains available with strong negative momentum in apartment REITs.
However, the valuation of the fundamentals looks downright excellent. This is a cheap multiple AFFO on a REIT with an excellent management team that has done a solid job of producing shareholder wealth for several decades. As it stands, at $209.29, ESS (at the time of writing) is trading at 67% of the consensus NAV estimate. ESS isn’t in debt that much, so moves to NAV shouldn’t be amplified much. In addition, ESS has minimal exposure to floating rate debt. The impact of rising interest charges should be minimal on their AFFO per share over the next few years. A recession could have a big impact, but not the interest expense.
Currently, ESS is trading at less than 16 times the expected AFFO. It’s cheap. Pandemic and recent months aside, ESS has not traded below 19x AFFO in the past 10 years.
Pandemic and recent months aside, the last time ESS traded below 18x AFFO was early August 2009. It was a pretty bad time for flats, as you may recall -be. With that in mind, I’m more concerned about waiting too long than moving too soon.
We followed this article by increasing our position in ESS. Specifically, we bought 49 shares of Essex Property Trust at $208.60.
The rest of this article comes from the trade alert we sent out in real time earlier today.
ESS is simply not too exposed to interest charges from rising rates and should still see at least moderate growth in portfolio income for next year.
The shares being 20% below the Q3 2022 redemption price and 25% below the Q2 2022 redemption price also reinforces my belief that ESS sees value in its own stock. Rather than increasing leverage, ESS will sell the occasional building to fund a buyout, as they believe it’s a more efficient way to generate shareholder wealth.
We agree. Sometimes ESS should issue new shares (when prices are high), and sometimes they should buy them back.
I use the $100,000 chart to compare major apartment REITs and threw in the Vanguard Equity Real Estate (VNQ) (largest REIT stock ETF) for a comparison:
Note: This is a table we use regularly for subscribers. It shows how much you had to invest the day before to reach $100,000 today. Because each line must end at $100,000, it focuses the chart on today. Rather than focusing on a single arbitrary start date, this allows us to visualize performance from all possible start dates over the measurement period.
VNQ, the purple line with triangles, appears as if it may have at least temporarily stopped falling. Similarly, Mid-America Apartment (MAA) experienced a slight rebound. However, the rest of the apartment REITs are still struggling to stabilize stock prices.
We don’t expect ESS’s fundamentals to be materially worse than its peers over the next few years, despite their weaker earnings outlook through 2023. Understandably, some investors may want to wait. to see prices rebound. I think we could see support strengthening by $200 simply due to the “round number effect” combined with ESS underperforming taking them to historically cheap levels.
Round numbers shouldn’t matter. There are no fundamental basis for it. Yet, we have seen this play out with industrial REITs very recently. Look at the 52 week lows:
- Terreno (TRNO): $50.36
- Rexford (REXR): $48.79
- Prologis (PLD): $98.03
Note: The point here is that the values are so close to $50, $50, and $100.
I considered waiting to see if we could snipe those stocks around $201, but decided I wouldn’t turn my nose up at ESS around 15.3x AFFO until then.
In a related sector, MH Park REITs enjoyed a respectable rebound. Sun Communities (SUI) is up over 14% from its lowest close and Equity Lifestyle (ELS) is up over 7% from its lowest close. It’s a small positive sign, but it helps nonetheless.
That time we sold ESS
In the interest of full disclosure, we sold some shares of ESS just over a year ago. On 9/10/2021, we sold some shares at $324.37 (total value $9,731.10). Today we spent $10,221.40 to buy 49 shares. Sounds like a good deal to me.
Buy in weakness
Our past periods of ESS buying included early to mid-2018, when concerns about new supply and rising rates weakened apartment REITs.
We also bought ESS in 2020. We bought when landlords had no right to evict tenants, the economy shut down and investors decided BLM would make apartments unlivable for countless years coming. That was when we were buying apartment REITs all the time.
This is precisely the kind of environment in which we tend to be enthusiastic about buying apartment REITs. Plunging prices. Contrary winds invade the waves. Are apartments finally dead? I doubt. People still like to have a roof.
Transactions are processed through Schwab:
For some investors, this trade will feel too soon. They will want to see ESS bounce back first. There is nothing wrong with investors taking this approach. Still, we’ve managed to focus on the fundamentals and assess which stocks are getting abnormally cheap.
It is possible that ESS will continue to suffer. Yet the shares are already trading at a substantial discount to consensus NAV (although I expect that number to decline). The number I expect to continue to grow is AFFO per share. If the current recession (which I believe we have entered even though it has not been declared) worsens, then we could see the results weaken temporarily. However, we see a dividend yield of 4.2% with strong coverage (only a 65% payout ratio) coming from a REIT with a strong management team focused on generating shareholder value.
With shares trading around 15.3x AFFO while peers range between 17.1x and 18.9x, I think ESS has been sold too hard.
Rent spreads are expected to be the main headwind referenced time and time again for apartment REITs. It’s not really a surprise. We warned investors about these headlines a long time ago. We were warning people even as apartment REITs were poised to set records. For ESS, the highest close was on 04/21/2022. In less than 7 months, the shares fell about 43.3%. Adjusted for leverage at ESS, this would equate to an apartment building down 30% to 35%.
Did the apartments fall like this? No.
Are they likely to? No.
Do investors have the ability to buy ESS anywhere remotely with a 30% NAV discount on a regular basis? No.
Below 19x AFFO? No.
This is why we are starting to build our ESS position again.