Real Estate Investors: Here's Why Canaccord Analysts Prefer Growth Over Size

In a rising rate environment, one rule-of-thumb is that equity REIT business models which can grow accretively will tend to outperform less dynamic peers.

On July 22, Canaccord Genuity analyst Ryan Meliker published a comprehensive 83 page report initiating coverage on the residential REIT sector.

Canaccord's coverage now includes three multifamily apartment REITs and two dedicated student housing REITs with a top pick for each sub-sector.

Tale Of The Tape - Apartments 2015 YTD

• Essex Property REIT ESS $14.5 billion cap, 2.6 percent yield; Hold, $235 PT.
• Apartment Investment and Management Co Real Estate Trust Class A AIV (AIMCO) $6.2 billion cap, 3 percent yield; Hold, $41 PT.
• Preferred Apartment Communities APTS $244 million cap, 6.6 percent yield. Buy, $13 PT.

Tale Of The Tape - Student Housing 2015 YTD

• American Campus Communities ACC $4.4 billion cap, 4.1 percent yield; Hold, $42 PT.
• Education Realty Trust (EDR) EDR $1.6 billion cap, 4.4 percent yield; Buy $37 PT.

Canaccord On REITs & Rates

Meliker noted that the broader REIT index is down 12 percent since the 10-Yr Treasury hit its low of 1.65 percent in January. The CG Apartment REIT Index was only down 5 percent during the same period.

He cautioned that the data shows that over the long-term, REIT performance has not been highly correlated to the 10-year Note.

He added, "Many non-REIT-dedicated investors -- who by definition drive net fund flows -- have pared back their REIT positions in response to the rise in long-term yields, which in turn are anticipating higher short-term policy rates."

Canaccord believes investors should "buy the dip."

Canaccord's Top Total Return Pick

Total Return: The Preferred Apartment Communities $13 target price represents a potential ~25 percent total return including its annual dividend yield.

Price Target: Canaccord's $13 year-end 2015 price target is based on a 15 percent discount to its $14.86 NAV estimate, utilizing a 6.25 percent cap rate. It is also supported by a Canaccord's discounted cash flow model, "…assuming a 14% cost of equity and a 2.0% terminal growth rate."

Risk Factors: According to Meliker "…challenges include the limited size and scale of the company, which leads to a high G&A load and limited diversification, and the company's external management agreement, which does not align the external manager with investors as well as others."

Preferred Apartments - A Complicated Story

Meliker believes that Wall Street "…continually misunderstands the company's development lending strategy," which he estimates generates annualized returns of ~14 percent. He noted, "APTS trades at just a 9.4x 2015E FFO multiple, well below the peer group average of 20.9x."

APTS has many moving parts besides operating multi-family apartment communities which contribute to the growth story, including:

Underwriting and providing developers bridge loans and mezzanine financing as a source of capital required for land acquisition, pre-development, construction and lease-up in return for fees, interest and attractive options to purchase the newly-developed communities.

In addition to traditional apartment communities, PCA is also focused on college student housing. This is a specialty niche within the multi-family sector, which uses the "number of beds occupied" as a leasing metric rather than the entire unit.

PCA increased the amount of non-multifamily assets allowed as a percentage of total PCA assets from 10 percent to 20 percent, in 2014.

A Shopping Center Componen

This paved the way for a new Preferred Apartment Communities grocery-anchored necessity shopping center division, which was announced on its Q2 2014 earnings call.

On that call, PCA declared a goal of reaching large enough operational scale to spin-out a stand-alone retail shopping center REIT, "New Markets" within approximately one and a half years.

Meliker is not a fan of the retail/residential asset mix, and noted while the retail spin-out will further reduce market cap, it should also serve as a positive catalyst for the APTS share price.

Canaccord - Investor Takeaway

"Apartment REITs have historically been less exposed to higher risk-free rates than most other property sectors, but surprisingly no more sensitive to GDP growth. As such, we believe the recent rate-driven pullback across Apartment REITs has created an intriguing entry point."

Meliker believes "…investors too focused on rising rates will miss a fantastic buying opportunity across the broader REIT group."