Armada Hoefler Characteristics: 7% Dividend Yield with Strong Coverage (NYSE:AHH)

Characteristics of the Armada Hoefler (NYSE: Oh) is one of the best investment opportunities in the field of real estate REITs. The REIT currently trades for a 9.14x multiple to mid-guideline for natural funds from operations (“NFFO”) of $1.21 to $1.27 per share for fiscal 2024. This would represent a 3-cent growth in the cap on the NFFO of $1.24 per share Achieved in 2023, the midpoint would mean consistent year-on-year growth. The AHH multiple reaches 14x in 2022 with Seeking Alpha putting the REIT at B+ evaluation grade Compared to their counterparts, real estate investment funds.

Commons is down 8% year to date to push the dividend yield to a near-record level as adjusted for the effects of the pandemic. AHH recently declared a quarterly cash dividend of $0.205 per share, up 5.1% sequentially and $0.82 per share. Annualize the stock for a dividend yield of 7.2%. The rise came amid a dividend winter for REITs for stocks weighed down by the dual impact of the Federal Reserve’s struggle with inflation and market anxiety about commercial real estate.

AHH is a diversified real estate investment trust, with a portfolio split between retail, office and multifamily properties. Retail made up the largest rental income sector at 41.4% of the $61.88 million in rental income for the first quarter of fiscal 2024. Office was at 35.3% and multifamily was at 21.2%. First-quarter rental revenue was up 10.1% compared to its year-ago company, with AHH generating first-quarter NFFO of $0.33 per share, a growth of 3 cents compared to its year-ago company. This diversification has been bittersweet for the REIT, as its current multiple reflects deep market concern about the future of office real estate. While AHH is up since my last coverage, the upside remains significant on the back of a low multiple and decent outlook for NFFO growth. Favorite (New York Stock Exchange: AHH.PR.A) remained flat.

Occupancy and NFFO growth

Total revenue for the first quarter was $193.48 million, up 34.2% compared to AHH last year and a solid beat on the consensus. This came as AHH’s average portfolio occupancy declined 94.7% sequentially from 96.1% in the fourth quarter. This decrease was due to a decrease in retail occupancy by 270 basis points to 94.7% from 97.4%. The office occupancy rate decreased to 93.6% from 95.3%, and the multifamily occupancy rate decreased to 95.1% from 95.5%. This is down everywhere, but the REIT’s construction business performed solidly against its $343 million backlog.

Commercial lease renewal spreads increased 11.5% on a GAAP basis and 3.7% on a cash basis during the first quarter, as AHH generated total real estate net operating income (“NOI”) of $41.35 million. This was 9.26% higher than the NOI’s $37.85 million last year. AHH is guiding full-year 2024 NOI to range between $166.6 million and $171 million. The real estate investment trust also closed 21 lease renewals and 3 new leases spread across 115,549 net rentable square feet during the first quarter. Crucially, AHH covers its high dividend by 151%, a payout ratio of 66% that opens up the potential for another near-term upside.

Credit, Liquidity and Federal Reserve Profile

AHH’s total debt at the end of the first quarter was $1.4 billion, with approximately 90% of it at fixed interest rates or covered by interest rate swaps. Total debt has increased since Q4 2022, but AHH’s net debt to total adjusted EBITDA fell sequentially over Q1 to 7.4x from 7.5x. The total value of debt to institutions is approximately 54%. The REIT’s leverage is showing some signs of strain, with the weighted average continuing to decline for years until its debt matures versus a leverage ratio that lies above management’s target of 40%.

AHH’s low and high dividend yield is a function of the stock market, which has deteriorated in REITs in the meantime. This sentiment will change on the back of pending interest rate cuts, with AHH well positioned to see its multiples expand due to strong coverage and higher dividend yields. REITs have been one of the worst performing sectors since the federal funds rate was raised to a 22-year high of 5.25% to 5.50%. Moreover, initial dovish expectations at the start of 2024 for at least three rate cuts have dropped to one rate cut at the next FOMC meeting in November or December according to the CME FedWatch tool.

AHH’s office occupancy rate far exceeds that indicated by the national office vacancy rate of 18.8% at the end of April. This rate increased by 210 basis points year on year. REITs are sensitive to the federal funds rate because of the significant leverage they use to finance their asset purchases. So they have positive duration risks. We can see this from the decline in price-to-free cash flow for the respective office REITs since early 2022 when the Fed’s battle with inflation began.

The discounting of office REITs reflects this zeitgeist, and whether this has stabilized at some point versus the rise in office-to-residential conversion and the collapse of new office construction is uncertain. AHH’s diversified portfolio, very safe dividends, and high occupancy rates mean the REIT deserves a higher multiple than NFFO. This is likely to come only when the Fed starts cutting interest rates. I expect this rerating timeline to occur at the end of 2024 and early 2025 with FedWatch Took pricing this period as the highest potential for a rate cut. This would be the baseline scenario if inflation resumes its decline, with the worst-case scenario putting interest rate cuts away from investors in an uncertain period after 2025.