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Washington Real Estate Investment Trust (NYSE:WRE) specializes in the ownership and rental of apartment communities in the greater Washington, D.C. Metro and Southeastern regions of the U.S.
The stock is a lighter volume equity with a market cap of around +$1.5B. This is on par with two other residential real estate investment trusts (“REITs”), NexPoint Residential Trust (NXRT) and Centerspace (CSR), who operate in different geographic regions but are similar in size and scope.
Though WRE trades at a premium to both NXRT and CSR, at nearly 23x forward funds from operations (“FFO”), it has lagged both peers over the past three years, with negative returns encroaching on 7% versus positive mid-single digit returns in both their counterparts.
YCharts – WRE’s 3-Yr Total Returns Compared To Peer Set
They fare better on a YTD basis, but with losses of over 20%, the stock has proved a disappointment compared to the alternatives available in both the broader S&P 500 and the narrower real estate market.
YCharts – WRE’s YTD Total Returns Compared To Peer Set
A narrow 52-week trading spread does offer investors some respite against recent market volatility. In addition, there is upside potential in the quarterly dividend payment, which was reset lower by over 40% in mid-2021 as part of the company’s internal transformation to a more pure-play multifamily REIT.
Still, WRE faces an uphill climb in the current market, which is marked by an uncertain acquisition environment and narrowing forward guidance. Though they can weather the market challenges, upside will remain constrained over the next several reporting periods.
WRE’s current portfolio includes almost 9k homes in 27 communities, concentrated primarily in the Washington, D.C. Metro region, an area that represents over 75% of their total net operating income (“NOI”). Prior to 2021, the company also owned a portfolio of office and retail properties. But as part of their strategic shift away from the commercial sector to the residential sector, all but one of these properties were sold for a total contract price of +$930M in the third quarter of 2021.
The sale not only simplified their portfolio to one reportable segment, but it also reduced their exposure risk to two sectors that face elevated threats from shifting secular trends in working arrangements and consumer shopping habits. In contrast, the residential sector, particularly multifamily rental units, is likely to experience a continued runway of strength due to its essential nature and relative affordability compared to outright ownership.
Funds received from the sale were then partially recycled into the Southeastern market through acquisitions of apartment communities in Georgia. This resulted in much-needed diversification to their portfolio of assets, which was over 90% concentrated to the D.C. Metro at the end of 2021 but now 80% following the acquisitions in Georgia over the past year. While this additional level of diversification is a positive, WRE is still too top-heavy in just one region of the country. Though the company intends on further southbound expansion, they may face challenges in the current market environment.
The rapid rise in interest rates has produced challenging conditions for price discovery among buyers and sellers. As an all-cash buyer, WRE is less exposed than their more leveraged competitors. But they are not immune to the slowing transactional market.
In the current period, for example, they walked away from a potential transaction due to additional capital requirements stemming from rising acquisition costs. The setback consequently forced a reassessment of their acquisition timing and near-term guidance, which was lowered and tightened by $0.02/share at the midpoint.
WRE also halted their development activities for their Riverside project due to the impact of rising construction costs, which are up over 20% over the past two years, on their going-in yields. While management believes the market is moving in a positive direction, they cited prudence in light of current uncertainties as one factor for the suspension.
Despite paring overall guidance, management is still expecting to complete +$125M in acquisitions this year. But with rates continuing to trend higher since their earnings call, it’s possible for this figure to be revised lower on their Q3 release. Given their outsized exposure to a single geographic region, it’s especially important for WRE to meet their targets, not only for their future growth prospects but also to mitigate the risk of a downturn in the local D.C. market.
Q2FY22 Earnings Release – Revised Full Year 2022 Guidance
Through the first half of the year, WRE’s operating markets have displayed continued strength. In Northern Virginia, where 80% of their same-store portfolio is located, effective rents were up 3.5% in the second quarter and 13% YOY. This pales in comparison to the Atlanta region, however, where rents were up nearly 17% in the second quarter, alone, and are at near record levels on a YOY basis.
The Washington Metro does have a greater shortage of housing units, 151k versus 81k in Atlanta. In addition, the premium to own a starter home in the region is about $700 more per month. The premium, however, is accelerating at a faster rate in Atlanta due to rapidly increasing home prices. At any rate, the shortage of homes and the resulting premium to own will continue to be tailwinds for WRE and the broader multifamily sector at large.
These tailwinds are reflected in the move-out figures related to home purchases, which declined 20% during the second quarter and over 25% on a YOY basis for their same-store portfolio. For prospective buyers, there is limited respite on the horizon as higher rates further amplify the affordability challenges of ownership. This is likely to force many to remain in place in their rental units until there is moderation in either interest rates or new housing supply.
The favorable market dynamics combined with a same-store occupancy and retention rate of 95.8% and 63%, respectively, should continue to empower WRE to drive rents in the coming reporting periods. In addition, timely lease expirations will also enable the company to mark-up rents to current market rates.
Between July and September, for example, over 30% of their leases will have expired. This should have provided a lucrative opportunity to WRE to realize a portion of their total loss-to-lease, which stood at a blended rate of 11% at period end.
Another indication of the opportunity embedded in the lease expirations is in the figures related to their new lease trade-outs in the Washington region, which increased to 15.4% in the quarter. This is up 430 basis points (“bps”) from last quarter. And the strength continued into July, with effective new lease trade-outs at 13.9%.
July 2022 Investor Presentation – Graph of Effective Rent Growth on New Leases and Renewals
Double-digit loss-to-lease and trade-out figures provide valuable visibility to future earnings potential. In addition, their recent expansion into Georgia should provide an additional boost to non-same-store growth.
In fact, by the fourth quarter of 2022, WRE is expecting NOI from their Atlanta communities to be approximately 20% of their multifamily NOI. This would be a significant milestone in their diversification efforts, though it may prove dependent upon the company’s ability to meet their acquisition targets, which is not guaranteed.
At the end of the second quarter, WRE had total liquidity of +$745M, comprised of cash on hand and full availability under their revolving credit facility. Additionally, aside from a +$100M maturity in 2023, the company has no other debt due prior to 2027. As such, there are no near-medium term debt repayment risks.
Q2FY22 Investor Supplement – Debt Maturity Schedule
They are further protected by a composition of debt that is comprised principally of fixed-rate bonds. This insulates them against interest rate volatility, especially in the current rate environment. In addition, they are well in compliance with all their required debt covenants. This provides additional confidence of their ability to meet their reoccurring obligations on favorable terms as they come due.
A balance sheet that is not overly levered, with a net debt multiple in the mid-5s, fixes WRE in a solid position to capitalize on any breakthroughs in the transactional market. It also enables them to maintain their quarterly dividend payout, which stood at $0.17/share as of the most recent filing period. At a yield of 3.3%, it’s not the most attractive payout. But it does appear safe, with a payout ratio of about 81% on a core adjusted FFO basis.
Q2FY22 Investor Supplement – Dividend Summary
WRE is successfully pivoting to being a pure-play multifamily REIT. In 2021, they disposed of all but one of their commercial properties. They then recycled a portion of those proceeds into an expansion into communities in Atlanta, Georgia, a critical region of growth in the Southeastern U.S. Proceeds from the dispositions were also used to pay down debt, providing enhanced flexibility to capitalize on new opportunities.
Continued expansion outside of the D.C. Metro region, which accounts for the majority of their operations, is a vital part of WRE’s growth thesis. Geographic diversification is also necessary from a risk perspective. While the local economy appears healthy at present, a downturn could result in material losses to the company. In addition, rent control and other restrictive laws and regulations are ever present threats that may materialize at any time, especially in the current environment where WRE is realizing double-digit rent spreads on tenants who have few alternatives to renting, given affordability issues with ownership.
Though WRE has made significant strides in their expansion efforts into the Southeastern part of the U.S., there are indications the transactional market is slowing. Rising rates and construction costs have produced an uncertain environment for price discovery between buyers and sellers. And this has reduced transaction volumes. The unfavorable impact to going-in yields even forced WRE to pause development on a key project. While management does expect to meet their acquisition targets for the year, skepticism is well-warranted.
At over 20x forward FFO, WRE trades at a premium to two multifamily peers that are more geographically diversified, NXRT and CSR, both of which trade below 20x. With their expansion plans in doubt, the premium is even more unjustified. For existing shareholders, the stock offers a 3.3% yielding dividend and a relatively stable 52-week trading range.
If the transactional market becomes more fluid, WRE will be in a solid position to capitalize on the increased activity. And this will produce some upside from current trading levels. Though this will benefit existing shareholders, prospective investors would be better off remaining in “show me” mode.
This article was written by
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