Interview With BSR REIT (Strong Buy Reaffirmed)
Important Note
Before going into today's article, I wanted to let you know that we will soon conduct interviews with the management teams of the following REITs:
Farmland Partners (FPI)
Easterly Government Properties (DEA)
VICI Properties (VICI)
H&R REIT (HR.UN:CA)
Safehold (SAFE)
Cibus Nordic (CIBUS)
Canadian Net REIT (NET.UN:CA)
Let me know if you have any questions for them and I will make sure to ask them for you. You can put your questions in the comment section below.
Thanks!
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Interview With BSR REIT (Strong Buy Reaffirmed)
BSR is today our largest apartment REIT investment and it represents 8% of our Core Portfolio. We invest so heavily in it because:
It owns class B garden-style apartment communities in the famous Texan Triangle - Dallas, Austin, and Houston - which enjoys some of the fastest job and population growth in the nation.
Its rents are today still very affordable at just around $1,500 per month, representing just about 20% of its resident's income, which is nearly 2x lower than the average in gateway markets. BSR grew its same property NOI by 7% in 2023, and it it is expected to grow it by another 2% in 2024, even despite the current oversupply in its market. We expect its growth to accelerate in 2025 and 2026.
The company has a good balance sheet with a 45% LTV, which we view as optimal for these assets to maximize long-term returns without putting the long-term solvency of the company at risk. Its debt maturities are relatively short, but it retains nearly 50% of its cash flow to deleverage and interest rates are expected to come down in the near term.
The company is also very well aligned with the management owning about 40% of the equity and insiders have kept buying more shares with their personal money and also funding significant share buy backs in recent years.
The shares are currently priced at a 27% discount to their net asset value, which essentially means that you get to buy an equity interest in its assets at 73 cents on the dollar, and you then get the added benefits of diversification, professional management, economies of scale, liquidity, and limited liability on top of it. I would also note that their net asset value is based on real market transactions since they follow IFRS accounting rules.
Based on their cash flow, they are priced at a 7.5% FFO yield. They pay out about half of that in dividends, resulting in a 4.3% dividend yield, and retain the rest for share buy backs and deleveraging. The company is doing so well that they just recently hiked their dividend by 7.7%.
The biggest near-term risk is oversupply. A lot of new development projects are currently underway in the Texan Triangle and it could lead to some bumpiness in the near term. However, it should be just temporary and growth should strongly accelerate in the coming years because most new development projects have now been put on halt, but the population growth remains very strong.
Recently, I had the opportunity to speak with the company's CEO, Daniel M. Oberste, about their recent performance and their strategies for unlocking value for shareholders.
Below, I first share my main takeaways from the conversation and I then share the transcript of the interview as well.
My Takeaways From The Interview:
It seems that their net asset value is now stabilizing. It is calculated with a 5.2% cap rate, which seems reasonable for relatively new high-quality garden-style apartment communities in these rapidly growing markets. KKR recently closed a deal with a cap rate in the high 4s and Equity Residential (EQR) acquired a portfolio with many assets located in Dallas at a 5% forward cap rate. Interest rates are now expected to return to lower levels, rent growth should accelerate, and transaction volumes should recover, all of which should support its current NAV or even lead to NAV growth going forward.
These cap rates may seem low, particularly the deal closed by KKR, but you need to think long term and understand that the cap rates are based on today's NOI, which could be far higher in just 5 years from now. Next year, we are expected to get the lowest level of multifamily deliveries since 2013 and therefore, the current oversupply will soon likely turn back to structural housing shortage. These private equity players understand this and they are long term oriented.
Right now, the discount to NAV is 27%, but keep in mind that this is based on their heavily reduced NAV. Their NAV estimate has dropped from $22 at its peak to just around $17 today. But if rent growth now accelerates, interest rates are cut, and cap rates start to compress, its NAV could surge in the coming years, leading to an even greater discount unless its share price adjusts higher.
As a result of the discount, their shares are today still trading at an implied cap rate in the low 6s, which is too high for these assets, and this is why they expect to keep buying back shares even as their current share buy back authorization expires. The CEO confirmed that they plan to renew their authorization once the current one is completed.
Apartment REITs, including BSR, have now started to recover and as interest rates return to lower levels, rent growth accelerates, and NAVs stabilize, we expect this rally to continue in the coming years. The fact that KKR, Blackstone, and other private equity players are heavily investing in this space is a strong buying signal and we get to invest at even lower valuations than them.
The new Texas Stock Exchange provides a great listing opportunity for BSR. So far, they have decided to not list in NYSE because it is much more expensive than the Toronto Stock Exchange for small REITs. However, the downside of the TSE is that Canadian investors may not be as well-informed about Texan real estate markets, potentially causing its shares to trade at a discount relative to its peer group. In that sense, the new Texas Stock Exchange could be a great opportunity for BSR because it is also expected to be a lot cheaper than the NYSE but its investors will have a unique understanding of the appeal of investing in a Texas-focused REIT, potentially leading to a higher valuation of the company. It will start listing companies in 2026.
Interview Transcript:
1) Your net asset value per share has declined from a peak of around $22 to $16.87, largely due to the expansion in cap rates following the surge in interest rates. Do you anticipate further declines in your NAV, or do you believe cap rates are stabilizing?
Too soon to tell. Political volatility, economic uncertainty, deficits and their resulting impact on the long-end of the curve, global wars and their impact on U.S. treasuries, all have an impact on cap rates. We do believe the future looks brighter than the past. We see continued NOI improvement in the coming years, and street cap rates never really expanded as significantly as the capital markets predicted. Maybe they will eventually, but they haven’t yet and don’t look to for our product in the near future.
While transaction volume still remains low, the recent individual and portfolio comps seem to indicate a sun-belt trade at 200bps from where we saw values peaking in 2021 (3.15% cap). We also see an opportunistic acquisition environment in 2025 and 2026. It would seem right now there are more reasons to support NAV improvement than deterioration. Regardless, the story here isn’t with our NAV at a 5.2% cap, it’s the implied cap rate us and many other Sun-belt peers trade at that is absurd. I can’t find another sector where the product owners who sell more products with increasing market share are rewarded with a lower relative multiple. Some things don’t add up logically in the capital markets. This should create a compelling buying opportunity for the astute stock investor.
2) Recently, KKR announced the acquisition of a $2 billion apartment community, with a year-one yield in the 4s. Many were surprised by their willingness to invest at such low cap rates in this high-interest-rate environment. What do you think they see that other investors might be overlooking about multifamily real estate?
KKR would be the best to clarify their position here. With that said, we believe they see precisely what we see; the long-term superiority of returns generated by newer acquisitions in Dallas, Austin and Houston, three markets, among about a dozen others, on the receiving end of a demographic population shift taking place in the United States. This shift is driven by jobs and affordability.
Investors who purchase real estate are acquiring relatively illiquid investments (relative to stock investors). Real asset investors must be extremely selective regarding the assets they acquire. Criteria includes future MSA economic growth potential, population growth projections, sustainability of population growth drivers, access to water, schools, among other important factors. KKR acquired $2B in apartments directly in the path of growth in (relatively) affordable future gateway markets. I’m sure they will be happy with their future lookback cap driven by NOI growth.
3) You’re guiding for 1-3% same-property NOI growth this year, one of the fastest rates in your peer group. Do you expect this growth to accelerate in 2025, or will it take longer for supply to be absorbed?
Lots of factors drive NOI growth, aside from the largest in revenue growth. As we depicted this last quarter, we can drive NOI growth with other levers, including expense reductions and other income increases, when rental growth is muted.
We expect rental growth to increase in 2025, 2026, 2027 and 2028, but it is simply too soon to forecast resulting NOI growth in those years as real estate taxes, insurance, and other operating expenses aren’t yet clear.
4) A significant driver of your strong 4.6% same-property NOI growth in Q2 was the increase in tax refunds and lower real estate tax assessments. Do you expect similar benefits in the coming years?
The driver wasn’t just tax refunds. We are accustomed to receipt of tax refunds every year. The driver was a combination of additional refunds plus the timing of refunds which came in earlier than we anticipated, enabling the team to retire debt prior to forecast, and resulting in interest savings. Another noncontrollable expense, insurance cost, reduced in 2024. As we discussed during 2023, the REIT experienced an unexpected and considerable increase to its insurance cost in 2023. This increase was shared across the real estate market in the U.S. and driven by a number of factors including bond yields. In 2024, we experienced an insurance reduction year-over-year. The reduction drove NOI growth as well.
5) The discount to NAV has narrowed recently due to the surge in your share price and a slight decline in NAV. You’re also approaching the maximum allowable number of units for repurchase under your current NCIB. With your shares trading at a 27% discount to NAV, do you plan to continue buybacks at these levels, or will you prioritize deleveraging or new investments?
We currently plan to renew our NCIB in October on schedule for the next year.
We have historically deployed capital into share repurchase when we saw exceeding value in repurchases.
We will continue to methodically allocate capital into the highest bucket of return for our shareholders.
6) It’s been reported that the Texas Stock Exchange will begin listing companies in 2026. Currently, your Canadian listing seems to contribute to your company’s lower valuation compared to peers, despite faster growth prospects. Are you considering a potential listing on the new Texas Stock Exchange once it becomes available?
The Toronto Stock Exchange and OTC market represent the perfect ecosystem to grow a REIT as we have done. The U.S. with its average REIT size of $12B simply affords no real opportunity for a smaller REIT like BSR to grow. Contrasting in Canada, we’ve grown our ~$2B REIT with the support of a large syndicate of excellent investment banking and sales & trading teams. With that said, real estate has always been a local business. Investors seem to ascribe more value and lower risk to a real estate investment if they drive past it every day; because they understand their local market. Our Canadian investors live a long way from their investment in Texas, and a potential value gap can be created in times of volatility.
As we look forward strategically, if BSR is to grow, we will explore every listing alternative in an effort to maximize total unitholder return. As really the only pure play Texas multifamily REIT, if a listing on the Texas Stock Exchange creates TUR for our investors, which it logically should, we will certainly consider.
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Finally, feel free to contact us anytime. You can send me a direct message on the chat or email me at jaskola@leonbergcapital.com
Sincerely,
Jussi Askola
Analyst's Disclosure: I/we have a beneficial long position in the shares of all companies held in the CORE PORTFOLIO, RETIREMENT PORTFOLIO, and INTERNATIONAL PORTFOLIO either through stock ownership, options, or other derivatives. High Yield Landlord® ('HYL') is managed by Leonberg Research, a subsidiary of Leonberg Capital. All rights are reserved. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. The newsletter is impersonal and subscribers/readers should not make any investment decision without conducting their own due diligence, and consulting their financial advisor about their specific situation. The information is obtained from sources believed to be reliable, but its accuracy cannot be guaranteed. The opinions expressed are those of the publisher and are subject to change without notice. We are a team of five analysts, each contributing distinct perspectives. Nonetheless, Jussi Askola, the leader of the service, is responsible for making the final investment decisions and overseeing the portfolio. We do not always agree with each other and an investment by Jussi should not be taken as an endorsement by other authors. Past performance is no guarantee of future results. Our portfolio performance data is provided by Interactive Brokers and believed to be accurate but its accuracy has not been audited and cannot be guaranteed. Our portfolio may not be perfectly comparable to the relevant index. It is more concentrated and may at times use margin and/or invest in companies that are not typically included in REIT indexes. Finally, High Yield Landlord is not a licensed securities dealer, broker, US investment adviser, or investment bank. We simply share research on the REIT sector.