The buy thesis

Camden (NYSE:CPT) has proven itself to be top-notch quality. Its large apartment portfolio is located in the best markets, its balance sheet is pristine and management acts reliably in the best interest of shareholders. These characteristics have been true for years, but now there is fresh appeal to its stock: Valuation. CPT has usually traded at a premium to its peer set but today it trades near the cheaper end at just 21X forward FFO and a 20% discount to net asset value.

We sold CPT from the 2CHYP portfolio a few months back when it was getting pricey, but after a stiff correction and continued FFO/share growth it is looking quite attractive again. In this article I will discuss:

• Occupancy as a driver of further rent growth
• Substantial undersupply
• Relative affordability as a driver of continued rent growth
• Valuation
• Weakness of bear argument
• Risks to thesis

Let’s get started:

Continued fundamental strength

By now the historical dominance of CPT is well known, but just as a quick refresher here are 2 charts that illustrate what they do. Since 1993 CPT has delivered a 2923% return to shareholders.

This gain was made possible by a strong dividend and substantial growth in FFO/share.

You may note in the chart above that CPT has been through some difficult times. In 2000-2001, the general economic recession caused rent/occupancy to dip a bit. The housing bubble created oversupply which compounded with the great financial crisis in 2008-2009 leading to some serious down years. Finally, in 2020, COVID shut down the economy making it challenging for some tenants to pay rent.

However, in each instance, CPT is positioned intelligently to minimize damage and bounce back stronger. There will be recessions in the future and some think the rising rate cycle threatens a recession in the near term. I really don’t know if it will be recession or just a slowing of growth, but either way, CPT is battle-tested and positioned to outperform.

High-quality sunbelt apartments like the ones CPT’s portfolio consists of are particularly well-positioned. In addition to the job growth, population growth and rising proximal affluence which I discussed more deeply in a previous CPT article, there are a few new factors that I think bode well for rent growth:

1. High current occupancy
2. Persistent undersupply
3. Relative affordability

97.1% occupancy which CPT posted in the first quarter isn’t just high, it is really high. Apartments have enough natural turnover that normal “full” occupancy would be closer to 94%-96%. The 97% is simply a result of excessive demand relative to supply such that the downtime to re-tenant a vacated unit has been shortened.

With this imbalance, CPT has the green light to yet again raise rents significantly. The demand is there to absorb it and as we will discuss later there is enough of an affordability gap that it is feasible for tenants to pay as much as 20% more.

Persistent undersupply

Apartment construction has ticked up in recent quarters and is now slightly above the long-run average. Some are looking at this number and thinking it means oversupply, but quite the opposite is true.

See, apartments last 30, 50 or even 100+ years. Camden’s class A portfolio is largely only competing with those built in the past 30 years as most of the older properties have been demoted.

As such, the supply is not just measured by how many properties are under construction now, but rather how many properties were built in the last 30 years. Every year since 1990 has been below the long-run average until the last 2 years which are approximately at the long-run average.

I suspect developers will get a bit more ambitious and that construction will soon exceed the long-run average, but it will take many years of above-normal supply to even come close to undoing the undersupply that has built up.

Further, apartments are perpetually competing with single-family homes. They too have had a dearth of supply in the past 15 years and are only just now starting to get back to long-run averages.

It is in this competition that relative affordability comes in.

Homeowner’s pain is Apartment’s gain

Mortgage rates have risen to a far greater extent than treasury yields or the Fed Funds rate. This makes home ownership vastly more expensive. Using the median home price and average loan to value, the cost of home ownership has increased by $400 per month.

Well in choosing whether to rent or own, this is the figure most people look at. When homes are $400 per month more expensive than just a few months ago, apartments can raise rents quite significantly and maintain relative affordability.

I don’t think the full $400 will happen, but $200 or $300 is quite feasible while still making apartments the cheaper option (at least on a monthly basis).

The substantially more expensive mortgages have started to take a bite out of home sales. Full month of April data just came out and revealed a 16.6% drop in new home sales month over month.

Source

That looks a bit rough for the homebuilders although I think much worse is already priced into those stocks.

What may be less apparent in this data is that it means all those would be homebuyers who now see mortgage rates as unaffordable are still apartment renters. For each person that doesn’t buy, that is one extra retained renter.

I think the rising rate environment will cause home ownership rates to drop back down a bit which in turn means renter rates are higher.

In combination with the undersupply, I see apartments continuing to raise rents another $200 to $300. Camden operates at the higher end which means their affordability is compared to bigger, more expensive homes with bigger mortgages so they are probably looking at $300+ remaining rent growth while staying affordable on a relative basis.

Valuation

My outlook on rental rate growth is quite bullish, but it is actually quite in line with wall street consensus.

Analysts have FFO/share growing steadily from $6.51 in 2022 to $8.01 in 2025.

At today’s price of $139.50 that is a 2022 multiple of 21.4X and a 2025 multiple of 17.4X. Despite this growth, Camden is trading about equal to multifamily peers.

Middle of the pack FFO multiple is a highly unusual spot for Camden. They are the longstanding blue-chip with an A-rated balance sheet.

In normal times it is CPT, Essex (ESS), AvalonBay (AVB) and Equity Residential (EQR) as the premium multiples with everything else multiple turns below them. This tightness of multiple spread is a rarity among multifamily REITs and is a great time to trade up in quality.

Independence Realty (IRT) is quite honestly a junky REIT and has no business trading at the same multiple as Camden.

In my eyes, it is clear mispricing when you can get higher growth, higher quality and lower risk at the same multiple.

Asset value

Net Asset Value (NAV) confirms Camden’s cheapness with it trading about 20% below NAV. Historically CPT has only traded at such a discount a few times:

• The depths of the financial crisis
• 2013-2014
• Depths of COVID crash

In each of these instances, purchase at the discount would have resulted in phenomenal returns. The future is of course uncertain, but this seems like a really good time to buy CPT.

With that in mind, I want to take a bit to examine the bear thesis.

The bear case: Unaffordable housing

There is a housing affordability crisis in America and this refers equally to apartments, single-family rental and home ownership.

Bears argue that the unaffordability will destroy demand until rent/home costs come down enough to restore affordability. The bear case has spread like wildfire, with apartments and homebuilders trading down extreme amounts in anticipation of some sort of impending hit to earnings.

Part of it seems to be rooted in public sentiment with a growing vitriol in colloquial discourse regarding corporate owners of housing. The property owners are being blamed for the rising cost of housing.

While I am sympathetic to this argument from an emotional perspective as I can imagine how terrible it would be to not be able to afford rent, I make it a conscious effort to invest with my brain rather than my heart.

Basic economics shuts down the idea that property owners are at fault. Rental rates and home prices are set by the market. In fact, most of the apartment REITs, Camden included, do NOT actively set their own pricing. They use software that examines supply and demand to find the market-clearing price.

No business is going to voluntarily lower rents when occupancy is at 97%. Thus, the only one way out of the affordable housing crisis is to build more homes and more apartments such that supply becomes balanced with demand. Until that time, rents will continue to rise and Camden will continue to grow FFO/share.

Camden is not the cause of the affordable housing crisis, they are simply a beneficiary.

It will take time for supply to catch up. If the developers really get ambitious the imbalance could be corrected in roughly 3 years. At that point rental rate growth will slow to a more normal pace of a couple of percent per year.

As such, my outlook for CPT is a few years of rapid growth followed by a return to its normal mid-single-digit growth. At current pricing, I think this is a great outcome and I see Camden as opportunistically cheap.

Risks to thesis

A true recession would derail the outsized growth that I and the other analysts are expecting for CPT. As such, it behooves CPT investors to keep an eye on leading indicators of U.S. GDP.

Given its strong balance sheet and the long-term viability of its properties, Camden can weather a recession, but it would make its current multiple a fair bit less attractive.