Preferred Apartment Communities (NYSE: APTS) has been under a lot of pressure over the last 18 months. Overall, shares of the apartment real estate investment trust (REIT) are down more than 25% since the start of 2020. That steep decline suggests the company might be in some trouble.
Here's a closer look at what has been weighing on the company and whether investors should worry.
A challenging year
Last year was a tough one for Preferred Apartment Communities. The company reported an 18.6% decline in its adjusted funds from operations (AFFO) per share due to some pandemic-related headwinds. Several factors weighed on AFFO, including lower rental collection rates (especially in its grocery-anchored retail portfolio) and declining occupancy in that portfolio and its office properties.
Given those pandemic-related headwinds, Preferred Apartment Communities took some steps to enhance its financial profile to ensure it made it through the downturn. These initiatives included slashing its dividend by 33% to conserve cash, selling assets, refinancing debt, and redeeming preferred equity.
Putting its troubles behind it
One reason Preferred Apartment Communities needed to cut its dividend was to shore up its financial profile. It had an elevated leverage ratio due in part to its funding strategy focused on issuing preferred equity, hence the first part of its name. This strategy of utilizing debt-like funding along with property-level mortgages put pressure on its balance sheet early on in the pandemic.
However, the company has taken great strides to improve its financial profile in recent months. Last November, the REIT closed the sale of its student housing portfolio for $478.7 million, or $233.7 million after repaying property-level debt. Meanwhile, the REIT continued its simplification strategy in April of 2021 by agreeing to sell most of its office portfolio to office REIT Highwoods Properties (NYSE: HIW). It will receive $717.5 million for the seven-property portfolio, which should close in the third quarter. Preferred Apartment Communities expects to sell its remaining office properties over time.
The REIT intends to use the sales proceeds to strengthen its balance sheet by steadily redeeming its preferred equity. In addition to that, it will keep growing its core portfolio of Class-A multifamily properties and complimentary grocery-anchored shopping centers across fast-growing Sun Belt markets.
When combined with the eventual full exit from the office sector, those two transactions put the company in a much stronger financial position. That gives it more financial flexibility to focus on growing its multifamily business, which it believes will produce better returns over the long term.
The REIT has a unique strategy to grow its multifamily platform. It provides developers with loans to finance new multifamily projects, which include the option to purchase the community upon stabilization. For example, in March of 2021, Preferred Apartment Communities provided a $16.8 million loan to help finance a 320-unit Class A multifamily community in Orlando. It will earn a solid return during the life of the loan, with the potential of purchasing the community upon stabilization. The company made similar loans last year to support multifamily developments in Raleigh, NC, and Atlanta. Those investments are less risky for the company than internal development projects, which could experience construction cost overruns or slow stabilization should market conditions cool.
Shifting to a better strategy
Preferred Apartment Community had become more of a diversified REIT in recent years due to its investments in multifamily, student housing, offices, and grocery-anchored shopping centers. When combined with its heavy emphasis on issuing preferred equity to finance growth, that unclear strategy caused some trouble during the pandemic.
However, it's getting back to its roots by exiting the student housing and office sectors. Meanwhile, it's getting away from its namesake funding strategy by using the sale proceeds to retire some of its outstanding preferred equity. That's putting the company in a better position to succeed. Moreover, it's allowing the REIT to sharpen its focus on the Sun Belt migration megatrend driving demand for housing in the South. Because of that, its troubles appear to be fading.