Bluerock Residential: Attractive Valuation But Its Balance Sheet Is Leveraged – Bluerock Residential Growth REIT, Inc. (NYSEMKT:BRG) No ratings yet.

Investment Thesis

Bluerock Residential Growth REIT (BRG) owns a portfolio of residential properties located in Nevada, Texas, Colorado, and Southeastern region of the United States. The REIT should continue to benefit from favorable demographic trends, and strong market fundamentals in its major markets. The company also has a value-creation strategy through renovation that should help grow its average monthly rental rate in the next few years. The company’s shares are currently trading at a discount to its peers. While part of this discount is due to its leveraged balance sheet, we think the gap is too wide. Given its 5.2%-yielding dividend, Bluerock is not a bad choice for income investors. However, we think a pullback will provide a higher margin of safety.

Data by YCharts

Recent Developments

Bluerock delivered solid Q2 2019 with top and bottom lines growth. As can be seen from the table below, its same store revenue increased by 5.3% year over year thanks to favorable leasing spread. The company was able to increase its average rental rate by 5.5% year over year. Its same store net operating income grew by 9% year over year thanks to its effort to control its operating expenses.

Source: Q2 2019 Supplemental

Earnings and Growth Analysis

Situated in markets with above national average population growth rates

Bluerock has a portfolio of properties located in Texas, Colorado, Nevada and Southeastern part of the United States (see map below). We like Bluerock’s focus in these markets as these markets have much higher population growth and employment growth rates than the national average.

Source: June 2019 Investor Presentation

In fact, its major markets such as Nevada, Texas, North and South Carolina, Florida, and Colorado are among the 10 highest population growth States in the United States in 2018. As can be seen from the table below, these states enjoy population growth of more than 1% in 2018 and is above the national average of 0.6%. If the trend continues, it will support demand for rental properties in Bluerock’s major markets.

Source: U.S. Census Bureau; Idaho Local News

As can be seen from the map above, Bluerock is also planning to expand to other strong markets such as Arizona, Utah and Virginia. Arizona and Utah are also among the top 10 states in terms of population growth rates in 2018. We like Bluerock’s focus on markets with high population growth rates.

Significant value creation opportunities through renovation

Bluerock has a value creation strategy through renovation. The company has completed about 2,200 value-add renovations to date. The average return on investment of these value-add renovations was 26%. The REIT has also identified about 4,600 units to be renovated in the future. As can be seen from the chart below, Bluerock’s value-add creation strategy has the potential to add $200 ~ $250 per unit to its current average monthly rental rate of $1,299 per month.

Source: June 2019 Investor Presentation

Investments and Developments: A good source of income

In Q2 2019, Bluerock invested $9 million in its preferred equity and mezzanine programs. The company’s total investment and development in preferred equity and mezzanine loans stood at $276 million across 15 projects ($100.7 million in preferred and equity investments, and $175.8 million in mezzanine loans). As can be seen from the table below, these investments generates core funds from operations of about $8.1 million in Q2 2019, and $15.9 million in H1 2019.

Source: Q2 2019 Supplemental

Highly-leveraged balance sheet

One area where we are concerned about Bluerock is its leveraged balance sheet. Its net debt to assets ratio of 60.1% is high. Similarly, it has a leveraged debt to adjusted EBITDA ratio of 10.03x with poor fixed charge coverage ratio of only 1.32x. This is less of a concern in an environment where interest rates are declining. However, it could be problematic in a rising interest rate environment. Fortunately, there are no significant debts maturing before 2022. Investors should continue to monitor Bluerock’s balance sheet.

Valuation Analysis

Share price of Bluerock has risen by about 38% since the beginning of the year. Bluerock expects its 2019 adjusted funds from operations to be in the range of $0.81 ~ $0.84 per share. Using the midpoint of the guidance, its price to 2019 AFFO ratio is 15.1x. This is significantly below the 24x average of its major U.S. peers. We feel this is partially justified given its leveraged balance sheet.

A 5.2%-yielding dividend

Bluerock currently offers a quarterly dividend of $0.1625 per share. This is equivalent to an annual dividend yield of 5.2%. As can be seen from the chart below, its dividend yield is towards the low end of its past 3-year yield range. Its dividend is safe with a dividend payout ratio of 74% in Q2 2019 (based on its core funds from operations).

Chart

Data by YCharts

Other Risks and Challenges

Macroeconomic risk

Although people always need to find a place to live, it will be challenging for Bluerock to raise rental rates in an economic downturn. This is because layoffs will likely result in lower demand for residential rentals.

Elevated supply risk

Favorable long-term demographic tailwind and demand for residential units has resulted in elevated supply in many markets in the U.S. If these markets are not able to absorb the new supply (e.g. lower demand as a result of a recession), it may become challenging for Bluerock to raise its rental rate and continue to enjoy good revenue growth.

Investor Takeaway

Bluerock should continue to benefit from favorable demographic trends in its major markets. Its shares are currently trading at a discount to its peers and the company pays an attractive 5.2%-yielding dividend. While the company may look attractive, we think investors may want to apply higher margin of safety due to its leveraged balance sheet. Therefore, we think a pullback will provide a better buying opportunity.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not financial advice and that all financial investments carry risks. Investors are expected to seek financial advice from professionals before making any investment.

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