In May of this year, we explained why America First Multifamily Investors, LP (NASDAQ:A TAX) was a far superior alternative to mortgage REITs and municipal bond ETFs. While the stock didn’t fit the exact characteristics of either comparator, had many similarities, including a play on real estate loans and the tax-sheltered nature of most of his income. It has been an incredible success story.
ATAX was much less brutal with the municipal bond funds that we suggested they would lose. However, our 4 comparatives in that space, Nuveen AMT-Free Quality Muni Income (NSA), Nuveen Quality Muni Income (NAD), Nuveen AMT-Free Muni Credit Income (NVG) and Income from Nuveen Municipal Credits (NZF), underperformed enough for investors to take notice.
The biggest advantage ATAX had over mortgage REITs was simply a relative lack of leverage. Less leverage means less volatility in stressful times. Less leverage means less decline in tangible book value, a metric that should interest all investors. In the last 3 years, ATAX’s lower leverage has helped quite a bit in this arena.
We’ll see why ATAX outperformed municipal bond funds, after looking at Q3 2022 results.
Recent ATAX press releases had a lot of good news for the bulls. ATAX delivered its second special distribution this year.
America First Multifamily Investors, LP (the “Company” or “ATAX”) announced that the Board of Directors of Greystone AF Manager LLC (“Greystone Manager”) declared a distribution to holders of Charitable Unit Certificates (“BUC”) of the Society of $0.57 per BUC. The distribution consists of a regular quarterly cash distribution of $0.37 per BUC plus a supplemental distribution payable in the form of additional BUCs worth $0.20 per BUC. The supplementary distribution will be paid at the rate of 0.01044 BUC for each BUC issued and in circulation on the date of registration.
Font: ATAX press release
These special distributions have come about as ATAX has sold many of its properties at favorable prices. looking at the 10-Qwe can see that the gain on sale totaled $10.6 million this quarter and $39.7 million in the first 9 months.
These are huge amounts relative to the company, with only 22.2 million units (or BUC as they like to call them) in circulation. Another way to examine the impact is to look at cash available for distribution or CAD per unit. ATAX starts from net income to arrive at this figure in CAD. You will notice that they do not subtract the gain on sale when arriving at CAD.
This paints a more troubled picture for the company. If you take profit out of sale amounts, ATAX would have a virtually flat CAD in Q3 2022 ($11.7m minus $10.6m). To date, the CAD, excluding gain on sale, would be approximately $11 million. With 22 million units in circulation, we expect around 50 cents in CAD. This has big implications for stocks and distribution in the coming year.
ATAX is seeing a massive drop in normalized CAD (excluding all gains on sale). The question is whether they can continue to sell real estate assets at a profit while their income from the mortgage bond side remains weak. The big question is whether they would want to do it. One advantage of ATAX over municipal bond funds was the actual physical real estate they owned. These apartment values were, and continue to be, positively correlated with inflation. This provided it with a natural hedge, a hedge that allows it to outperform municipal bond funds. We think these sales will drop and that will probably allow for much lower CAD and distribution in the coming year.
ATAX is also sensitive to interest rates, both on its balance sheet and income statement. On the income statement side, further rate hikes will make a dent in its already adjusted normalized CAD.
This sensitivity is despite ATAX adding significant coverage.
On the balance sheet side, total equity has been falling steadily, even though it has been buoyed by a big gain in real estate sales.
This drop is now shifting the equity-to-asset ratio into an unfavorable zone.
The outperformance against mortgage REITs and municipal bond funds was driven by lower leverage and perhaps the crystallization of their physical real estate holdings. We believe that these two advantages are coming to an end.
ATAX’s leverage is increasing as the rate hike cycle is affecting even its equities.
Investors focused on big rallies have driven ATAX at a huge premium over tangible equities.
The chart above does not incorporate book values for Q3 2022 results, which would take the ratio to 1.35X. Further increases in long-term interest rates will further reduce the value of the ATAX Mortgage Income Bonds. This could be offset to some extent by spread compression, but risks remain high at these levels. Examining our relative call here tells us that municipal bond funds are also now trading at deep discounts to NAV. This has also been a driver of ATAX’s superior performance.
Therefore, we believe this is a time to stop insisting that ATAX outperform mortgage REITs or municipal bond funds. Indeed, in light of the large premium coupled with a much lower CAD in the coming year, we are downgrading ATAX to a sell rating on valuation. We would look to switch to neutral maybe 15-20% lower.
Please note that this is not financial advice. It may look like it, it may seem like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their goals and limitations.