In fact, Paula Poskon, a senior research analyst with Robert W. Baird & Co., a Milwaukee-based wealth management and private equity firm, says that AEC management has cited in the past that less than 4 percent of its portfolio is exposed to the auto industry. On a year-over-year basis, AEC’s same-store NOI in their Midwest portfolio remained positive through the third quarter of 2009, with same-store revenue in that portfolio turning slightly negative in that last-reported quarter. “That Midwest portfolio is very stable,” she says. “We have toured the Cleveland and Columbus assets. They’re stable properties in good suburbs with regional employment drivers and no new supply.”
There’s no current supply in a lot of these markets either. “In the Auroras [a Cleveland submarket], the housing stock is far more expensive than [the general] Cleveland market,” says John T. Shannon, senior vice president of operations for AEC.
The Potential Pitfalls
Despite AEC’s recent success during the Great Recession and the tremendous strides it’s made over the past decade, questions still linger—about its potential value going forward, its reputation, and mostly, about Friedman himself.
Homeownership Hurts
After losing renters to the housing boom, Associated Estates is now benefitting from the foreclosure crisis.
When low-interest mortgage loans were prevalent four or five years ago, Associated Estates Realty Corp. (AEC) was as hard-hit by the exodus to homeownership as anyone in the rental sector.
“The toughest time for us in the Midwest was when interest rates were lowest and every one of our primary renters were leaving to buy homes,” says Jeffrey I. Friedman, chairman, president, and CEO of the Cleveland-based REIT. “We didn’t have pricing power because our renter was getting a no down payment loan at 2 percent interest and leaving our apartments.”
But now, with the Great Recession taking its toll on consumers, the tables have turned. Some AEC markets, including Detroit and Cleveland, have been hardest-hit by the national foreclosure crisis. This time, though, Friedman says those foreclosures aren’t pulling his renters away. He says that more than 90 percent of his renters choose to live in one- and two-bedroom apartments, and those renters are not really interested in moving to a single-family, foreclosed-upon home.
On top of that, Friedman is seeing fewer renters move out for home buying in general. “We’re finding the financial flexibility that a customer has from renting is so much greater,” he says. “They don’t know how secure they are in their job or whether they want to stay in the area, so they rent while they figure it out.”
But the Midwest foreclosure issues have had one effect on the REIT. Like many of its peers, AEC has had to modify the way it screens its prospective renters.
“In the old days, if you applied for an apartment and had a default on a mortgage, you couldn’t rent from us,” Friedman says. “Today, you get dinged a little, but if you’re employed and current on your credit card, we rent to you.”
Take its stock price, which at $11.37 (as of Feb. 10), still trades at a tremendous discount to its net asset value (NAV). There’s not one simple reason for this, but an amalgamation of issues that trace back to the company’s colorful history, including general uncertainty regarding management and the negative perception of its Midwestern base. “They’re not really in high-growth markets,” McCulloch says. “They’ll underperform in the long term. The growth story isn’t there like it is for the other REITs.”
Poskon sees these markets as safe havens. “Over time, are people migrating out of the Rust Belt? Yes, but it’s over time,” she says. “There’s no meaningful, if any, new supply in those markets. If you have legacy assets there that are well maintained, they’re very likely cash cows. That’s what these guys have. There’s no reason to summarily dismiss this notion of being exposed to the Midwest, as some institutional investors do. It really depends on the dynamics of the submarkets where the assets are and what you’re able to get out of them.”
And, along with not fully grasping the dynamics of the Midwest, a lot of these investors still harbor misconceptions about AEC. “A lot of people look at this as an affordable, older 25-year-old apartment company that hasn’t been kept up very well,” says William Acheson, a REIT analyst with Benchmark Capital. “Nothing could be further from the truth.”
But others remain concerned that apartments in the Midwest will be unable to generate the capital proceeds needed for the company to reinvest in other markets. Even though AEC isn’t in the hardest-hit Midwestern submarkets, its Midwest association could still hinder its ability to get premium prices. “I get fliers about Michigan assets,” says Rod Petrik, managing director at St. Louis-based Stifel, Nicolaus and Co., a regional brokerage and investment banking firm. “I don’t want to say they’re giving them away, but cap rates in New York have no relation to Detroit.”
