Government reform of the GSEs strengthens the outlook for rental housing demand as mortgage insurance costs climb 25 basis points and minimum down payments rise to $10k. Higher ongoing financing costs and significantly higher down payment restrictions will keep consumers in the rental market longer, supporting rental rates and occupancy at major apartment REITs, including AvalonBay Communities (AVB).
AVB is already seeing solid improvement in rental metrics. In 2010, year-over-year rental rates moved from down 2.5% in Q1 to up 2.5% exiting Q4. And AvalonBay sees further strengthening in 2011, projecting 3% to 6% rental rate same store growth in 2011 on high single digit effective rent increases. Stronger rents and occupancy will support 16% FFO growth to $4.50-4.75 per share this year.
In 2010, young renters benefited from a 1.3 million increase in private sector jobs. And more jobs are likely this year given the American Staffing Association’s weekly staffing index, a bullish precursor to full time employment growth, which is running 13% higher than last year.
In the meantime, AvalonBay is riding a tidal wave of higher demand as home ownership continues to fall, reflecting ongoing foreclosure rates and stubbornly stiff mortgage lending standards. In 2010, home ownership dropped 70 basis points, creating 700,000 new renter households, half of which typically find themselves in multi-family communities like AvalonBay’s.
Recognizing the opportunity, AvalonBay is tapping a solid balance sheet to expand its multi family apartment portfolio. Construction costs are low, real estate is cheap and foreclosure and financing rates are favorable. All of this is good news for faster community ROI and bullish for future profit growth. And, this is good news for investors as rising free cash flow provides the fuel for higher dividends.
In Q4, AVB completed $500 million in development and started construction on five new communities. AVB also completed three redevelopments and began another five redevelopments. Overall, in 2010, AVB started seven redevelopments, completed $400 million in acquisitions and started $650 million in new developments; 70% more investment than initially planned entering the year.
And AVB’s investments will continue in 2011. The company added $600 million worth of new development rights and plans to add another $300 million of development rights in Q1. AVB plans on boosting investment by 25% from 2010, starting $850 million in new development. Combined with 2010, the company will have $1.4 billion of development under construction in 2011 – levels consistent with mid cycle spending in 05’ and ‘06. AVB will also start an additional $100 million in redevelopment this year, a similar level to 2010.
AVB is also taking advantage of cheap real estate in its investment management fund, spending $150 million. The fund has purchased two existing communities and announced an additional acquisition in January. The remaining $400 million in the fund should be deployed by Q3 this year.
Cash flow has also benefited from the company taking advantage of cheap money and improving commercial lending markets. Since 2009, AVB has been able to reduce its long term fixed debt-financing costs by 25 basis points to 5.66%.
Another reason AvalonBay is set to profit is due to recession era shelving of investment projects. A freeze in industry construction through the economic downturn is expected to push rental-housing supply to an expected 50-year low in 2011. This equates to a 60% drop in supply in AVB’s core markets.
And the renter population is expected to move higher through 2015. The industry expects about two thirds of all new households will be renters, boosting the overall rental household population by six million. The government’s projections are a bit more timid, however still robust. The Treasury Department’s white paper on GSE reform states the U.S. hosts 37 million renter households with another 4.4 million to be created by 2015.
Either way, reform supports rental markets as changes are geared toward making sure homeowners have higher equity levels. As home ownership becomes more difficult and costly, people will be forced to rent longer while they save for larger down payments – a great reason to buy shares in AvalonBay Communities.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AVB, PPS over the next 72 hours.