AvalonBay Communities (NYSE:AVB) is an excellent apartment REIT. It debuted with a Buy rating on the back of its solid growth and excellent valuation. This is one of the largest apartment REITs, and it is operationally excellent. It owns and operates upscale apartments in coastal markets.
AVB stands out among REITs for its expertise in developing new properties. In addition to running its portfolio effectively, the REIT is building new properties at attractive prices.
(Source: AVB Investor Presentation)
This emphasis on producing new apartment buildings is one of the key factors that sets AvalonBay apart. This is one of the reasons I believe it is an excellent security for the B&H (buy-and-hold) investor. AvalonBay's effective development of new properties enables it to grow more efficiently than many REITs would be able to.
Valuation
We should dive into the analysis with a clear look at AVB’s performance on the fundamental metrics. If a REIT has been failing on these metrics over the last few years, it would indicate a severe problem with the company.
(Source: AVB Investor Presentation)
AVB has performed extremely well on the fundamentals. Its same-store NOI growth has been slightly behind the multi-family sector average. However, the REIT has developed a high volume of new properties that created additional value for the portfolio. The result is a very attractive growth rate in core FFO per share. I looked over a prior reconciliation for core FFO, and I am satisfied with the company's accounting. It was not making garbage adjustments.
It should be no surprise that AVB's dividend growth has also been quite attractive. When a REIT has reasonable same-store NOI growth, an excellent pipeline for new developments, and solid growth in core FFO per share, it should be matched with growth in dividends per share.
Let’s turn to the company's outlook for 2018:
(Source: AVB Investor Presentation)
Management is providing clear guidance on what shareholders should expect for 2018. Growth should be a little lower than what was recorded for 2017, but it is still quite attractive. I believe it is reasonable to expect moderate steady growth in core FFO per share.
Where does apartment rental rate growth come from?
When investors begin evaluating apartment REITs, they need to understand the fundamentals that support the sector. The major factor to recognize is the impact of wage growth. When wages are growing, the apartment REITs have more room to raise rental rates.
(Source: AVB Investor Presentation)
Unemployment claims are down, and the unemployment rate is exceptionally low. We are finally seeing growth in hourly earnings. This is extremely important to the sector. The growth in same property NOI and core FFO came despite very weak growth in average hourly earnings. A moderate improvement in wage growth would be very favorable for the apartment REITs. Further, the target renters are performing better than average. We are seeing the 25- to 34-year-old age bracket recognizing sudden growth in income.
Job growth is still dependent on locations. If job growth was primarily happening in markets where AVB did not own assets, it would not be as relevant. The areas where the REIT operates are all projecting significant gains in personal income.
(Source: AVB Investor Presentation)
There is one caveat I would like to make about this slide. It represents growth in total personal income, but it does not indicate total personal income per capita or per worker. Consequently, the expected average wage growth should be lower than what is indicated in the chart. However, it is quite reasonable to expect some growth in average wages and growth in same property revenue.
(Source: AVB Investor Presentation)
(Source: AVB Investor Presentation)
The company is merely projecting for growth at about 2%. Given the uptick in average wages, that seems like a perfectly reasonable estimate.
Developing new apartments
AVB’s new development pipeline will be a little slower for completions in 2018.
(Source: AVB Investor Presentation)
This reduction is temporary. In 2019, its new developments should accelerate again.
(Source: AVB Investor Presentation)
AVB often has a significant amount of new development underway. Over the last few years, it has often been around $3 billion in new development underway at any point. This is a significant chunk of the company’s value, and it is easy for investors to miss it.
Funding development
Given AVB’s extremely high level of new development, it must have capital planning done well in advance.
(Source: AVB Investor Presentation)
The company has already spent the majority of the cash necessary for its upcoming developments, and it has hedged part of its exposure to interest rates for the funding on the other parts. A REIT planning to spend so much cash on development should have a strong balance sheet.
Balance sheet
AVB is exceptionally strong. Its net debt-to-core EBITDA multiple is only 5.0x, and interest coverage is 6.9x. Both of those metrics are excellent.
(Source: AVB Investor Presentation)
The strong balance sheet combines with solid growth and excellence in developing properties to make AVB a great choice for long-term investors. The company's debt maturity schedule is excellent.
(Source: AVB Investor Presentation)
AVB’s maturing debts are extremely low through 2020. The company will probably look to handle the debts for 2020 well in advance also. The weighted average years to maturity of 9.9 is excellent. Apartment REITs are generally more stable than several other REIT sectors. However, even among apartment REITs, AVB stands out.
Why apartment REITs?
The REIT Forum recently recommended Equity Residential (EQR). Apartment REITs will be getting a little extra attention because of the favorable fundamentals for the sector. Several of them have solid balance sheets and steady growth. The demographics are also favorable for apartment REITs. It is ironic to see so many positive factors for a sector where some of the best players are trading at a discount to the rough estimated value of their assets.
(Source: AVB Investor Presentation)
The apartment REIT fundamentals are supported by a moderate growth in workers entering the 25- to 34-year-old age bracket. Those potential renters are generally doing well over the last couple of years in the labor market. The increase in the average age for first marriage and beginning motherhood is another positive factor for apartment REITs. It makes the apartment lifestyle more attractive for a longer period, during which many of the expected renters should be seeing growth in their wages. This won’t be true for every single individual, but on the broader level, it creates a positive tailwind for apartment REIT performance.
Conclusion
AVB is an exceptional company with a dividend yield of 3.62% and an FFO multiple of 18.2x using management’s guidance for 2018. It has a unique expertise in developing new assets and a very conservative balance sheet that gives it more flexibility to do so. This is one of the best apartment REITs, and it carries a very attractive valuation. For the B&H investor, this is one of the exceptionally strong candidates for the portfolio. The dividend is solidly covered, and investors should expect continual growth. AVB is not recession-proof, but it should perform better than peers if we have a recession.
Buy rating for AVB.
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