Assessing The Dividend Of AvalonBay Communities

Summary

• Share price continues to hover around the 3% mark which is below average in this sector.
• FFO continues to grow steadily.
• We look at how key dividend metrics have been trending.
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Many investors only look at valuation metrics when doing their respective due diligence on their investments. The REIT space is very popular with respect to this strategy. Consensus seems to believe that because the respective REIT may be well diversified with respect to location as well as tenant, the risk of the valuation decreasing significantly is small due to the sheer numbers of properties involved.

However, because REITs pay out the vast majority of their earnings to their shareholders in the form of dividends, many investors' principal priority is the sustainability of the dividend. When a REIT is able to consistently grow its dividend without affecting the payout ratio that much, it usually means that management is doing a good job of buying and selling property.

One such residential REIT which we are eyeing up at present is AvalonBay Communities (NYSE:AVB). AvalonBay (with interest in approximately 300 apartment complexes) deals with apartment communities in areas such as New England and California to name a few.

Fourth quarter earnings were announced at the beginning of last month. Management announced FFO growth of 5.2% in the fourth quarter (FFO of $2.43) which resulted in 3.8% for the full year. $1.3 billion was raised in external capital in 2019 which should fund more developments going forward.

Consistent growth over the past while along with strong forward-looking guidance has resulted in shares trading with a trailing P/FFO ratio of 22.84. Furthermore, the forward multiple (21.69) is not far off the trailing multiple. The sustained increase in the share price over the past while has decreased the dividend yield to just under 3%. The sector median, for example, comes in at around 4.5%.

However, let's look at AVB for a sheer dividend standpoint to see if it deserves our hard-earned investing dollars.

Dividend growth in AVB has slowed a tad over the past 5 years. The 5-year growth rate comes in at 5.55% whereas the 12-month growth rate comes in at 3.4%. Growth is important for investors because it fosters confidence concerning future growth plus it also protects against purchasing power erosion.

Dividend per share growth comes in at flat 4% for AVB. The sector median is 2.24%. Therefore (on average), AvalonBay Communities is growing its dividend faster than other residential REITs even though its own dividend growth has declined somewhat in recent times.

To see if the decline is a result of poorer cash flow coverage, we go to the payout ratio. AVB's forward dividend per share comes in at $6.36 whereas its funds from operations come in at $9.83. This gives us a payout ratio of 64.7%. Management have done a good job of keeping this key metric pretty constant over the past while.

This is important because it facilitates future growth to take place more easily. The sector's average FFO payout ratio is above 72%, so this trend is also encouraging for AVB.

Nevertheless, what we have discussed so far is backward-looking. Therefore, in order to get a solid read on whether the dividend can experience sustained growth, we look to the interest coverage ratio and the debt to assets ratio. These metrics inform us on how solid the REIT is financially. AVB's long-term debt/total assets ratio, for example, comes in at 0.38 which is well below the average of 0.43 in this sector. AvalonBay has done a really good job in recent years with respect to managing its balance sheet. We see stability here.

Furthermore, AVB's interest coverage ratio comes in at 4.08 which is well ahead of the industry average of 1.97. Again, this number points to more stability and states that the dividend should be able to weather difficult trading conditions over the near term.

Therefore, to sum up, when we take into account 2020's FFO projection of $9.83, cash flow trends, interest coverage, as well as the balance sheet, we see a strong dividend here in AvalonBay at present. We recommend present investors to keep on reinvesting dividends to reduce the cost basis of the shares over time.

Analyst’s 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.