2023-09-04 08:05:00 ET
Summary
- AvalonBay Communities is a viable choice for conservative investors seeking value, income, and long-term growth in the real estate market.
- AVB has consistently generated top and bottom line growth over the past 10 years and is well-positioned in a tight housing market with limited new supply.
- Meanwhile, it's seeing robust operating fundamentals in the near term and has the backing of a strong balance sheet.
Real estate is one of the best ways to accumulate wealth over time, but most retail investors lack access to low cost capital and therefore the ability to efficiently scale a real estate operation. Plus, who has the spare time with the "three Ts" of being a landlord, with those being tenants, toilets, and trash?
This brings me to AvalonBay Communities ( AVB ), which I last covered here back in April with Buy rating. The stock has done well since then, giving investors a 9.2% total return, which virtually matches the 9.4% rise in the S&P 500 ( SPY ) despite not being a tech stock. In this article, I discuss why AVB remains a highly viable choice for conservative investors who prize value, income, and long-term growth, so let's get started.
Why AVB?
AvalonBay Communities is one of the largest multifamily REITs on the market today with 294 apartment communities in 12 states and the Washington D.C. area. Its properties are primarily located in Tier 1 markets along both U.S. coasts and it also has a growing presence in the growing Sunbelt region, namely in Texas, North Carolina, and Florida.
Benefits of investing in AVB come from having efficient scale and an experienced management team, in which operating expenses at the corporate level are spread over a wide asset base. This also gives AVB access to low cost of capital, particularly in debt markets, which retail investors simply can't tap.
One of the true tests for REITs is whether it's been able to generate both top and bottom line growth consistently over an extended period of time. AVB passes this this test with flying colors, with revenue more than doubling and FFO/share more than tripling over the past 10 years, as shown below.
AVB is benefitting from a tight housing market, in which home owners are reluctant to sell their homes lest they give up a mortgage rate that's far lower than the prevailing rate, which currently trends over 7%. This means that even if a home owner downgrades to a cheaper house, they could be paying more in monthly costs due to a higher interest rates. Moreover, AVB expects to see less new supply in its key markets, with just 1.5% apartment unit growth this year compared to 3.9% growth in Sunbelt regions.
The limited supply of new housing bodes well for AVB, and this has supported strong near-term growth, with Core FFO/share growing by 9.5% YoY during the second quarter. This was driven by same-store revenues growing by 6.3% YoY. Operating expenses remain in check, as management expects to see lower repair and maintenance costs, offset by higher legal costs as due to AVB reclaiming landlord rights to evict non-paying tenants. Considering that the latter issue is a temporary item as a result of COVID-era policies, I would expect overall operating expenses to trend down as those cases come to a resolution.
AVB also has other avenues for continued growth beyond standard rental increases, as it's recycling capital, as reflected by recent dispositions of three assets at a low 4.7% cap rate with the aim of redeploying proceeds into higher yielding projects. AVB has $3 billion in liquidity and expects to deliver $16 million of incremental NOI this year, and management is guiding for 7.9% FFO/share growth this year. Plus, 95% AVB's NOI is unencumbered by secured debt (i.e. mortgages) and it carries a strong balance sheet with a low net debt-to-Core EBITDAre ratio of 4.1x, sitting well below the 6.0x level considered safe by ratings agencies.
Risks to AVB include higher than expected interest rates, which would increase its cost of debt. However, higher interest rates would be a response to higher inflation and apartment REITs like AVB are generally inflation-resistant, since their rental contracts are usually 12 months in length. Another risk to AVB includes potential for challenges in the tech sector, which AVB is weighted towards with its West Coast properties, as that could push up its bad debt expense.
Considering all the above, AVB remains good value at the present price of $181 with a forward P/FFO ratio of 17.2, sitting well below its normal P/FFO of 22.2, despite the strong aforementioned growth and analyst expectations for 5-9% annual FFO/share growth over the next 3 years. Meanwhile, income investors collect a 3.6% yield that's well protected by a 62% payout ratio. Management has also signaled a return to dividend growth with a $0.06 bump this year after freezing it in 2021-2022.
Investor Takeaway
All in all, AvalonBay Communities is a premium multifamily REIT for conservative investors who prize value, income, and long-term growth. It's benefiting from efficient scale, a strong balance sheet, and positive supply/demand characteristics in its established markets.
AVB remains good value with a below average P/FFO and pays a respectable 3.6% dividend yield that's backed by a 62% payout ratio and a resumption of dividend growth. For these reasons, AVB remains a quality pick for long-term investors at the current price.
For further details see:
AvalonBay Gives You Value, Growth, And Income