2023-09-08 03:39:22 ET
Summary
- AvalonBay Communities is a residential REIT with a focus on coastal markets in the US.
- Legacy markets are becoming more favorable due to lower supply and strong demand.
- AVB has seen impressive growth in FFO per share and increased its full-year guidance.
Dear readers/followers,
AvalonBay Communities ( AVB ) is a major residential REIT with high-quality apartment communities located primarily in coastal regions of the US, with a minor (recently added) 7% exposure to the Sunbelt.
Because of its heavy presence in legacy markets, the REIT has largely fallen out of favor in 2022 as many investors have shifted their focus to faster growing southern markets. As a result, the stock has long traded at a slight discount to its peers with pure Sunbelt exposure, such as Mid-America Apartment Communities ( MAA ).
Last time I wrote about AVB was in March. I issued a BUY rating for the company, expecting a double-digit annual return over the next two to three years. Since then, the stock has moved up by about 10% and so has the S&P 500. Following latest earnings and developments in the market, I want to publish an update.
I've written extensively on residential REITs here on Seeking Alpha and the core message of most of my articles has been that legacy markets are the place to be in 2023. My thinking was that the South did not deserve the premium it was trading at, because of a significant risk of oversupply in the coming years.
The thing is that construction of A-Class apartments has boomed in the Sunbelt after the pandemic, nearly doubling the amount of space to be delivered in 2023-2025.
And the forecast now calls for over 4% annual inventory increases in the Sunbelt. Legacy markets, on the other hand, are likely to see new supply below 2% of inventory for years to come which is more in line with historical trends. So from a supply perspective, the coastal markets are much better positioned to deliver stable results.
Of course, demand is equally important, and on this front it seems that the tide in the market is slowly changing. Last year, Sunbelt REITs completely dominated its coastal peers in terms of rent growth, which I believe is a good proxy for demand, delivering strong double-digit growth. This year, however, some legacy markets are delivering equally impressive numbers.
During the first half of the year, AvalonBay has been able to grow its FFO per share by an impressive 12% YoY, driven by strong same-store NOI growth of 7.9%. For comparison, MAA's same-store NOI growth over the same period of 8.6% stood at nearly the same level.
Going through the results, it's clear that the Northeast (New England and NY/NJ) is performing as well (if not better) than the Sunbelt. The West Coast and especially Southern California continues to lag with the lowest NOI growth of all.
A close peer of AVB, Equity Residential ( EQR ) also reported that New York is currently their best market in terms of rent growth and occupancy. So I guess, NYC is not dead after all. Could it be that legacy markets were the place to be all along?
Following good results, AvalonBay has increased its full-year FFO per share guidance by about 2.2% to $10.47 per share, up 7% YoY. The forecast now calls for 6% same-store revenue growth at mid-point (vs 5% previously), as the outlook has improved in all AVB's established markets compared to Q1 expectations. Notably, management expects East Coast to outperform West Coast by 200 bps.
Beyond this year, growth will continue to be driven by (1) new development and (2) further rent increases and is expected around 5-6% per year until 2025.
AVB has a very active in-house development arm, which allows it to get new properties at a higher initial yield than simply acquiring them in the market.
Currently, the REIT has about 5,700 units under construction, expected to deliver an initial NOI yield (on cost) of 5.8% which is nicely above the average yield achieved on disposals of 4.7%.
Next year alone, nearly 4,000 units are scheduled for completion, which will add about 5% to AVB's stock. If AvalonBay manages to lease this newly finished space, it will hit its growth targets even without increasing rents on the rest of its portfolio. Any increase in same-store NOI will simply be further upside.
AvalonBay is a conservative investment with a $6.60 per share dividend which yields about 3.7%. The dividend was increased by 4% from last year and going forward, I expect further increases of around 5% per year. This is supported by a very comfortable forward payout ratio of 63% - in line with management's target.
The REIT maintains an A- rated balance sheet which is one the best in the sector. A large portion (92%) of their debt is fixed rate, they maintain low leverage of 4.1x EBITDA and their near-term maturities are well manageable with annual NOI of about $1.8 Billion.
Overall, the stock should deliver market-level returns of 8-10% without any sort of multiple expansion, in particular I expect:
- a nearly 4% dividend yield, growing at 4-6% per year
- 5% annual FFO growth
On top of that, the stock currently trades at a relatively depressed multiple of 17.4x and an implied cap rate of 5.6%. Both of these indicate that there is some potential upside here, if the right catalysts play out.
Personally, I see AVB at 20x FFO and a 5% cap rate at some point over the next three years, which would add another 15% upside to the expected market return, getting us over the double-digit hurdle. I rate the stock a BUY here at $180 per share with a price target of $230 per share.
For further details see:
AvalonBay: Increased Guidance And Improved Outlook