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AvalonBay: Good Time To Turn Its Financials Inside Out

1 year ago

beritaja.com

REIT. Concept image of Business Acronym REIT arsenic Real Estate Investment Trust. 3d rendering

My portfolio has included multifamily REIT AvalonBay (NYSE:AVB) until very recently, though not without mixed feelings. Their excellence and ostentation protection battles pinch a dividend output that remains debased moreover now.

I bought AVB chiefly successful precocious 2021, from the position that it would beryllium a bully ostentation hedge. This is still true.

Other than that, my expectations were for a full return successful nan precocious azygous digits. I sold wrong nan past period for reasons developed present and successful my caller article connected inflation protection.

But my reasons whitethorn not beryllium your reasons. As AvalonBay person conscionable reported their financials for 2022, this is simply a bully clip to move them wrong out. At rumor is their business model, its information against adversity, and its prospects for growth.

This is nan 2nd REIT to get this curen from me this year. The first was Simon Property Group (SPG).

What and Where AvalonBay Is

AvalonBay is 1 of nan 2 largest Multifamily REITs, pinch a marketplace headdress adjacent $25B. They are besides 1 of only 3 Multifamily REITs to transportation an A- in installments rating.

In its essence, AvalonBay is simply a developer of multifamily housing. As we will spot below, this is nan main spot wherever they turn shareholder value.

Over caller decades their economical maturation are 1 of nan champion amongst REITs. Their nominal maturation complaint of FFO/share has exceeded 7% based on immoderate point-to-point comparisons.

A person look astatine that facet was elaborate successful my analysis past twelvemonth for members of High Yield Landlord. More accurately their semipermanent maturation complaint is simply a spot smaller, possibly 6.5%. More connected that below.

Historically AvalonBay has emphasized apartments successful coastal gateway cities. This has been wherever 1 recovered nan strongest economical growth.

Yet nan emerging inclination complete caller decades has been nan travel of organization to nan sunbelt. The pandemic accelerated this for a time, but nan long-term, slower inclination remains.

AvalonBay has responded to this, adding 4 description regions to their pre-existing six. On their Q4 2022 net call, they had this to say:

Our extremity is to displacement 25% of our portfolio to our 6 description markets complete nan adjacent 6 to 7 years. At nan extremity of 2022, including our improvement presently underway, we accrued our description marketplace vulnerability to 7%. And taxable to nan superior allocation situation this year, we expect to beryllium astatine 10% by nan extremity of 2023.

Here is their representation from Q2 2022.

The inset present makes an important point. Many whitethorn definitive interest that ostentation of costs will make improvement little profitable. In isolation this is true, arsenic 1 tin spot by scanning immoderate horizontal row.

But ostentation besides comes pinch increases successful rent and Net Operating Income, aliases NOI. If you look astatine nan cardinal cell, shaded green, and way 10% increases successful some difficult costs and NOI, you tin spot that improvement yields spell up successful response.

In bid to found themselves successful caller regions, AvalonBay has acquired a number of existing flat complexes. Here is their descent connected 2 of them.

They put astir $1B into each of these 2 regions, acquiring 12 comparatively caller communities and processing 4. This represents astir 5% of their full of ~300 communities. These mean ~300 homes each. That $2B is significant, representing 8% of their full gross property.

AvalonBay has besides begun utilizing section developers to build caller communities for them successful nan description regions. They telephone this their Developer Funding Program, described successful this image:

Further colour connected this programme was provided successful nan Q4 2022 net call:

[It] does 2 things for us. One, it accelerates our finance activity successful nan description regions because it does return clip to get nan teams connected nan crushed arsenic -- and we're further on successful immoderate markets than others. Where we're doing nan DFP truthful acold has been much for illustration say, North Carolina, wherever we conscionable started location a twelvemonth aliases 2 ago, not truthful overmuch successful Denver wherever we've been location for 5 years already.

Real Estate Is Very Local

One of my pet peeves is seeing arguments astir nan imaginable of immoderate people of existent property based connected nationalist averages and trends. Real property markets ever first and foremost bespeak section proviso and demand.

The caller net calls by AvalonBay and Camden Property Trust (CPT) person emphasized that moreover metro-level statistic are excessively wide to really picture conditions for a fixed property.

Camden, for example, discussed really their section positioning successful Austin and Houston implies that they are not threatened by nan wide proviso glut successful those metros.

Similarly, successful each respects- demand, supply, and affordability - nan AvalonBay portfolio is superior to nan mean location market. AvalonBay provided this descent to exemplify that:

Just to lb this constituent location much broadly: In immoderate region location are ever amended and worse places to buy, sell, aliases build. Choosing residential REITs based connected nationalist aliases moreover location statistic is not nan champion focus. Find nan champion companies.

Dispositions Matter for AvalonBay

AvalonBay is an progressive recycler of capital, which helps money their development, arsenic we will see. Here is their show of dispositions, from their astir caller 8-K.

They person been trading an mean of astir 7 communities per year. Note that this is besides their complaint of processing caller communities.

This represents astir 2.3% of their total. The measurement they responded to marketplace conditions was successful nan holding play of nan communities they sold.

AvalonBay took advantage of nan precocious prices successful 2021 to waste communities that they had held overmuch longer than their semipermanent average. They sold high, astatine a 3.7% headdress rate, and apt sold less-desirable communities arsenic well. The disposition headdress complaint was still beardown successful 2022, astatine 4.0%.

As conditions successful nan in installments and real-estate markets person evolved, AvalonBay has changed their acquisition and improvement activity. They picture nan changes here, besides from nan Q4 2022 net call:

As nan twelvemonth progressed, we pivoted from our original anticipation of being a $275 cardinal nett purchaser to ending nan twelvemonth arsenic a $400 cardinal nett seller, a displacement of astir $700 cardinal successful total. We besides ratcheted down caller improvement starts, fixed nan shifting environment, to $730 cardinal from our original guidance of $1.15 billion.

This agility is what 1 wants to spot (and successful fairness is not unsocial to AvalonBay).

AvalonBay has precocious added a mezzanine financing program. These look to travel and spell arsenic various REITs deliberation they tin utilization their expertise by applying it to loans, without undue guidance distraction.

Color maine a spot skeptical connected that because fewer REITs look to instrumentality pinch specified programs semipermanent and because nan lending facet involves a chopped accomplishment set. I'll stake nan numbers look awesome connected immoderate finance-type's spreadsheet, though. This programme does not move nan needle now and whitethorn not ever, truthful we won't attraction connected it here.

Truth successful Cash Flows

GAAP accounting renders galore financial statements worthless successful determining nan rate elements of a business model. The financial connection successful nan modular SEC filings that is nan slightest impacted is nan Statements of Cash Flows.

The constituent of looking backward astatine these is to spot really nan business responded to changes successful its business environment. One tin past judge what is and is not apt to strengthen going forward.

We will now build up a schematic depicting nan AvalonBay rate flows. One could stack nan sources and uses of costs successful immoderate order; rate is fungible. The bid utilized present reflects my position of wherever nan attraction of AvalonBay lies.

Each twelvemonth connected nan graphics has 2 sets of bars. The near shows sources of costs while nan correct shows uses of funds, each arsenic indicated by colour successful nan legend.

Cash from Operations (Green) and Distributions (Light Blue)

Here are Cash from Operations, aliases CfO, and distributions:

In astir years and particularly caller ones CfO is nan largest rate travel item. For AvalonBay, CfO is numerically adjacent to nan NAREIT Funds From Operations, aliases FFO. When this is true, nan REIT has fewer of nan oddball aspects that tin lead FFO to mislead.

You tin spot that really CfO has changed from twelvemonth to year. It dropped from 2008 done 2010, nether nan effect of nan Great Recession. It dropped from 2020 done 2021, successful consequence to nan pandemic. Otherwise, it has increased.

The distributions, present nan correct group of bars, move steadily upward pinch CfO but stay good beneath it. They are good covered and not astatine consequence (save successful nan arena of an extended financial situation led AvalonBay to temporarily trim nan dividend - spot below).

Dispositions (Red) and Development (Purple)

Now we adhd dispositions supra CfO connected nan near group of bars. We adhd improvement (including redevelopment which is overmuch smaller) supra distributions connected nan correct group of bars.

Above nan distributions, improvement is shown successful purple. In each case, nan sum of nan ray bluish and purple bars is larger than CfO. The accusation is that further capital, beyond CfO, has been utilized to support development. You tin spot that nan superior root of specified superior has been nan dispositions.

Acquisitions (Yellow) and Stock Issued (Gray)

Acquisitions (yellow) complement improvement astatine times. Issuing banal provides further capital.

The gait of acquisitions (the yellowish bars) varies rather a bit. But 2021 and 2022 really guidelines out. This is nan pivot to adhd sunbelt exposure, discussed above.

We tin spot that successful nan years from 2018 guardant acquisitions person mostly been funded from dispositions. Disposed properties were pricey; it was an opportunistic clip to beryllium selling.

In contrast, location has been mini banal issuance since 2015 and almost nary for nan past 3 years. Stock has been inexpensive and truthful not worthy issuing. AvalonBay moreover bought backmost banal successful 2020.

Net New Debt (Brown), Archstone, and Other

Now we adhd 3 last categories. These are nett caller debt, successful brown, nan nett alteration successful rate and rate equivalents, successful black, and nan (always small) superior expenditures connected existing communities, aliases recurring capex, successful gold.

In bid to prolong a target level of Debt/EBITDA, 1 needs to adhd indebtedness arsenic EBITDA increases (whether from improvement aliases from inflation). You tin spot this hap successful caller years, though nan magnitude is simply a mini fraction of CfO.

AvalonBay would not request immoderate caller indebtedness to proceed some operating and growing, successful opposition to nan sentiment expressed successful this article, which successful my position is ill-informed and includes galore errors. But location would beryllium nary constituent successful driving leverage down beneath their existent debased level.

The recurring capex is mini and is consistently adjacent 10% of FFO. In addition, different non-cash adjustments to GAAP gross are small. In response, nan coming study focuses connected FFO and not connected Adjusted FFO.

The astir melodramatic events connected nan floor plan are from 2012 and 2013. In those years AvalonBay made a awesome acquisition of Archstone. This included assuming astir $2B successful debt.

They sold equity to raise cash. By 2012 nan value of AVB had recovered backmost supra its 2007 high, making this a sensible usage of equity issuance. They past paid down nan indebtedness successful 2013.

The ample yellowish barroom successful 2013 seems to beryllium chiefly portion of that acquisition, utilizing up nan remainder of nan rate that was raised. But I did not excavation heavy capable to cognize what other whitethorn person happened.

Looking astatine nan floor plan arsenic a whole, nan sources of costs (left bars) shown connected nan crippled now are astir often a spot beneath nan uses of costs (right bars). This reflects nan omission of a number of items successful "Cash Flows from Investing Activities". The ascendant 1 is distributions from unconsolidated existent property assets, which runs from astir $10M to $100M, pinch an exceptional worth of conscionable complete $200M successful 2014.

The big-picture constituent I transportation distant from nan study of rate flows is that AvalonBay is agile. They person adjusted really they root and usage superior successful consequence to changes successful nan markets. That would look apt to continue.

Perils of Debt and Debt Structure are Small

AvalonBay is 1 of only 3 multifamily REITs to transportation an A- in installments rating. They usage comparatively small indebtedness and person besides reduced leverage since nan Great Recession.

They besides person fantabulous indebtedness management. Here is their schedule of indebtedness maturities:

The mean indebtedness maturing complete nan adjacent decade is $680M per year. This is little than half their Cash from Operations and little than a 3rd nan sum of that positive dispositions.

It is applicable that AVB maintains a in installments installation expandable to $3B, much than 4 times their mean indebtedness maturity and much than their full yearly rate expenditures. Difficulties specified arsenic an extended financial situation surely could trim net maturation and AVB could determine to trim nan dividend. But successful nan semipermanent discourse that would beryllium a blip.

Turning to nan full debt, nan ratio of Total Liabilities to NOI ran supra 7x early successful this century. From 2014 connected they reduced this ratio truthful that it now is usually beneath 6x.

Early successful nan century, liking expenses ran supra 30% of NOI. Today they tally astir 15% of NOI, reflecting some little liking expenses and little leverage.

Taken successful isolation, an extended play of higher liking rates could measurement connected FFO/sh growth. Notably, nan weighted mean indebtedness maturity for AvalonBay is 8.1 years, truthful astir 6% of their indebtedness would reprice each year. A doubling of nan liking complaint connected each year's tranche of indebtedness would nutrient a headwind of astir 1% of FFO/sh each year.

It would return a agelong clip astatine higher rates to propulsion liking expenses up markedly. In addition, truthful agelong arsenic those higher liking rates travel on pinch precocious inflation, location would beryllium larger offsetting benefits, arsenic I discussed here.

AvalonBay does person astir $600M successful variable-rate debt; astatine 7% of their full this is noticeably little than what immoderate REITs carry. That indebtedness now is astatine an liking complaint astir a 4% higher than a twelvemonth ago, which is akin to everybody else.

Despite that, they person managed to trim nan liking complaint connected their fixed indebtedness moreover arsenic it accrued modestly twelvemonth complete year. The resulting headwind connected FFO/share maturation for AvalonBay is only 100 bps, overmuch smaller than projected by Camden aliases by Federal Realty Investment Trust (FRT).

Those 3 are each outstanding REITs. Perhaps this constituent of outperformance by AvalonBay is coincidental. But past again, possibly they are better; they person managed nan higher semipermanent maturation rate.

Pandemic and Recovery

The pandemic did not overmuch impact nan wide business of AvalonBay. They stayed progressive successful each area, isolated from acquisitions during 2020, and were backmost astatine everything successful 2021.

But it did effect CfO (the greenish bars above) and FFO. Let's look astatine quarterly TTM FFO.

[Here Excel was not cooperative; it often struggles pinch gridlines connected log plots. But retrieve that immoderate fixed vertical spacing connected a log crippled represents a fixed fractional change. So nary matter really you standard them you spot nan aforesaid thing. Here you spot half of FFO/share, which sewage nan gridlines right.]

You tin spot that nan fluctuations complete clip successful FFO/sh (blue line) are rather ample and that nan pandemic alteration was not astatine each unusual. Over timescales of a fewer years, flat net are volatile. But you tin besides spot that 6.5% semipermanent growth, shown arsenic nan dashed line. What past investors person seen, complete short timescales beneath a decade, is highly variable.

No wonderment that spectacular maturation successful 2022 did not lead to a spectacular dividend raise. But AvalonBay is yet backmost adjacent their semipermanent inclination and has guided for astir 6% maturation of FFO/sh successful 2023 (the golden dot). [They guided for a 5.3% maturation complaint of their preferred "Core FFO," but we will not effort to unpack nan quality here.]

This whitethorn get them backmost to decent dividend growth. They did raise it 3.8% successful February.

At nan infinitesimal guardant dividends are only 64% of guided 2023 FFO/share. It seems apt to maine that this payout ratio will summation going forward. If it does not, past FFO/share and dividends will some turn incrementally faster done accrued reinvestment.

The guided maturation is astir successful statement pinch what we are seeing from different value Multifamily REITs. But by comparison pinch nan overmuch flatter guidance from immoderate REITs successful different sectors, it is outstanding.

Whence Earnings Growth

What we attraction astir coming is early maturation of FFO/sh. The supra worldly provides a bully discourse wrong which we tin deliberation astir this growth.

Here is 1 measurement to stack up nan supra numbers:

$500M successful dispositions astatine 4.5% is $22.5M successful mislaid NOI.
$1B of improvement astatine a 6.5% return is $62.5M successful gained NOI.
That quality of astir $40M is conscionable nether a 3% summation successful NOI.
Add a 3.5% rent summation and you get 6.5%, which is nan historical maturation rate.

On apical of this would beryllium immoderate accrued nominal maturation occurs successful consequence to inflation. For nan lawsuit of 5% ostentation for 15 years, my article connected ostentation protection recovered a nett AFFO/sh maturation complaint of 8.7%.

It is besides worthy reasoning astir imaginable antagonistic futures. Sustained higher liking rates are discussed above. Structural changes to nan US system aliases changes successful guidance capacity could driblet that FFO/sh maturation complaint further.

In addition, immoderate specified developments could push adjacent FFO multiples down, moreover astatine humble discount rates. Such imaginable eventualities are why 1 diversifies.

Valuation

In nan discourse of valuation, I find this crippled worthy contemplating.

Except during carnivore markets, investors person agelong been contented to person dividend yields from AVB that were comparable to nan rates connected 10-year treasuries. During nan past decade, nan dispersed has typically been beneath 100 bps.

But nary 1 would reason that AVB should nutrient nan aforesaid full returns arsenic treasuries. Investors person treated AVB arsenic a maturation stock, counting connected that summation successful FFO/share.

Dividends were 77% of FFO successful 1996 and 78% successful 2022. So nan FFO output has been astir 30% supra nan dividend yield.

My recent article discussing REIT rate net and valuation recovered that Funds disposable for Distribution and Reinvestment, which I called FDR, ran astir 77% of FFO for multifamily REITs. That estimate besides applies good to nan circumstantial numbers of AvalonBay.

Applying nan discounted-cash-flow methodology from my article connected net multiples gives, vs discount rate, nan ratio of Net Present Value to FFO shown conscionable below. This shows 3 cases, pinch maturation rates arsenic indicated. The terminal maturation complaint is 3% successful each cases.

Here is my position of this graph. When ostentation is moderate, maturation rates of 5.5% to 6.5% are relevant.

In that case, a discount complaint astir 10%, which has been communal for a batch of REITs, this gets you a aggregate connected FFO successful nan precocious teens for a costs building for illustration that of AvalonBay.

Using nan aforesaid discount rate, nan higher maturation complaint for nan inflationary lawsuit pushes nan aggregate up to nan debased 20s. Perhaps nan marketplace would beryllium contented pinch this, pinch nan higher maturation complaint anticipated to compensate for nan summation successful nan ostentation rate. Or possibly not.

For nan lawsuit pinch mean inflation, nan discount complaint has to driblet beneath 8% to get into nan mid-20s and further than that to get up supra 30x. Even for nan inflationary case, it has to driblet beneath 9%.

Yet immoderate multifamily REITs were trading adjacent 30x successful precocious 2021, arsenic shown here. These days 3 of nan 4 shown are successful nan ballpark of 17x. The alteration since 2021 reflects some nan driblet successful value and nan summation successful FFO/sh.

So what was going connected crossed overmuch of nan past decade? Perhaps nan marketplace really thought that nan maturation of AvalonBay is truthful definite that AVB could beryllium weighted pinch a little discount rate.

Alternatively, possibly this is TINA astatine work, pushing discount rates beneath reasonable levels. I'm nary instrumentality of TINA and dream she has near nan building.

In contrast, harking backmost 30 years nan dividend output was adjacent 8% for an FFO output adjacent 10%. The P/FFO of 10 corresponded to a 14% discount rate. If you are young, dream for a return to that and bask nan full returns good into nan mid-teens erstwhile it comes. (Also nonstop immoderate of those returns to your grandmother, who is apt to request it.)

It is worthy noting that nan consequence from present is asymmetric. The alteration successful discount rates that would nutrient a 50% summation is overmuch smaller than nan summation that would nutrient a 50% loss.

What to Demand from Investing successful AVB?

It seems to maine that nan marketplace has been overdoing it successful pricing AVB and nan stocks of different Multifamily REITs arsenic maturation stocks. To return to FFO multiples successful nan mid-20s would require a patient belief that TINA will return aliases that we will spot important ostentation pinch small summation successful nan discount rate.

If nan marketplace priced successful nan afloat effect of ostentation for nan lawsuit modeled above, nan value of AVB would summation by astir a third, from little than 17x coming to little than 23x. That's much than thing but acold short of returning to nan levels of precocious 2021. On apical of that, expanding liking rates could thrust discount rates up and marketplace multiples down.

As nan carnivore marketplace of 2022 developed, I progressively saw AVB arsenic an upside play. Not anymore. There is conscionable not overmuch if immoderate separator of information here.

On apical of that, moreover a full return successful nan precocious azygous digits depends fundamentally connected nan marketplace rewarding AvalonBay for growth. This mightiness not hap if so it turns retired that P/FFO moves down. And to put nan nail successful nan coffin for me, nan more-reasonably-priced, Net Lease REITs turned retired to person a adjacent magnitude of ostentation protection, arsenic shown successful nan related article.

But location is different broadside to nan story. At 3.8% nan output of AVB is not negligible. It is apt to turn pinch ostentation and moreover somewhat much than that.

An investor seeking secure, increasing income and satisfied pinch that output tin rather reasonably bargain AVB. That is why I included it successful my Buy-Hold-and-Go-Fishing Portfolio.

None of my much caller study and reasoning changes nan merit of AVB for a "Go Fishing" portfolio. It conscionable became a overmuch worse fresh for what I americium trying to do at nan moment. So I sold, but possibly you should buy.

I dream nan supra has fixed you capable information and discourse to amended your individual decisions astir AVB (and astir different apical Multifamily REITs).

If you want entree to our full Portfolio and each our existent Top Picks, consciousness free to subordinate america for a 2-week free trial astatine High Yield Landlord.

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