AvalonBay Communities (AVB)

TOP CONTRIBUTORS

Michael Francis

AvalonBay Communities builds and rents apartment buildings in the U.S. The company focuses on developing upscale housing for higher-income families in 10 states and the District of Columbia. AvalonBay owns around 43,000 units and enjoys an average rent per unit of around $1,400 per month^[1] compared to $650 on average in the U.S.^[2]

AvalonBay is intricately tied to interest rate tides, which have several important effects:

• While the company competes for tenants with other apartment operators, it also competes on the relative attractiveness of owning a home versus renting an apartment. When home prices are high, renting becomes more attractive (and vice versa). Interest rates determine the attractiveness of mortgage financing. When interest rates are high, renting becomes more appealing as financing a mortgage becomes more expensive.
• It is also important to note that AvalonBay operates as a real estate investment trust (REIT). As such, the company must distribute at least 90% of its cash flow to shareholders every year in the form of a dividend. When interest rates rise, so do demands for investment yields on dividends, which can depress a REIT's stock price.

AvalonBay attempts to mitigate these effects by appealing to a higher-income consumer base that is less likely to be affected by macro-economic shifts. The company also tries to build a competitive advantage by limiting development to urban and suburban geographic regions with high barriers-to-entry, either because land is in scarce or zoning laws are especially difficult to navigate.^[3]

Financial and Operating Metrics

Below are several metrics of operating performance for the company. The company has been able to steadily increase its rental revenue per apartment unit over time, fighting inflation and driving organic growth. It has also increased its apartment unit base as shown in the chart below.

Trends and Drivers

• National and Local Job Market and Employment. The strength of the labor market has important implications for the company.^[6] Jobs fuel demand for all types of housing, including multi-family/apartment dwellings. Strong job growth can drive higher occupancy rates and lead to increased unit rental revenue. High unemployment and slow job growth, on the other hand, can hamper the apartment rental market and, when job growth is negative, the company can experience falling occupancy rates and lower revenue per unit, which leads to less efficient apartment buildings as the utilization of the complex falls. Avalon may be slightly less effected by shifts in the job market as its tenants are generally higher-than-average income households who can generally weather slowdowns more readily.

• The Housing Market and New Home Construction. Factors driving the non-apartment, alternative housing market can have a substantial impact on the company. Throughout 2007, falling housing prices in the company’s key markets, coupled with decreasing new home construction and the rising cost of financing mortgages increased demand for apartments relative to houses and other living alternatives. However, if housing prices continue to fall, houses can become more attractive to purchasers, and they may substitute away from apartments and opt for single-family housing instead.

• Interest Rates. Rising interest rates have several effects on this company and other apartment REITs:^[7]

1. Other investments become more attractive, thereby hampering demand for apartment investors. This, in turn, decreases the market prices of the company’s properties.
2. Available and existing financing becomes less attractive. Getting favorable terms on any new debt to finance building purchases becomes more difficult. The company’s interest expense on its floating rate debt increases, pressuring margins and increasing financial risk.
3. The stock price can fall as investor’s demand a greater dividend yield. As a REIT, the company must, by law, distribute at least 90% of its cash flow to shareholders in the form of a regular dividend. When interest rates rise, investors demand higher dividend yields on REITs, thereby driving down their stock prices.

• Mortgage Rates. The attractiveness of mortgage financing for home purchasers has important ramifications for the apartment REITs. If mortgage rates fall and credit is plentiful, buying a home becomes more attractive than renting an apartment, thus stifling demand for the company’s rental units. On the other hand, if the availability and attractiveness of mortgages declines, as did during the fallout from the subprime lending crisis, renting an apartment becomes more appealing, so occupancy rates and rental revenue per apartment increase.

• Local population growth. The rate of population growth in the company's operating regions is another key determinant of the company's success. In towns whose populations are rapidly increasing, limited housing supply and/or the lag time in building houses leads to greater demand for the company's apartment units. The growth in local population is also closely correlated to the rate of job growth (see National and Local Job Market and Employmentabove).

• Focus on high barrier-to-entry regions. Avalon has pursued a strategy of operating in areas that have limited land supply and/or very perplexing entitlement and zoning processes. This gives the company something of a competitive advantage over other publicly traded competitors whose markets are more readily accessible to other investors. Avalon believes it brings expertise in the complex legal regulations of their core markets and that they can experience steady appreciation in the value of their properties in light of the limited supply (e.g. Manhattan). Some of its major markets include New York, DC, and Northern and Southern California.^[8] This strategy, of course, also means that the company itself may have difficulty acquiring new properties at favorable prices going forward.

Competition and Market Share

The company competes against a wide array of other apartment rental owner/operators. The National Multi Housing Council estimates that around 17 million apartment units exist nationwide. The median rental income per unit is around $650 per month.^[10]

The market for multi-family housing is highly fragmented geographically as well as within any given region. To the left are industry statistics for each of the major markets of publicly traded apartment REITs. The company’s real estate portfolio is highly diversified across geographic region, and operates in nearly every state. Based on data compiled by the National Multi Housing Council, the company was the largest operator of apartment units across the nation.^[11]

Furthermore, below is a table of relevant competitive data as compared to rival or comparable companies:^[12]

Footnotes

1. ↑ 2006 AVB 10-K, "Business," pg 1
2. ↑ Apartment Rental data, 2005, compiled by National Multi Housing Council
3. ↑ 2006 AVB 10-K, "Business," pg 1
4. ↑ AVB 2006 10-K, "Selected Financial Data," pg 46.
5. ↑ EQR 2004, 2005, 2006 10-K, "Business"
6. ↑ AVB 2006 10-K, "Risk Factors," pg 9.
7. ↑ AIV 2006 10-K, "Risk Factors," pg 10.
8. ↑ 2006 AVB 10-K, "Business," pg 1
9. ↑ Data from Apartment Stock data, 2006, compiled by National Multi Housing Council
10. ↑ Apartment Rental data, 2005, compiled by National Multi Housing Council
11. ↑ Apartment Stock data, 2006, compiled by National Multi Housing Council
12. ↑ All data from annual reports of companies. Market share statistics were taken as the percentage of addressable units owned by the company. "Addressable" refers to units in the companies' stated target markets