The average real estate investment trust (REIT) is down around 20% so far in 2020, using Vanguard Real Estate ETF as a proxy. Apartment landlord AvalonBay Communities (NYSE:AVB) is down almost 30%, near a five-year low for the stock.
COVID-19 and the U.S. recession are key factors in the drop, but investors should take a closer look at this company before writing AvalonBay off. Here's what you need to know about this bellwether apartment REIT to help you decide whether it's a buy.
Focused in on key markets
AvalonBay owns roughly 300 apartment buildings containing around 86,500 apartment units. Add in a $23 billion market cap and the real estate investment trust is most certainly a large player in the U.S. apartment niche. However, it's fairly particular about where its apartments are located, operating in just 11 primarily coastal states.
Within the selected states, it tends to focus on submarkets that have growing employment in high-wage sectors of the economy, low housing affordability, and a high quality of life. It's a pretty simple model: AvalonBay tries to put up great apartment properties in desirable locations. That leads to higher rents and a more stable business through good times and bad.
It buys, it sells, and it builds
The other thing that's notable about AvalonBay's portfolio is that it's not static. The REIT has a long history of actively managing its portfolio with the goal of maintaining a desirable collection of assets. Even the best apartment building gets old and falls out of sync with changing consumer tastes. And areas that were once hot can fall out of favor, too. The only way to deal with this is to sell buildings that are no longer as desirable as they once were.
Management then takes that cash and reinvests in the business by acquiring more modern assets in desirable markets or building from the ground up. It currently has around 20 properties under development. In fact, the company's ability to build from the ground up is a differentiating factor here. Management believes this allows it to earn higher returns, especially when the cost of buying an existing apartment building is high. The ability to buy or build allows AvalonBay to put money to work in just about any market. And -- just as important -- keeping its portfolio modern and fresh helps it keep its rents high.
A history of success
There's any number of ways to look at how well AvalonBay has done over time, but perhaps one of the best is its impressive dividend record. The dividend has been increased annually for nine consecutive years. That's not bad, but it basically means that record only tracks back to the 2008-09 recession. The more important takeaway here is that the REIT didn't cut its dividend during that downturn, like many of its peers did. It held the line. It has, in fact, kept the dividend steady or increased it every year since its late-1993 IPO. That span includes two recessions in addition to the one that is currently happening.
The average annualized dividend growth since the REIT's IPO is roughly 5%. While that may not sound like a huge number, it easily beats the roughly 3% historical growth rate of inflation. And, thus, the buying power of income that dividend investors generate has grown over time. The funds from operations (FFO) payout ratio in 2019, meanwhile, was a very modest 66%. That provides ample flexibility for AvalonBay to deal with some headwinds in 2020.
Holding up well
That flexibility is important today because, as noted above, the United States has fallen into a recession due to the country's efforts to slow the spread of COVID-19.
There are some REIT niches that are having a lot of trouble collecting their rents, like malls and other retail centers. But AvalonBay just reported that it collected roughly 95% of its May rents. It would certainly be better if the REIT was able to collect 100%, but it is still doing quite well despite the economic pullback that's left other REITs reeling (and led to dividend cuts). Occupancy, meanwhile, is around 94%. That's down slightly from April, but still strong given the recessionary environment.
AvalonBay's long-term success is no secret and the stock is rarely cheap. In fact, with a dividend yield of just 4% or so, investors looking to maximize current income might want to take a pass. But that yield is near its highest levels over the past 10 years, suggesting that the stock is relatively cheap compared to its own history. Furthermore, the REIT's price-to-FFO ratio (which is like a P/E ratio for an industrial company) is roughly 14 right now -- the lowest it has been in a decade. Once again, that suggests the stock is a good deal today relative to its own history. That should make this industry-leading name worth a close look for most dividend investors.
Paying for quality
At the end of the day, AvalonBay stock isn't necessarily cheap on an absolute basis, but great stocks at fair prices are often very good investments. And AvalonBay has a well-honed business model that it has executed extremely well in good times and bad.
Yes, the U.S is currently experiencing a difficult period, which understandably has investors worried. But long-term investors willing to step in while others are fearful should still strongly consider adding an industry-leading name like AvalonBay to their portfolios today.