AvalonBay (AVB +1.59%) is one of the largest residential real estate investment trusts (REITs) by market capitalization. Specializing in the ownership, development, and operation of upscale Class A apartments in some of the nation's top markets -- like Southern California, San Francisco, New York City, and Seattle, among others.This REIT has been a popular investment due to its size, reliable dividend return, and high-quality portfolio.
But the coronavirus pandemic created cracks in the company's business model, with its latest earnings for 2021 showing the foundation could actually be starting to crumble. Here's a closer look at how the company performed in 2021 and whether AvalonBay is a buy right now.
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A closer look at AvalonBay today
AvalonBay became a REIT in 1993, with 22 apartment communities in its portfolio at its initial public offering (IPO). The company has grown considerably over the past few decades, now having interest or ownership in 297 properties, comprising a total of 87,992 apartments in 12 states. It uses four core brands to market its apartments, which rent in the range of $2,100 and up, meaning its rental apartments serve mostly upper-income earners.
To this point, AvalonBay has focused on owning properties in the most popular coastal cities of the country -- like Washington D.C., Los Angeles, and Boston -- but with the slowing demand in these markets over the past few years, the company has expanded its portfolio into new high-growth rental markets, including Southeast Florida, Denver, and Charlotte, North Carolina.
That has definitely helped the company. As of the fourth quarter of 2021, Southeast Florida and Denver make up the highest year-over-year rental growths, with a 17.3% and 11.4% change, respectively. But its rental revenue is still down 2.2% for the full year of 2021.
Urban markets, particularly high-cost markets like the ones AvalonBay primarily operates in, have struggled to obtain and retain tenants since the start of the pandemic. The ability to work from home, combined with the closures of restaurants, bars, and other recreational businesses, motivated tenants to relocate to seek more affordable housing outside of the city, pushing rental rates down. This has equated to a 3.7% decline in funds from operations (FFO) and a 4.6% decline in net operating income (NOI).
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Should you invest in AvalonBay right now?
Decreases in revenues happen, but it's definitely not a great sign, given rental demand is soaring for most other residential REIT operators. Camden Property Trust, Mid-America Apartment Communities, and Equity Residential all saw positive growth across the board in 2021, meaning there's a bigger issue at hand when it comes to rental demand for AvalonBay's portfolio.
Rental collections improved noticeably from 2020 to year-end 2021, with 97% of all rents being collected and occupancy remaining strong at 96%. Earnings per share (EPS) is also up 22%. It's likely AvalonBay will simply have to wait longer for rental rates to return to pre-pandemic levels in cities that experienced large outward migration.
The company is bullish on its growth prospects, having 17 developments underway that are expected to cost $2.14 billion to complete. Effective rent change in January 2022 is up 12.4% for its portfolio, a positive sign that demand is returning.
AvalonBay has outperformed the S&P 500 over the past year, but historically, that hasn't been the case. For the past 10 years, the S&P 500 outperformed AvalonBay by more than double. Personally, I think there are better options for residential REITs with better historical performances, positive growth prospects on the horizon, and more stabilized demand and rental growth when compared to AvalonBay. AvalonBay does have a high-quality portfolio and strong management, but given its price to FFO being 30 times, I think it's overvalued for its performance and risk exposure.
