For the quarter, funds from operations (FFO) grew 17% and net operating income (NOI) increased 11%. In established communities, rental revenues grew 7.4% as a result of a 7.7% increase in rental rates, offset by a small decrease in occupancy. For the year, FFO grew 17% and net operating income grew 9%.
Strong rental rates have been the primary driver of AvalonBay's success. Looking at the fourth quarter, the Pacific Northwest and Northern California were the biggest growers, with 11.6% and 9.8% increases in rental revenues and 18.3% and 14.1% increases in NOI.
In 2007, management believes the economy and its markets will moderate, but believes it can grow NOI about 5.5% to 7.5%. The company believes that its core apartment rental markets should continue to benefit from solid demand, thanks to 1% job growth (which it estimates will translate into demand for 200,000 rental units) and weakness in the for-sale market (which competes with renters like AvalonBay for occupants). Management also noted that although rental housing supply would pick up, capacity increases were well within expected absorption rates.
Moving and shaking
The more property AvalonBay can build at a good yield, the more profit it can earn to kick back to shareholders via dividends. Thus, AvalonBay's $5 billion development pipeline (with $1.3 billion in construction) bodes well for the future. As these projects come online, AvalonBay has been rewarded with strong demand. In its recently completed San Francisco and Manhattan communities, rent escalation had increased yields 110 basis points from the time construction began until completion. In 2007, the company hopes to start $1 billion worth of projects, and hopes that the 6% yields it's looking at during construction can increase to 7% by the time the property stabilizes.
It seems that AvalonBay continues to benefit from strong demand for its rental units, its stock, and most importantly, its debt. Because investors crave good yields (thanks to ultra-low interest rates worldwide -- Japan's key lending rate is 0.25%), they're willing to let AvalonBay pay relatively low interest rates. This directly decreases AvalonBay's cost of funds. AvalonBay also doesn't think it's hitting a ceiling in terms of building its development pipeline. Currently, the company estimates it has about 10% market share (competitors include Apartment and Investment Management
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Fool contributor Emil Lee is an analyst and a disciple of value investing. He doesn't own shares in any of the companies mentioned above. Emil appreciates comments, concerns, and complaints. The Motley Fool has a disclosure policy.