About a year ago AvalonBay Communities (NYSE:AVB) completed a big acquisition, but it's real strength lies in building desirable apartments in high-barrier to entry markets. In fact, it's expertise on the construction front sets it apart from competitors like Sam Zell's Equity Residential (NYSE:EQR), which partnered with AvalonBay on that acquisition.
An unusual purchase
AvalonBay and Equity Residential partnered on the purchase of Archstone from Lehman Brothers for $6.5 billion, closing the deal in late February last year. AvalonBay got 66 properties (about 22,000 apartments) and Equity Residential took 78 apartment buildings (about 23,000 apartments). It was a big deal for both companies, materially increasing each company's portfolio with desirable properties in good markets.
For AvalonBay, buying properties on this scale is an unusual event. That's because the landlord generally prefers to build its own apartments. For example, in 2013, the real estate investment trust (REIT) completed construction of 12 apartment buildings, containing over 2,800 apartments. It also broke ground on another 13 communities with nearly 3,800 units in them. And, it augmented its pipeline for future development with 26 additional "development rights."
That's vastly different than Equity Residential, which built a grand total of four apartment complexes. However, this REIT has historically been a much more active wheeler and dealer, buying and selling its way to dominance in the apartment space. Over the last decade or so the company has been slowly shifting its portfolio toward the very markets that it was able to buy into in bulk with the acquisition of Archstone.
Building is a key difference
But AvalonBay's construction expertise is an important differentiation. It's similar, in fact, to Prologis (NYSE:PLD). This industrial REIT is focused on fostering international trade by owning properties in key trade hubs. While it too uses acquisitions to grow, it is also a builder. In 2013, Prologis, "initiated $1.8 billion ($1.5 billion Prologis' share) of new development projects, 42 percent of which were build-to-suits."
In other words, it's building exactly what its customers want. Prologis had over 30 million square feet worth of construction projects on the drawing board at the start of the year. The REIT is a giant in the industrial space, but the ability to build makes it more than just a landlord—it's a partner to many of its tenants. That's a differentiation from competitors like fast growing STAG Industrial (NYSE:STAG).
STAG bought 39 properties in 2013, increasing the size of its portfolio by over 30%. That's a big increase and makes this relative newcomer focusing on secondary markets worthy of investor attention. It's following Equity Residential's model of buying its way to growth—clearly the model works. But adding in the ability to build changes the dynamics greatly.
You get what you build
As an example, AvalonBay's portfolio is fine tuned to six core markets. Equity Residential counts 10 markets as core, but is in 17 altogether. Equity Residential is using property sales of non-core assets to help fund its Archstone purchase (it sold 94 properties in 2013). In contrast, AvalonBay went to the capital markets and issued additional shares, as it simply doesn't have that many non-core assets to jettison. In all of 2013 AvalonBay sold eight properties, four of which came from the Archstone acquisition.
At the end of the day, if you focus on acquisitions, you can only buy what people are willing to sell. And if you buy a portfolio of properties, you have to take the good with the bad—that encompasses both location and building quality. If you build properties, you can make sure you end up with exactly what you want, where you want it -- allowing for a more resilient portfolio. Income investors will appreciate that AvalonBay didn't cut its dividend during the deep 2007 to 2009 recession, but Equity Residential did.
There's no question that construction takes more time than acquisitions and comes with its own risks. However, if you are looking for a slow but steadily growing apartment owner operating in some of the country's best markets, AvalonBay has proven itself to be a long-term winner. Much of that success can be attributed to its focus on building its own properties—that's a game plan from which it has no intention to deviate.