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Better Buy: AvalonBay Communities vs. Essex Property Trust

Jul 18, 2020 by Matthew DiLallo

AvalonBay Communities (NYSE: AVB) and Essex Property Trust (NYSE: ESS) are two of the largest publicly traded apartment REITs. That focus on residential real estate makes them ideal options for investors who like the idea of generating passive income from real estate but don't want the hassle of being a landlord.

Here's a look at which of these residential REITs is the better one to buy right now.

Analyzing their financial profiles

The first thing real estate investors should do when comparing two investment options is to take a close look at the financials. Here's how these two REITs stack up against each other.

REIT Dividend Yield Dividend Payout Ratio Credit Rating Debt-to-Adjusted EBITDA
Avalon Bay Communities 4.1% 65% A3/A- 4.6 times
Essex Property Trust 3.7% 60% Baa2/BBB+ 5.9 times

Data source: AvalonBay and Essex Property Trust.

As the table shows, both apartment REITs have rock-solid financial profiles. They have conservative dividend payout ratios, investment-grade balance sheets, and low leverage levels. However, AvalonBay does stand out because of its A-rated credit and lower leverage ratio, which is below its 5.0 to 6.0 times target range.

That's by design. CFO Kevin O'Shea stated on the REIT's first-quarter conference call that "we very much drove that leverage number down over the last few years to give us more scope and more capacity" to get it through the next real estate sector downturn. Because of that, the company has lots of flexibility now that market conditions have deteriorated.

Comparing their portfolios

Another thing that investors should do when considering two similar REITs is to look closely at their assets. In AvalonBay's case, it owns interests in 296 communities (including 19 under development) that contain 86,596 apartment homes. These properties are primarily in New England, the New York/New Jersey Metro area, the Mid-Atlantic, the Pacific Northwest, and California, though it's also expanding into Southeast Florida and Denver. That diversified portfolio provides investors with exposure to many of the country's leading markets where employment has been growing but housing is scarce.

Meanwhile, Essex Property owns interests in 250 communities with 60,000 apartment homes, including six under development. All its properties are on the West Coast. The bulk are in Northern and Southern California (42% and 41% of its NOI, respectively), with its remaining NOI (17%) coming from Seattle. These markets benefit from strong employment, especially tech-related, and limited housing supply.

Both companies focus on owning apartment communities with strong market fundamentals. However, AvalonBay stands out for having a more geographically diverse portfolio.

A look at what's ahead for these two REITs

One of the main growth drivers for both REITs in recent years has been development projects. As noted, each currently has several communities under construction that should boost results in the coming years.

Essex and its partners are investing $1.1 billion to build 1,761 new apartment homes. Most of these projects have reached the stage of initial occupancy. Because of that, only about $168 million of capital spending remains, $75 million of which Essex will fund. Beyond that, the company doesn't plan to start construction on any new developments this year because of COVID-19. While that could affect future growth, it does have the option of using its solid balance sheet to make acquisitions and other investments.

Meanwhile, AvalonBay has 19 projects currently under construction, including building 6,198 apartment homes and 64,000 square feet of retail space. It expects to invest $2.3 billion on these developments, with $873 million of remaining spending over the next several years. On top of that, the company has development rights for an additional $4.1 billion of projects. While it hasn't started construction on any more communities this year due to COVID-19, it could move forward with new developments once economic conditions improve. Given its top-notch balance sheet, it has ample financial flexibility to move forward with more projects and capture outside acquisition and development opportunities that could emerge following this year's downturn.

Verdict: AvalonBay is the better buy

Essex Property is a great residential REIT as it has a strong financial profile and a solid dividend, which it has increased for 26 straight years. However, AvalonBay has an even better financial profile to go with a slightly higher dividend yield on a payout that it has also increased for the past several years. Add that to its diversification and the greater visibility in its growth prospects, and it stands out as the better buy between these two apartment REITs right now.

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Matthew DiLallo owns shares of AvalonBay Communities. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.

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