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Is AvalonBay Communities a Buy?

[Updated: May 18, 2020 ] May 18, 2020 by Matthew DiLallo
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This year has been a challenging one for the real estate sector. The COVID-19 outbreak has devastated the economy by forcing many businesses to close and lay off their employees. Both groups have struggled to pay rent, which has weighed on landlords, including real estate investment trusts (REITs).

Multifamily-focused REIT AvalonBay Communities (NYSE: AVB) hasn't been immune to the sector's issues. Overall, its stock has fallen nearly 30% this year. That sell-off, however, likely has some REIT investors wondering if the stock is a buy. Here's a look at the cases for and against buying AvalonBay Communities stock right now.

The bull case for buying AvalonBay Communities stock

AvalonBay is one of the largest REITs focused on owning, developing, and acquiring apartment communities. It currently operates in 20 U.S. markets, concentrated mainly along the coasts where the cost of homeownership remains high. As a result, occupancy levels and rental rates are above average.

AvalonBay has a long track record of growing its portfolio, FFO, dividend, and shareholder value. It has delivered this value-creating growth by maintaining a conservative financial profile. That includes having a lower-than-average leverage ratio and a conservative dividend payout ratio. It only paid out 65% of its FFO last year and was on track to maintain that level in 2020 at its initial guidance range. Because of those factors, AvalonBay's 4.2%-yielding dividend appears to be on solid ground.

Meanwhile, its fiscal conservatism has provided it with the financial flexibility to make investments that expand its portfolio. It currently has $2.3 billion of development projects underway to help increase its FFO and dividend upon stabilization. On top of that, it has a development rights pipeline consisting of another $4.1 billion of community developments.

The bear case against buying this apartment REIT

One concern with buying AvalonBay in the current environment is the impact the economic downturn will have on rent collection and occupancy rates. AvalonBay was able to collect 93.9% of the residential rent it billed in April, which was about 97.9% of what it typically collects in a month. On the other hand, retailers that rent space within its communities only paid 44% of what they owned -- though, at 1.4% of total revenue, retail is a small portion of its income. Because of those near-term uncertainties, AvalonBay pulled its 2020 guidance.

If the pandemic causes a prolonged economic downturn, resulting in even more people losing their jobs and retail closures, AvalonBay's income and occupancy rates will deteriorate. In a worst-case scenario, the company might need to reduce or suspend its dividend.

The economic weakness could also impact AvalonBay's ability to expand. The company had 19 communities under construction at the end of the first quarter, six of which it temporarily suspended due to local regulations. Meanwhile, it hasn't started any new communities this year and might need to hold off on future developments until the economy begins recovering. Those issues could stunt its near-term growth.

Verdict: AvalonBay Communities stock looks like a compelling buy

While AvalonBay isn't immune to the current issues facing the real estate market, it's not as exposed to the weakest areas as other REITs. Because of that, and its conservative financial profile, the company should make it through this downturn without reducing its dividend. That view makes it look like one of the top REITs to buy these days, considering that it's trading at a 30% discount to its valuation from earlier this year and now offers a much higher dividend yield.

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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.