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Why I Couldn't Resist Buying More of This High-Yield Dividend Stock

Like so many stocks, shares of AvalonBay Communities (NYSE: AVB) have taken it on the chin this year. The real estate investment trust (REIT) has lost a quarter of its value due mainly to the Federal Reserve's decision to raise interest rates to fight inflation. Higher interest rates have historically weighed on REIT stock prices. That pushes up their dividend yields to compensate investors for their higher risk profile relative to other income-focused investments like bonds and bank CDs.

As someone who likes to earn passive income, I couldn't resist the opportunity to add to my position and lock in a 3.4% dividend yield, more than double the S&P 500's average these days. AvalonBay has been a solid income producer over the years and should continue delivering for income investors like me in the future.

Durable dividend income

AvalonBay has been a dependable dividend stock over the years. The apartment-focused residential REIT has delivered nearly three decades of dividend stability and growth. While it hasn't increased its dividend payment every year, AvalonBay has grown it at a 5% annualized rate overall since its initial public offering in 1994. AvalonBay's ability to maintain its dividend during some very challenging periods for the economy is a testament to its resilient business model and balance sheet.

One of the keys to the REIT's success is its high-quality apartment portfolio. It owns 296 apartment communities with 87,918 apartment homes across a dozen states and the District of Columbia. It has historically focused on leading metro areas along the coasts like New York, Seattle, and Los Angeles, owning both urban and suburban apartments. Demand for apartments in major metros tends to grow steadily. That keeps occupancy levels high and enables AvalonBay to increase rents.

The REIT further supports its dividend with a conservative dividend payout ratio and an elite balance sheet. These factors make its high-yielding dividend reasonably low risk.

Strong market conditions

AvalonBay's rock-solid high-yielding dividend is only part of the draw. Demand for apartments is robust these days. Due to soaring housing costs, it's too expensive for many renters to consider buying a home. That's leading many to continue renting despite sharply rising rental rates due to strong demand and occupancy levels. AvalonBay recently reported that occupancy across its portfolio hit 96.5% in May, up from 96.4% in April and 96.3% during the first quarter. As a result, rental rates continue to rise. They grew 13.8% year over year in May, an increase from April and the first-quarter growth rate. Rents are growing fastest in urban communities as more people move back to cities and head back to the office at least part of the time.

The housing market isn't likely to improve anytime soon. There's a growing shortage of homes because builders haven't kept up with demand coming out of the financial crisis, leading to a nearly 1 million single-family home shortage by one estimate. Because of that, home prices could keep rising. Meanwhile, higher interest rates are making it cost more to take out a mortgage. The growing unaffordability of buying a home will likely force more people to continue renting. Unfortunately, there's an ever-increasing shortage of apartments, with one estimate indicating we're 1 million short of demand. That suggests occupancy will remain high across AvalonBay's portfolio, which should drive continued strong rent growth.

Meanwhile, AvalonBay has several other growth drivers. The REIT has been steadily selling communities in slower-growing markets to expand into faster-growing ones in the Sun Belt region. It's also developing several new apartment communities and has a $4 billion development rights pipeline to continue growing. AvalonBay has also started helping fund new third-party developments through high-yielding mezzanine and preferred equity investments. Finally, it has ample financial capacity to pursue new investments as opportunities emerge. This combination of catalysts should enable AvalonBay to continue growing its cash flow, providing further support for its high-yielding dividend that it should be able to keep increasing in the future.

A high-yield stock with significant upside potential

Investors are acutely focused on rising interest rates these days, causing them to sell off REITs. While this pressure could remain for a while, I couldn't resist taking the opportunity to add to my position in AvalonBay and lock in its higher dividend yield. The apartment REIT should continue to benefit from the tight housing market. That should enable it to keep growing its cash flow and dividend and produce an attractive total return in the coming years.

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Matt DiLallo has positions in AvalonBay Communities. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.


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