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Here's Why Rising Home Prices Help Avalon Bay

Apartment real estate investment trusts (REITs) had a rough go of it during the past couple of years as COVID-19 caused a surge in delinquencies, and companies were often forced to make concessions to keep tenants in their apartments. Many states imposed no-eviction policies, which caused an increase in non-collectible accounts. As the U.S. emerged from the pandemic, real estate prices took off. These rising prices are providing the basis for rent increases which will help drive earnings.

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Avalon Bay has exposure to some of the hottest real estate markets

Avalon Bay (NYSE: AVB) is an apartment REIT that operates in 12 states and had 81,803 units as of the end of 2021. Avalon Bay is concentrated in urban areas, primarily in the Northeast, the Mid-Atlantic, Southern and Northern California, and the Pacific Northwest. It is also expanding into the Southeast, Southwest, and the Mountain states. Avalon Bay is developing new properties in its expansion markets and looking to reduce some of its footprint in established markets like the Northeast and California.

During the second quarter, funds from operations (FFO) per share rose 22%, which came in above company guidance. The increase was driven by a combination of high occupancy, increased asking rents, and improvement in bad debt expenses. The company said on the earnings conference call that asking rents are up 9% from the beginning of the year and are increasing about 15% year over year. FFO is how REITs generally state their earnings to investors. This is because depreciation and amortization (D&A) are big expenses that must be recognized under generally accepted accounting principles (GAAP). D&A is a non-cash charge, which means the company doesn't actually reach into its pocket and write a check. FFO adds back these charges, which give the investor a better picture of the cash flow generation of the company.

It will take another year to overcome the COVID issues

As a general rule, rents and home prices tend to correlate. In many of Avalon Bay's markets, single-family homes are expensive, which keeps tenants in their apartments and makes increasing rents easier. Avalon Bay reported a strong 96.4% occupancy rate at the end of the quarter. That said, Avalon Bay is still dealing with some of the regulatory fallout from COVID and said on the earnings conference call that it might take another year to get rents up to normal market levels in California.

Avalon is expanding into the best markets

Avalon Bay is expanding into some of the hottest real estate markets, especially Raleigh-Durham, North Carolina, Dallas, and a number of Florida cities. These cities are seeing annual home price appreciation of 30% and higher. Construction costs are rising, but many of its costs have already been funded at lower interest rates, so rising rents increase the return on investment. Note that rising construction costs also make the real estate market even tighter, which is one reason housing construction remains subdued.

Dividend hike on the horizon?

Avalon Bay pays a quarterly dividend of $1.59 per share. Unlike many REITs, Avalon Bay maintained its dividend during the COVID pandemic. The company has forecast full-year FFO per share to come in at $9.86, which means the $6.36 annual dividend is amply covered. Since REITs must distribute most of their earnings as dividends, the company is ripe for a dividend hike. The stock currently yields about 3% and is trading at 21 times projected FFO per share. Avalon Bay is a way for investors to gain exposure to the red-hot housing market and also to some of the country's fastest-growing regions.

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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool recommends AvalonBay Communities. The Motley Fool has a disclosure policy.


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