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AvalonBay's Strategy: Managing High Supply and Interest Rates

August 3, 2024

Note: We reveal investment insights through the quotes of top business leaders.

Key Takeaways

  • AvalonBay leverages its strong market position and sustainability leadership to maintain robust financial performance amidst high supply and interest rates.
  • The company balances investments between expansion and established markets, renovates existing units, and pivots to aggressive acquisitions as supply is absorbed.
  • AvalonBay secures favorable debt deals and aligns new transactions with current cap rates to manage high interest rates effectively.
  • Operational efficiency initiatives, including technology investments and centralization, drive meaningful efficiencies and support earnings growth.
  • Competitors report strong demand and low new supply, benefiting occupancy and renewal rates, indicating a stable industry landscape.

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AvalonBay's Current Market Position

AvalonBay maintains a strong market position, recognized for sustainability leadership and innovative practices. The company owns 299 apartment communities and is expanding in key metropolitan areas. Financially, AvalonBay reported solid EPS and FFO, indicating robust performance amidst high supply and interest rates.

"AvalonBay continues to be recognized as a corporate sustainability leader in the real estate industry by maintaining its "A" rating from MSCI and "A-" rating from CDP, being listed as one of Newsweek's America's Most Responsible Companies for the fifth consecutive year, and receiving the Green Lease Leader Gold award from the Institute for Market Transformation for the first time." --- (AVB, press release, 2024/07/22)

""I have long admired AvalonBay's track record of successful investment, integrated capabilities, and innovative operating practices, and I am excited to join the AvalonBay team as the Company continues its long history of leadership in the industry," said Ms. Thomas, who is expected to formally join AvalonBay on July 8, 2024, and be based out of the Company's Arlington, VA headquarters." --- (AVB, press release, 2024/06/05)

"AvalonBay Communities, Inc. (NYSE:AVB) (the "Company") reported Earnings per Share – diluted ("EPS"), Funds from Operations attributable to common stockholders - diluted ("FFO") per share and Core FFO per share (as defined in this release) for the three and six months ended June 30, 2024 and 2023 as detailed below." --- (AVB, press release, 2024/07/31)

"About AvalonBay Communities, Inc. As of March 31, 2024, the Company owned or held a direct or indirect ownership interest in 299 operating apartment communities containing 90,673 apartment homes in 12 states and the District of Columbia, of which 17 communities were under development." --- (AVB, press release, 2024/05/07)

"About AvalonBay Communities, Inc. AvalonBay Communities, Inc., a member of the S&P 500, is an equity REIT in the business of developing, redeveloping, acquiring and managing apartment communities in leading metropolitan areas in New England, the New York/New Jersey Metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California, as well as in the Company's expansion regions of Raleigh-Durham and Charlotte, North Carolina, Southeast Florida, Dallas and Austin, Texas, and Denver, Colorado." --- (AVB, press release, 2024/07/31)

Strategies for Managing High Supply

AvalonBay's strategy for managing high supply involves balancing investments between expansion and established markets, renovating existing units to compete with new supply, and pivoting to a more aggressive acquisition mode once supply is absorbed. They also view supply as a potential benefit, requiring minimal demand to achieve healthy market performance.

"I'm just trying to understand how kind of the current supply and the rate uncertainty may impact kind of your acquisition strategy and maybe urgency into moving into these, if we fast forward a year or 2, and the supply picture has started to improve." --- (AVB, earning call, 2024/Q1)

"It's a strategy that we have employed for years. And generally, the new supply that's coming into our markets is about $300 per unit on average, more expensive than our existing communities, which gives us the opportunity to go in to renovate our kitchen and our baths, to be able to drive additional rent growth above market rent growth and really compete a little bit closer with some of that new supply." --- (MAA, conference, 2024/06/05)

"And that's why, again, we want to stick with our strategy of having balance, being in the 12 best markets, these expansion markets, for 20%, 25% of NOI, and the remainder in these established markets where our higher-end resident wants to be and take advantage of the supply imbalances, and frankly, the preference that we think is going to be pretty persistent for rental housing." --- (EQR, earning call, 2024/1-40)

"And so it's a very reasonable trade to make. And so ultimately, we'll be able to pivot to a more aggressive mode when we start seeing that the supply does get taken up between now and, say, the middle of the summer." --- (CPT, earning call, 2024/1-14)

"What we are seeing is that the supply definitely is a significant benefit for our markets, and it's something that we've been stating for several years now, in that we don't need much demand for us to achieve our plan and to have a healthy performing market." --- (ESS, earning call, 2024/Q1)

Approaches to Dealing with High Interest Rates

AvalonBay is managing high interest rates by securing debt deals at favorable rates, such as a $250 million deal at 3.7%. They are also navigating market volatility and maintaining strong demand and pricing power. Additionally, they are aligning new deals with current cap rates, particularly in markets like suburban Boston.

"The $250 million are basically effectively struck at a 3.7%, 10-year rate. So if we were to do a small debt deal, we'd probably be looking at the cost of debt today, somewhere in the low 5% range versus an unhedged 10-year debt deal that would be more like ." --- (AVB, earning call, 2024/Q1)

"So, we just feel like the need to transact continues to build while we're not seeing transactions I think the difficulty has been the volatility on interest rates has really slowed the market down from transactions occurring." --- (MAA, earning call, 2024/Q1)

"So to us, that's like the implications that we have strong demand, good pricing power as rates are accelerating sequentially to keep that volume going is a big positive." --- (EQR, conference, 2024/06/04)

"The interest rates on our unsecured revolving credit facility is based upon, at our option, (a) the daily or the one-, three-, or six-month Secured Overnight Financing Rate ("SOFR") plus, in each case, a spread based on our credit rating, or (b) a base rate equal to the higher of: (i) the Federal Funds Rate plus 0.50%, (ii) Bank of America, N.A." --- (CPT, sec filing, 2024/Q1)

"And it's going to be higher in markets that have the inverse of that. And so where you see where deals actually clearing those today, we expect to start a deal in suburban Boston in kind of the mid 6s, which maps well to where cap rates are in those markets." --- (AVB, earning call, 2024/Q1)

Operational Efficiency Initiatives

AvalonBay's operational efficiency initiatives include increased investments in technology and centralization, which are driving meaningful efficiencies. These efforts are expected to enhance future service efficiency, support earnings growth, and yield higher returns on new developments and acquisitions.

"Property management and other indirect operating expenses increased $2,002,000, or 5.7%, for the three months ended March 31, 2024, compared to the prior year period, primarily due to increased costs related to initiatives to improve future efficiency in services for residents and prospects and investments in technology." --- (AVB, sec filing, 2024/Q1)

"• The increase in consolidated total NOI is primarily a result of the Company’s higher NOI from same store properties, largely due to improvement in same store revenues as noted above and the Company's continued focus on same store expense efficiency." --- (EQR, sec filing, 2024/Q1)

"We are increasingly also focused on bringing our strategic capabilities and particularly our operating model initiatives." --- (AVB, earning call, 2024/Q1)

"We're on track with these operating initiatives for 2024 with a strong runway of future earnings growth ahead of us. Importantly, we're also increasingly tapping these operating capabilities to drive outsized yields and returns on new developments and acquisitions." --- (AVB, earning call, 2024/Q2)

"As we detailed at our Investor Day last November, our collective set of initiatives, from investment -- from our investments in technology and centralization to our reimagined operating neighborhoods are driving meaningful operating efficiencies and allowing us to drive healthy" --- (AVB, earning call, 2024/Q2)

Financial Performance Amidst High Supply and Interest Rates

AvalonBay has maintained strong financial performance amidst high supply and interest rates, with positive rent changes in East Coast markets and a notable increase in same store property NOI. However, performance in the District of Columbia has been volatile due to new supply impacts.

"So for us to look at this absorption, to have a portfolio that's 97.5% occupied with pricing and rates accelerating while the market's absorbing this demand is really kind of a great positive sign for us." --- (EQR, conference, 2024/06/04)

"The Company may increase or decrease these rates based on a variety of factors, including overall supply and demand for housing, concentration of new apartment deliveries within the same submarket which can cause periodic disruption due to greater rental concessions to increase leasing velocity, and rental affordability." --- (ESS, sec filing, 2024/Q1)

"We experienced positive momentum in rent change throughout the quarter across the East Coast markets, which was particularly notable in Mid-Atlantic, while performance in the District of Columbia has been soft and volatile due to a number of issues, including the impact of new supply." --- (AVB, earning call, 2024/Q1)

"We expect new lease rates, which is the most competitive with the new supply we're seeing in our market." --- (MAA, conference, 2024/06/05)

"The $5.3 million approximate increase in same store property NOI for the three months ended March 31, 2024 was primarily due to an increase of approximately $8.9 million in same store property revenues which was partially offset by an increase in same store property expenses of approximately $3.6 million as compared to the same period in 2023." --- (CPT, sec filing, 2024/Q1)

Competitive Landscape and Industry Comparison

AvalonBay's competitors, such as EQR and Essex, report strong demand and low new supply, which benefits their occupancy and renewal rates. AvalonBay's use of FFO for performance comparison highlights its strategic focus on financial metrics, while MAA emphasizes renewal pricing performance, indicating a competitive yet stable industry landscape.

"As you saw in our release, our overall operating fundamentals remain healthy, driven by good demand across our portfolio and a strong renewal process that resulted in low resident turnover and strong occupancy of 96.4% for the quarter. As Mark mentioned, we are benefiting from what we see as a solid job picture across the country keeping our residents well employed with growing wages as well as very little competitive new supply in our established markets." --- (EQR, earning call, 2024/Q2)

"FFO can help with the comparison of the operating and financial performance of a real estate company between periods or as compared to different companies because the adjustments such as (i) gains or losses on sales of previously depreciated property or (ii) real estate depreciation may impact comparability as the amount and timing of these or similar items can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates." --- (AVB, sec filing, 2024/Q1)

"So we're aware of it. And to be honest, we're not that concerned, fewer developers means less competitive product in the near future and should create additional opportunities for Essex." --- (ESS, earning call, 2024/Q2)

"We think yields an opportunity for us to continue to achieve the renewal pricing performance along the lines of what we've outlined, and we don't see any particular concerns about the spread in terms of what you're referring to." --- (MAA, earning call, 2024/Q1)

"And then we will take your questions. We are pleased with our first quarter performance, which was ahead of January expectations and reflects the strong demand for the lifestyle our well-located apartment properties provide as well as little new competitive supply across most of our established markets." --- (EQR, earning call, 2024/Q1)

Future Outlook and Strategic Direction

AvalonBay is leveraging its strong balance sheet and strategic capabilities to pursue growth opportunities, aiming to drive outsized returns. The company is also considering the impact of a better job outlook, despite the prevalence of part-time and lower-paying jobs, on future demand.

"And finally, with one of the strongest balance sheets in the sector, we are focused on growth opportunities in which we can tap our strategic capabilities from our operating prowess to our development strength to drive outsized returns for" --- (AVB, earning call, 2024/Q1)

"This better job outlook provides an incremental list of demand, not necessarily on the same trajectory as it may have in the past, given that a disproportionate share of these additional jobs may be part-time and seem to be more concentrated in lower-paying sectors of the economy." --- (AVB, earning call, 2024/Q1)

See also