There's no way to sugarcoat AvalonBay Communities' (NYSE: AVB) fourth-quarter 2020 earnings or full-year results. They were pretty ugly. And the near-term future is likely to be even worse. However, there were some early signs that the real estate investment trust's (REIT's) business is starting to stabilize. Here's the bad news you need to be ready for and the good news that's on the horizon.
A very tough year
When historians look back at 2020 it will likely be remembered for the coronavirus pandemic. That's exactly what AvalonBay would like to forget, but its financial results will bear the scars forever. In the fourth quarter, the apartment landlord saw core funds from operations (FFO), which is like earnings for an industrial company, fall a painful 17% year over year. For the full year, the drop was roughly 7%, which suggests that thing got worse as the year progressed.
That is exactly how the apartment sector works. AvalonBay focuses heavily on high-barrier-to- entry markets in wealthy regions, which basically translates to cities. During the pandemic, people fearful of the coronavirus chose to move out of cities to urban areas. So occupancy at the REIT properties fell. That makes total sense. To combat falling occupancy, however, landlords often offer lower rents. This move keeps apartments filled, which is good, but locks in lower revenues for the length of the new lease term (usually a year to two years). Both were major issues in AvalonBay's FFO performance and neither is likely to return to pre-pandemic levels in 2021.
So, with lower occupancy and lower average rents, it is highly likely that 2021 will be another tough year for the REIT. In fact, AvalonBay is projecting a sequential core FFO decline of 6%, at the midpoint, in the first quarter. That would be a roughly 20% decline compared to the first quarter of 2020. And because lower rental rates are locked in for the length of a lease, a recovery will take some time to work its way through the company's financial statements.
It wasn't all bad
So AvalonBay isn't out of the woods just yet and won't be for a little while. Which leads to the next question that should be on investors' minds: How bad will it get? The answer is that the fourth quarter showed that early signs of a turnaround are starting to present themselves. Some specifics will help.
For starters, AvalonBay's suburban properties have held up relatively well. Occupancy declined, but not all that much (think a couple of percentage points), and rental rates remained fairly steady. Occupancy appears to have bottomed out in August and has been working higher since. The real pain was in the company's urban apartments, where occupancy dropped by around 10 percentage points and rents materially declined.
That said, urban occupancy rates appear to have hit bottom in September and have been trending higher since. Although still nowhere near the early 2020 highs, the trend is no longer negative. Rent rates, meanwhile, look like they turned higher in January of 2021. So both of these key trends are now going in the right direction. There's a long way to go before AvalonBay's business is back to where it was before the pandemic, for sure, but its financial results will probably start to look better in the back half of 2021 and, for better or worse, year- over-year comparisons in 2022 should be pretty easy.
No easy fix
For investors looking at AvalonBay today, go in knowing that there's likely to be more bad news on the earnings front for at least a couple of more quarters. That's baked in because of rental concessions and occupancy trends. However, if you're a long-term investor, the underlying trends on both of these fronts appear to have turned for the better. That may not be much consolation right now, but it does mean there are green shoots growing that will lead to a brighter future down the line.