Shares of most real estate investment trusts (REITs) have sold off this year, with the average equity REIT falling nearly 10%, according to Nareit. Apartment REITs have performed even worse, with most down more than 20%. Among those laggards is AvalonBay Communities (NYSE: AVB), which has tumbled about 25% on the year.
Weighing on the REIT's stock price are concerns that COVID-19 will have a major impact on rental and occupancy rates. While the pandemic has had some effect, the REIT believes that the market has blown those fears out of proportion. Because of that, it thinks its stock is a screaming buy, which is leading it to act.
Relatively stable amid the storm
AvalonBay's apartment portfolio held up reasonably well during the turbulent second quarter. Overall, the REIT generated $2.23 per share of FFO, which was only about 1.8% lower than the prior year. While some residential and retail tenants didn't pay their rent, it offset most of that impact thanks to its expense reduction initiatives and the recent completion of some development projects.
However, what seemed to spook investors was some noticeable weakness in market fundamentals. A combination of work-from-home trends and record-low mortgage rates led renters to move away from higher-cost urban locations to the suburbs. That had some effect on occupancy and lease rates, especially in high-priced markets like New York and Southern California. While these headwinds will likely persist for several more quarters and have some impact on FFO, it doesn't seem like it will permanently reduce the company's earnings capacity by a quarter, which is what its stock price slump implies.
High-quality apartment buildings on sale
AvalonBay believes that the steep sell-off in its share price is too much, given the underlying value of its top-notch real estate portfolio. Because of that, the REIT launched a $500 million share repurchase program to take advantage of this disconnect.
The company noted that it initially plans to fund repurchases with a combination of existing cash, retained cash flow after paying its dividend, and its strong balance sheet. However, over time it intends to replenish these sources by selling some of its communities.
CFO Kevin O'Shea discussed the rationale behind the buyback program on the company's second-quarter conference call, stating:
Really the genesis behind that is we believe our stock is…trading at a compelling value, both absolutely and relative to other investments, including development. Because we have the balance sheet strength and liquidity to pursue the program, we intend to do so. Though, as we indicated in our earnings release, we're likely to act upon that on a long-term basis with asset sales and potentially some incremental debt, but we do intend to proceed and probably will do so initially on a measured basis to have clarity on those sources. But I think at this point, that's probably our most attractive investment that we have today.
CEO Timothy Naughton then put the company's valuation disconnect into context on the call, pointing out the difference between likely asset sale values and its stock price. He stated that they think apartment valuations in its markets are down by less than 10% because of the pandemic's impact on the rental market. However, with its shares down much more than that, the company can use that disparity to its advantage. It can sell properties to prove its portfolio's value and then use that cash to repurchase its discounted shares, which the CEO called "the most attractive investment" right now.
Betting big on itself
Investors dumped shares of most multifamily REITs this year due to concerns that COVID-19 will cause occupancy and rental rates to plunge. While the pandemic has had some impact, it doesn't seem likely to be as bad as the market fears. Because of that, AvalonBay believes its stock is such a bargain that it's willing to sell assets to fund a large-scale repurchase plan. That program is one of the many reasons it's among the top apartment REITs to buy these days.