The big story from 2020 for most companies was the coronavirus pandemic, and that's no different for apartment real estate investment trust (REIT) AvalonBay Communities (NYSE: AVB). But it is important to understand the nature of this company's business and to look at underlying business trends before you decide to invest in this landlord. Here's why this REIT may be worth buying despite all the bad news last year.
A terrible year
There's little point in trying to candy coat Avalonbay's performance last year. The apartment REIT has material exposure to large coastal cities, and they were hard hit by the pandemic. Core funds from operations (FFO) fell 7% in 2020 and a huge 17% year over year in the fourth quarter. That suggests that things got worse as the year progressed.
There won't be a quick and easy bounceback, either. When times get tough, like they are today, apartment landlords offer rent concessions to entice people into their properties and to retain current tenants who might want to leave. This is good in that it keeps units occupied, but it locks lower rents in for a year to two years, depending on the lease lengths offered. This will result in a dragged-out recovery, assuming that the markets in which AvalonBay competes bounce back.
So investors looking for a quick up turn probably won't be pleased if they buy AvalonBay. But long-term investors willing to be patient might want to focus more on the underlying trends in the REIT's business.
Getting better, slowly
During AvalonBay's fourth quarter 2020 earnings conference call, management broke its business up into two broad categories: rural and urban. The difference between the two was huge and telling. Rental rates and occupancy at the REIT's more rural properties held up reasonably well despite the pandemic, with a small drop in each. The bottom appears to have been August. This makes logical sense, given that it was big cities that were hardest hit by people moving away to avoid pandemic risks.
Next up are the REIT's urban properties, which saw a material drop in rental rates and occupancy. This segment was the main driver of AvalonBay's weak performance in 2020. However, even here the numbers have already started to turn higher again. The declines were worse, but the bottom appears to have been September for occupancy and December for rental rates. This suggests that the worst of the current downturn may be over, even though it will take time to get back to pre-pandemic levels.
Meanwhile, AvalonBay has always been a very active portfolio manager. It has in recent times been building in the regions where people are moving (think: rural locations) while selling older properties to help fund the investment. This constant pruning and development helps keep the REIT's portfolio modern and allows it to shift along with its customers. Obviously building, buying, and selling assets isn't going to produce overnight changes (these things take time). However, AvalonBay isn't sitting still. It has been through difficult periods before and managed to survive just fine. It's doing the same thing this time around and will likely exit the downturn a stronger company than it entered it because of its portfolio-level moves.
For the right investor
So, all in, for investors willing to deal with some near-term negatives, AvalonBay looks like it has a bright future. That includes the early indications of a business turnaround. However, with a 3.5% dividend yield, this REIT probably won't excite income-focused investors. It's more of a growth stock that's fallen on hard times, noting that the shares are still off about 20% from their early 2020 highs. Still, if you can stomach the current upheaval, growth and income types might want to take a deep dive here before the REIT's recovery becomes more obvious to the rest of Wall Street.