Whether you invest in single-family rentals or high-rise apartments, residential real estate is an essential part of our economy and can be a great way to participate in real estate. Real estate investment trusts (REITs) in particular, can provide access to high-quality real estate that would normally be out of reach for everyday investors.
AvalonBay Communities (NYSE: AVB), one of the largest publicly traded REITs, has been a leader amongst residential REITs with ownership or interest in 294 apartment suburban and urban communities. However, with concerns over the future of the residential industry amid the coronavirus pandemic, which has left hundreds of thousands of tenants unable to pay rent and created a mass exodus of tenants fleeing large cities, it's fair investors are keen to know where AvalonBay Communities will be in three years. Here's what its future could hold.
Where AvalonBay Communities is today
AvalonBay Communities acquires, develops, and manages 86,676 high-end apartment homes in 11 states and the District of Columbia. The company primarily focuses on ground-up development to help maintain its high-quality portfolio in some of the top urban and suburban markets in the Pacific Northwest, Northern California, Southern California, New England, and the Mid-Atlantic. As of Q3 2020, AvalonBay had 19 communities under development and one under redevelopment and completed $390 million in developments in 2020.
The coronavirus pandemic has definitely hit the company hard. Earnings per share decreased 21.9% while core funds from operations (FFO) is down 12% for Q3 when compared to the same year prior and down 3.5% year to date. Uncollectible lease revenues, declining rental rates, economic occupancy, and concessions have led to a 5.8% decrease in rental revenues year to date. Despite the decrease in revenues, the company is seeing an increase in new leases and historic occupancy levels with an average rental collection rate of 95.2% for the quarter. Financially the company has strong liquidity, with $182.4 million in cash and cash reserves with a debt-to-EBITDA of 5.4x, which is a bit high but understandable given the sharp decline in revenues.
Where AvalonBay is likely headed in the next 3 years
AvalonBay Communities has $2.4 billion allocated to developments. While I believe they have a long-term vision that will outlast the current crisis, conservation of funds is a priority to the company currently, as the economic situation weighs heavily on its portfolio. Over the next three years, I believe the company will focus on completing projects underway, while considering alternative plans for projects in high-density areas that are combating low demand. AvalonBay began expanding into new markets in 2018 and 2019, including certain areas in Florida, which as of Q3 2020 makes up just 1.7% of its income. I expect to see AvalonBay continue to increase its presence in emerging markets while focusing on increasing its share of suburban properties with major emphasis on portfolio conservation.
As of now, the company has maintained its dividend payout with payout ratios of 78%, which is well within healthy standards. It's unlikely a dividend cut is in Avalon Bay's future, at least in the next three years. I believe the lack of activity for its urban communities, which make up the majority of its portfolio, will continue to push revenues down over the next three years and we'll see pretty lackluster results until people return to cities. I also wouldn't be surprised to see the company liquidate some of its assets to help maintain debt obligations or mitigate liquidity concerns. Thankfully, cap rates are still strong, with the company's 2020 disposition activity of 10 communities producing an average 4.5% cap rate.
I think AvalonBay has a tough three years ahead that is likely to include flattened or declining FFOs, revenues, and share prices. I feel the company's focus on cash conservation to maintain debt obligations and shareholder dividends rather than growth and expansion is a good play considering the size of its urban portfolio. With that being said, I personally own shares in AvalonBay Communities and don't plan on selling anytime soon as I think long-term potential will overcome the current challenges the company is facing. I believe the 5- and 10-year outlooks, however, are much brighter, shifting from conservation to growth once again.