Playing by the numbers: Shareholder return

The most profitable REIT in the apartment sector is AvalonBay posting a high of 54.07 percent. Top that.

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While other multihousing rankings focus on companies with the largest ownership and management portfolios (NMHC) or the biggest equity capitalization (NAREIT), at Multihousing Professional, we believe the most important metrics are those reflecting shareholder value, and the best companies are those making the most money for their investors.

The most profitable REIT operating in the apartment sector is Alexandria, Virginia-headquartered AvalonBay Communities. AVB excels in the one important performance stat that really matters—shareholder return. Not only did AVB post a high of 54.07 percent in one-year returns for 2005, it has also had the highest 3-year return and was in the top tier for 5-year and 10-year returns.

Others agree with MHP’s findings. “AvalonBay is my favorite pick in the sector,” says Craig Leupold, principal with Green Street Advisors and one of the most widely respected financial analysts following publicly held apartment firms. “They’ve been an outstanding and consistent performer with excellent 1, 3, and 5-year returns.”

According to Leupold, AVB is a best in-class REIT that is consistently mispriced by the market due to over-reliance on inferior valuation metrics such as FFO (funds from operations) multiples and dividend yield.

“Despite being a prolific developer and creator of value, the company trades in line with the apartment peer group in terms of premium/discount to NAV (net asset value),” says Leupold. “This has created a consistent buying opportunity for astute investors, and they have been well rewarded. AVB has generated average annual total returns to shareholders of 21 percent over the last five years, compared to 18 percent for the rest of the apartment sector. That out -performance is especially impressive given AVB’s heavy concentration of properties in the San Francisco Bay area, one of the weakest markets nationally during that time frame.”

According to an article in The Wall Street Journal, Sherry L. Rexroad, managing director with Radnor, Pennsylvania-based, ING Clarion Real Estate Securities LP, sees top performance for apartment REITs in markets with strong job growth. She also sees development pipelines in markets with constraints in new construction that curtailed competition and oversupply. Those criteria fit AVB’s profile exactly.

George Skoufis, director with Standard & Poor’s (S&P), has a different take: “Total return is not a metric we generally focus on in our analysis, but it is indicative of the equity market’s support for a company; strong equity performance might reflect the ability to readily issue equity, although that is not thought to be very likely given the high cost of equity relative to investment yields. AvalonBay’s strong performance and its very attractive development pipeline, could create significant long-term value for the company.”

S&P’s, nonetheless, issued AvalonBay a BBB+/positive corporate credit rating and rated it as strong in its business risk profile. Skoufis likes AVB’s high-quality portfolio of upscale properties and presence in high-barrier-to-entry markets. He also sees AvalonBay’s sizable development pipeline positioning the firm as the most aggressive developer among multifamily REITs.

In a special review in the February 27 edition of The Wall Street Journal, the financial publication ranked the performance of 1,000 major U.S. companies versus their peers in 76 industry groups, placing AvalonBay at the top of apartment REITs with a one-year return of 22.9 and a 3-year return of 38.2. None of the other REITs cracked the 30-point market in 3-year returns.

With its approximate $8.8 billion total market capitalization, AvalonBay ranks as the third-largest rated apartment REIT, behind A-rated Equity Residential and BBB+-rated Archstone-Smith Trust.

“While the company’s portfolio of 156 properties is somewhat smaller than the average size of its REIT peers, the company’s real estate cost basis is substantial due to its generally higher cost per community,” says Skoufis. “This stems from AvalonBay’s upscale properties in high barrier markets. AvalonBay should outperform many of its peers as apartment fundamentals continue to improve, due to both the limited supply of new apartments and the high cost of homeownership in many of AvalonBay’s markets.”

In late January, AvalonBay announced a 9.8 percent increase in common dividend and declared a dividend for the first quarter of 2006 of $0.78 per share on the Company’s Common Stock (par value $0.01 per share). Bryce Blair, Chairman and CEO of AvalonBay, sees the recent high rankings for his company as recognition of the company’s sector-leading performance over the last decade.

“Certainly, 2005 was a successful year for AvalonBay with revenue and NOI growth from communities accelerating throughout the year,” said Blair. “Looking ahead, we are well positioned for continued earnings growth.”

The path to the top

How does an apartment REIT, or any apartment firm, achieve long-term success despite down cycles, weak fundamentals, and a stop-and-go economy? The answer lies in the development of market-centric strategies and the ability to execute those strategies on demand.

Leupold cites the company’s deep and experienced management team as key components in engineering AvalonBay’s success. The top senior executives of AVB have worked together for more than a decade. CEO Bryce Blair, President Tim Naughton and CFO Tom Sargeant all share common experience working for Trammell Crow Residential (TCR) where they learned the multifamily business under industry legends Richard Michaux and Ron Terwilliger.

They were present since the genesis of AvalonBay when it was spun-off from TCR under Michaux’s leadership. Blair, who succeeded Michaux, agrees that the breadth of talent and experience of AvalonBay’s team is one of the primary reasons for its success.

Within the decade or so since AvalonBay emerged from TCR’s shadow, the REIT amassed a portfolio of 45,161 apartment homes in ten states and the District of Columbia. It’s $4 billion development pipeline is larger than some firms’ existing portfolios. AvalonBay has roughly $10 billion in operating assets, making it one of the largest REITS in the sector.

“Having a very focused regional strategy that pinpoints high barrier-to-entry markets has worked well for us,” says Blair.

The majority of AVB’s apartment homes are located in California (34 percent) and the New York metro area, including New York, Connecticut and New Jersey (23 percent), the greater Washington, D.C. area (17 percent) and the Pacific Northwest (8 percent).

It is ironic that the most successful properties appear in the luxury or high-end category when there is such a dearth of affordable multifamily properties and huge demand for this product class.

“It’s an interesting set of forces at play,” says Greg Mutz, chief executive of AMLI Residential Properties Trust, which recently went nonpublic by selling itself to Morgan Stanley. “I call it the demographic tidal wave and it reflects the changing dynamics of the American population with echo boomers, active seniors and young professionals forgoing home ownership in favor of apartment living. We have whole new classes of residents who want mobility, access to services, amenities and downtown lifestyles fueling development of upscale apartment homes to meet their needs.”

Leadership strength

While he would be the first to deny it, Bryce Blair has played a pivotal role in AvalonBay’s outstanding performance. The benefactor of a classical education that includes an MBA from Harvard Business School and an undergraduate degree (magna cum laude) from the University of New Hampshire, Blair is adept at building talented teams and providing the technological resources to fuel AvalonBay’s growth.

His in-depth experience gained from nearly two decades in the industry, including his tenure at Trammell Crow Residential, is evident in his pragmatic approach to leveraging resources and maintaining the company’s tightly focused strategy and leveraging resources. Under his seasoned guidance, AVB pursued a balanced approach to the disposition of its properties during the condo conversion craze, generating more than $380 million from the sale of its properties and turning the proceeds back into funding its aggressive development pipeline. In the process, AvalonBay shed some of its older, poorer performing assets and streamlined its portfolio consisting mostly of properties eight years old and less.

Both Blair and AvalonBay tend to have a conservative, understated style, preferring to operate under the radar as opposed to some of their more flamboyant industry peers. What AvalonBay lacks in attention-getting activity, they make up for in ambition.

“We want to meet the expectations of our investors and residents,” says Blair, “and quite simply do what we say we will do. We’re optimistic about the future and our efforts to expand our portfolio and build on the reputation we’ve earned as a world-class organization.”