It’s also to support one of the largest development pipelines in the REIT space, one which is evolving from garden-style stock to a proclivity for high-rise urban apartment towers and more challenging mixed-use projects. Even after taking impairment charges for cancelling several projects in the fourth quarter of 2008, AvalonBay’s development activity is robust by comparison to its peers. Currently, 14 communities are under active development, eight of which are expected to deliver this year including Avalon Towers in Bellevue, Wash.
That pleases an analyst community that traditionally dings REITs for development dilutive to net asset value (NAV). “In the previous cycle, rents were rising and cap rates were falling. In that type of environment, almost anyone could be a developer, and you saw a lot of REITs get into development in a big way, many of which should have probably stayed on the sidelines,” says McCulloch of Green Street Advisors. “On the whole, development pipelines are NAV-destructive right now, but you still want AvalonBay to maintain its platform. Over the long term and through market cycles, the company should create value via development.”
Not surprisingly, executives announced last fall that the company would not begin any new development during the first half of 2009, a mandate reiterated on the 2008 fourth-quarter and year-end earnings call. Instead, Sargeant says, the company will look to create value with smart and balanced capital allocations, funded via a combination of new secured or unsecured debt, draws on lines of credit, asset sales, and retained cash flow. “We could allocate capital to new development, acquisitions, repurchasing debt, or we could allocate it to shareholder dividends.”
The envious could claim that AvalonBay is just another example of dry powdered posturing for distressed real estate exploitation, and in fact that claim might not even get much of an argument out of the REIT’s executive team. “We think there will be more distress coming and a potential for better opportunities in the future,” Blair says. “By 2015, I think we will have stronger market fundamentals from an improved economic condition, constrained supply, and positive demographics. If we tie up land in 2010 and entitle and build on it, we will deliver in 2015 and be harvesting those opportunities.”
Sargeant casts more of a historical light on AvalonBay’s current market position, and thereby reveals the caveat to the argument that the REIT is opportunistic just like everybody else. Strong financial management and solid balance sheets result from long-term, consistent decision making, he argues. In particular, “financial positioning at AvalonBay is a series of decisions made over the past 15 years that are grounded in good risk management, don’t encumber the balance sheet, and provide transparency and visibility,” he says. “The result is a competitive advantage in an upturning economy. The strong will be stronger, the weak will be weaker.”
At AvalonBay, it’s an ultimate market validation that has been a long time coming.
Smooth Operators
Eschewing a transactional real estate model, AvalonBay looks to maximize operating income with smart same-store expense management and thoughtful capital spend.
Even as net operating income is projected to soften due to the economy, executives at Alexandria, Va.-based AvalonBay Communities seem steeled in the resilience of the company’s operating platform and underlying asset base. As the REIT’s CFO Tom Sargeant puts it, “This is a company that has built its income streams primarily from real estate cash flows, so when the music stops on transactions, our earnings continue.”
While AvalonBay isn’t immune to an economy demanding cost containment for all, the dependence on funds from operations as opposed to an acquisitive model demands what company executive vice president of operations Leo Horey calls real estate fiduciary responsibility. “You can’t just not spend; you need to spend smarter,” Horey explains. “Expense management and containment coupled with thoughtful spending is the best proxy for operational effectiveness.”
