Alexandria apartment developer AvalonBay Communities Inc. has been taking advantage of the hot housing market to buy apartment properties and convert them into even more profitable condominiums.
“That [condo conversion] is where it’s happening,” said Steve Sakwa of Merrill Lynch. “Not all apartment complexes have such desirable assets.”
The real estate investment trust (REIT) strategically acquires upscale apartment communities in markets like Boston, Washington and Northern California, where housing is expensive and difficult to find.
In those markets, the value of land available for multifamily housing is increasing rapidly, said Legg Mason’s Gerard Petrick, who has a hold rating on the stock. Its strategy of buying land, obtaining permits for multifamily development, and then selling the property for condo conversion has worked well, he said.
The stock closed Friday at $80.86, near its record high of $81.52 set June 17. The markets were closed yesterday for Independence Day.
Sales of its real estate assets prompted the company’s first-quarter net income to jump to $67.44 million (40 cents per diluted share) from $23.10 million (24 cents) a year earlier. Its funds from operations, considered the best measure of a REIT’s performance, rose 24 percent to $71.25 million from $57.38 million. Diluted shares represent the value of options and warrants.
The company has given investors a total shareholder return of 20.31 percent from March 31, 1995, to March 31, 2005, outperforming the 14.77 percent return over the same period of the Bloomberg REIT Apartment Index and the 10.78 percent return of the S&P 500 index, Bloomberg News reports.
When AvalonBay develops apartments, it creates value on challenging sites, Merrill Lynch analysts wrote in a report. At a property on Manhattan’s Lower East Side, it combined market rate and affordable apartments to obtain tax-exempt debt financing and tax benefits. It also brought in upscale grocer Whole Foods Market, which ultimately will pay rent of almost $5.6 million, the report said.
Neither Merrill Lynch nor Mr. Sakwa holds any shares in AvalonBay.
But because AvalonBay’s portfolio consists almost entirely of properties on the East and West coasts, it is at risk when the housing bubble bursts, said David Harris of Lehman Brothers Inc.
He is skeptical that demand for housing will continue to outpace the rate of construction. Even speculative purchases ultimately need to have someone living in the housing, he said.
Lehman Brothers, or an affiliate, has received compensation for investment-banking services from AvalonBay Communities within the past year.
A Banc of America Securities analysis published last week identifies similar risks — an oversupply of apartments if employment growth does not materialize and renters looking to become owners if home prices drop. AvalonBay has been a client of Banc of America Securities in the past year.
The company’s other weak point is its high concentration of properties in Silicon Valley and other regions of Northern California. But as that market recovers, the load will lighten, Legg Mason’s Mr. Petrick said.
Neither Mr. Petrick nor Legg Mason has a relationship with AvalonBay.
As an owner of rental properties, AvalonBay’s capital expenditures per unit are among the lowest in the multifamily sector because the properties are young, Smith Barney said in an April report. Smith Barney is a division of Citigroup, which has received compensation from AvalonBay within the past year.
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