Shares of AvalonBay Communities (NYSE: AVB ) hit a 52-week high yesterday. Let's take a look at how it got there and whether clear skies remain in the forecast.
How it got here
The driving force behind AvalonBay's numerous rental communities has been an increase in foreclosures and tighter credit markets, which has made renting more attractive than owning in many cities. We've seen the affinity toward renting reflected in AvalonBay's recent earnings, which showed a 96.2% economic occupancy rate and, more importantly, a 6.2% rise in rental rates year over year.
Avalon isn't the only company booming from rental market strength. Nearly all of Avalon's peers are within striking distance of a new 52-week high including Apartment Investment & Management (NYSE: AIV ) , Equity Residential (NYSE: EQR ) , and UDR (NYSE: UDR ) and are benefiting from rising rental prices and strong demand.
How it stacks up
Let's see how AvalonBay stacks up next to its peers.
AVB data by YCharts
Outside of Apartment Investment & Management, which was hit the hardest when the housing bubble burst, the remaining three have rebounded nicely in the past few years.
| Company | Price/ Book | Price/ Cash Flow | Forward P/E | Dividend Yield |
|---|---|---|---|---|
| AvalonBay Communities | 3.2 | 31.2 | 40.1 | 2.7% |
| Apartment Investment & Management | 13.2 | 12.6 | 14.1 | 2.7% |
| Equity Residential | 3.4 | 24.5 | 51.7 | 2.2% |
| UDR | 2.7 | 21.8 | 17.4 | 3.3% |
Source: Morningstar, Yahoo! Finance.
The first thing you'll notice is that high rental demand hasn't exactly created any values in this sector based on cash flow. With Equity Residential trading for more than 50 times forward earnings and AvalonBay at 31 times cash flow, investors are willing to pay quite a premium for real estate investment trusts that have found the right formula for growth.
The truly differentiating factor between these companies has to do with growth since 2005-2006. AvalonBay is the only one of these four that has grown revenue since that time period. Apartment Investment has seen its revenue tumble as it's reported a loss in four of the past five years and its dividend has fallen by 80%. Similarly, UDR has lost money over the past two years. Equity Residential is the most comparable in growth to AvalonBay, demonstrating strong growth in multifamily rentals over the past two years, but relative to Avalon's growth throughout the recession, none of these companies is able to hold a candle to AvalonBay in terms of consistent growth in the residential REIT sector.
What's next
Now for the real question: What's next for AvalonBay Communities? That question really depends on whether rental demand remains strong enough to allow Avalon to continue to raise prices and whether Avalon can grow quickly enough to meet demand without overextending itself.
Our very own CAPS community gives the company a dreaded one-star rating (out of five), with 51.7% of members expecting it to underperform. In true contrarian fashion, I am part of the minority that has made a CAPScall of outperform on AvalonBay and am currently up three points on that call.
As Peter Lynch has often preached, owning what you know is always a good idea. Having lived at an AvalonBay property in the past, I was impressed with the regular occupancy, grounds upkeep, and overall happiness of the residents. It was clear then that Avalon was doing something right, and its recent growth as its peers have languished is evidence of this. Admittedly, at 40 times forward earnings and 31 times cash flow, my love affair with the stock is beginning to wane, but I'm also seeing no signs of demand slowing down in the rental market. Until we see those signs, I'll be more than happy to maintain my outperform call and collect that sweet 2.7% yield.
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