Is This REIT a Dangerous Investment?

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Investing in REITs is an interesting game. Most investors take an interest because of generous dividend payments. However, many of these REITs are also highly leveraged. AvalonBay Communities (NYSE: AVB) fits somewhere in the middle.

We’ll take a look at whether or not this is a positive or a negative and if now is a good time to be investing in REITs, and if so, whether another REIT is likely to perform better.

A responsible firm

Unlike many REITs, AvalonBay has displayed quality debt management, sporting a debt-to-equity ratio of just 0.68, versus an industry average of 1.2. And while AvalonBay might not offer enormous dividend payments like other REITs, a 3.10% yield is not to shabby.

AvalonBay develops, redevelops, owns, and operates multifamily communities in the United States. Below are some key stats for AvalonBay:

  • Owns 272 apartment communities
  • Owns 81,279 apartment homes
  • 27 apartment communities under construction
  • 5 apartment communities under reconstruction
  • FFO jumped 20.9% year over year
  • Same-store rental revenues up 5.2% year over year
  • Average rental rates increased 4.3% year over year
  • Management upped its FY2013 FFO guidance to $5.05-$5.25 from $4.98-$5.28

AvalonBay strategically aims for high-barrier-to-entry markets, where there’s a low supply of zoned apartment land. AvalonBay also focuses on coastal markets, which often allows for higher rental rates.

AvalonBay’s occupancy rates are up, and annual revenue has shown consistent growth. Earnings declined in 2012, but large profits should become more common. AvalonBay also has no intention of slowing down, as it has the rights to develop 27 more communities. One potential negative is that AvalonBay is trading around 47 times earnings.

Related options

Apartment Investment & Management Co. (NYSE: AIV), otherwise known as AIMCO, has seen consistent revenue declines annually and quarterly.

AIMCO aims for high-growth markets. Its operating portfolio has improved, and the pipeline is strong. Like AvalonBay, Aimco has seen increased demand and upped its guidance.

Aimco currently yields 3.70%, but it also owns a debt-to-equity ratio of 3.97. AIMCO has been divesting its non-core assets and focusing on its better-performing assets in order to reduce debt and improve profitability. However, debt is still a concern, and if interest rates increase in the near future, it could negatively impact AIMCO’s business and stock price. Additionally, AIMCO is trading around 42 times earnings, making it expensive.

Like AvalonBay, Equity Residential (NYSE: EQR) focuses on high-barrier-to-entry markets. And like AvalonBay, it has taken a stake in Archstone. AvalonBay has a 40% stake in Archstone properties (60 properties), and Equity Residential has a 60% stake in those properties (78 properties). This will increase expenses for Equity Residential, which might affect earnings in the near future.

Equity Residential has seen revenue increase over the past two years. Earnings have been inconsistent, but the firm is always profitable. In the second quarter, same-store revenue increased 4.9%, and same-store net operating income jumped 5.6%.

Equity Residential currently yields 2.80%, and it owns a debt-to-equity ratio of 1.13, which is lower than the industry average. Equity Residential is trading around 10 times earnings.

The industry

Though there are many positives listed throughout this article, it all comes down to investor confidence. And truth be told, investors aren’t feeling great about REITs right now. There is much speculation that interest rates will increase soon. If that’s the case, then investors will be quick to move out of REITs.

On the positive side, underemployment and student loan debt have led to decreased demand for houses and increased demand for rental apartments. This trend might gather momentum as the 30-year fixed mortgage moves higher.

Conclusion

Of the three REITs, AvalonBay and Equity Residential look to have the most potential. And demand is likely to increase. On the other hand, and unfortunately, the market doesn’t care.

Put simply, REITs don’t perform well when the market corrects. This was exemplified at the height of The Great Recession, when AvalonBay and Equity Residential fell 60%, and AIMCO plummeted more than 80%. With the threat of Ben Bernanke tapering, and interest rates increasing, investing in any REIT would be extremely risky and isn’t recommended, regardless of how well they’re managed. 

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