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AvalonBay Ramps Up Apartments in Bet Glut Disappears


Major apartment owner AvalonBay is making a $400 million bet that record vacancies will give way to a rental shortage by 2012

(Bloomberg) — AvalonBay Communities Inc., the second-largest publicly traded apartment owner in the U.S., plans to start $400 million of construction this year, a wager record vacancies will give way to a rental shortage by 2012.

The company began projects in Massachusetts and New Jersey in the fourth quarter after a nine-month hiatus, Bryce Blair, chief executive officer, said in an interview. Work on as many as seven more will get under way this year, as competitors wait for the market to improve or financing to become available.

AvalonBay, based in Alexandria, Virginia, is putting shovels in the ground when 8 percent of apartments sit empty, an all-time high, according to researcher Reis Inc. U.S. builders started 92,000 units in 2009, a 58 percent decline from 2008 and the fewest since the government began collecting the data in 1974. Demand will rise and supply will shrink as the job market recovers and the children of baby boomers move away from home or shared apartments and seek their own places, Blair said.

"We will have fewer apartments than the market will have need for, which will drive rents higher," said Ron Witten, founder of Witten Advisors LLC in Dallas, an apartment-market consulting firm.

Blair, with $300 million in cash and a $1 billion credit line, can afford to be contrarian. Construction financing for private developers, which make up a bulk of his rivals, dried up as banks were swamped by bad loans. Charge-offs of construction and land development loans by U.S. banks increased 70 percent in the third quarter to $7.6 billion from the same period in 2008, according to the Federal Deposit Insurance Corp. in Washington.

Difficult Time

"It is as difficult to finance a new development today as in any time in my 30 years in the real estate business," said Charles R. Brindell Jr., president and CEO of closely held Trammell Crow Residential Co., which has developed more than 225,000 multifamily units across the U.S.

Trammell Crow, which had averaged about 6,700 new units a year, didn't start a single project in 2009, the first lull in the 33-year history of the Dallas-based company. It couldn't line up financing for the four projects in the Northeast planned for last year, Brindell Jr. said.

The firm, which is seeking financing for 2,000 rental units in 2010, cut its workforce by more than half last year to 275, he said.

Rent Drop

Effective rents, or what tenants pay after concessions, fell 2.9 percent to $964 in 2009, the biggest drop since New York-based Reis started collecting the data in 1980. The economy is the biggest reason. With the U.S. unemployment rate at 9.7 percent after reaching a 26-year high of 10.1 percent in October, it's more attractive for people in their late teens through early 30s, known as Generation Y, to live at home or share apartments.

More than 147,000 vacant units would need to be filled before rents could rise in 2011, according to Reis. In 2007, about 99,000 units were absorbed by the market.

By 2012, U.S. rents may increase by about 6.5 percent and the vacancy rate may fall below 5 percent, consultant Witten said.

Job growth will climb to an annualized rate of 3 percent in the fourth quarter of 2011, compared with a 4.3 percent loss in 2009, according to a projection by Moody's Economy.com. The West Chester, Pennsylvania-based economic consultant projects that 3 million households will be formed in 2011 and 2012 compared with 1.9 million in the prior two years.

New York, Boston

Markets including New York and Boston are poised for better-than-average growth when employment improves, according to Ronald G. Johnsey, president of Dallas-based apartment- research company Axiometrics Inc., who based his projections on U.S. job growth of about 1.8 percent in 2012.

The New York metropolitan area may see effective rents jump 8.6 percent in 2012 after climbing 6.7 percent in 2011, according to Axiometrics' forecast. Rents in Boston will rise 5.6 percent in 2012. By comparison, Axiometrics projects U.S. rents to increase 3.7 percent on average that year.

Kristin Davie said she hopes to be among the new renters. The 22-year-old has been living at her parents' home in Colonia, New Jersey, since graduating from college in May. Her 27-year- old brother, Scott, is also there, along with the family's eight-month-old puppy, Charlie.

Stuck at Home

Davie and two friends gave themselves four months after graduation from Marist College in Poughkeepsie, New York, to find stable jobs and a Manhattan apartment they could afford to share. They pushed off the deadline until January. This month, Davie left a job where she was unhappy, making a move "really dependent on how quickly I can find another job and put some money away," she said in a telephone interview.

"When we all started college we said when we graduate we'd have our own places," Davie said. "I appreciate being with my parents and having the opportunity to save money, but I've gotten used to freedom after four years of college."

AvalonBay develops more apartments than other publicly traded real estate investment trusts, and is the only one with a significant number of new starts, said Richard Anderson, senior REIT analyst with BMO Capital Markets in New York. Equity Residential, the largest U.S. apartment landlord, Houston-based Camden Property Trust and UDR Inc. of Colorado rely more on buying and operating properties.

"There is a risk associated with development," Anderson said. "A lot of the other REITs have more of an acquisitive mindset."

Equity Residential

Equity Residential, founded by billionaire investor Sam Zell, is emphasizing acquisitions, though it plans to build 111 units and retail on a property in the Chelsea neighborhood of Manhattan that it acquired last year.

"On the development front, our focus in 2009 was to complete, to lease and to stabilize our existing deals," President and Chief Executive Officer David J. Neithercut said on a Feb. 4 earnings call with analysts and investors.

The Chicago-based company completed six projects with a cost of $670 million last year and has four more under development, he said.

AvalonBay is able to develop because it has one of the best balance sheets among residential REITs, BMO's Anderson said.

"It is just a very good and sophisticated organization, strong management team and balance sheet," said the analyst, who rates the company "market perform" and doesn't own the shares. "They don't universally outperform, but they do typically trade at a premium to its peers because of its core attributes.

Stock Trading

AvalonBay rose 0.1 percent to $78.10 at 10:06 a.m. in New York Stock Exchange composite trading. The shares have gained 82 percent in the past 12 months, compared with a 73 percent increase in the Bloomberg Real Estate Investment Trust Index.

The company's stock trades at 21 times estimated funds from operations, a measure of cash flow used by REITs, according to data compiled by Bloomberg. Equity Residential trades at 17, while UDR's multiple is 15.

AvalonBay is focused on tight markets with relatively low vacancy rates, Blair, 51, said last week. In the fourth quarter, the company started two apartments in Northborough, Massachusetts, which is 40 miles (64 kilometers) west of Boston, and West Long Branch, N.J., home of Monmouth University.

With construction costs down about 20 percent from the peak, Blair says the company can "build at an attractive price and deliver into an attractive market." Besides New Jersey and Massachusetts, the company is planning developments in New York, Connecticut and possibly the West Coast.

Supply Growth

Supply will expand as developers like Equity Residential finish units started before the economic crisis in 2008, said Victor Calanog, director of research at Reis. Reis projects 1.1 percent rent growth in 2011 and 3.4 percent by 2012. As demand surges, developers will respond with fresh supply, he said.

"When financing gets better, where there is opportunity, building is going to be quick," Calanog said. Reis's projections depend on construction financing loosening by 2011.

Developers probably won't overbuild because ramping up will take time, said Greg Willett, vice president of research at Dallas-based MPF Research.

"We do need to take a break for a little while in terms of significant amounts of construction," Willett said. "But we don't need a break that goes three to four years. If that happens, we're in shortage mode."


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