Access The Rest of The Real Estate Course

Access the Rest of the Real Estate Course
REIT Valuation Case Study: AvalonBay [AVB] – Full Stock Pitch [LONG]
Recommendation: We recommend longing AvalonBay [AVB], a leading multifamily REIT that

currently trades at $165.09 per share, because it is undervalued by 20-30%, and its stock price
could increase significantly in the next 6-12 months.
The company’s stock price has declined by 10-15% over the past 9 months because the market
has incorrectly penalized the company for earnings misses in FY 17, along with expectations of
rising interest rates and a multifamily slowdown in the company’s key coastal markets;
consensus forecasts also underestimate the company’s Development pipeline.
The company’s intrinsic value is likely close to $190 – $210 per share, and even if we’re wrong
about everything above, the company is only overvalued by 10%.
Catalysts to increase the company’s share price in the next 6-12 months include the
stabilization of a record $1.9 billion in FY 17 Development deliveries, same-store rental
increases above guidance, and expansion into new markets to maintain Development yields.
Key investment risks include a coastal multifamily market downturn in the next 1-2 years,
underperformance of the Development pipeline, and lower NOI margins due to rising
concessions. We can mitigate these risks by purchasing put options, longing multifamily REITs in
different geographies, or shorting a broader multifamily/real estate index fund or ETF.
Company Background: AvalonBay [AVB] is a development-focused REIT with a major presence

on the East and West Coasts of the U.S.; the company owns primarily Class A properties, and its
average monthly rent per unit is over $2,300.
In its most recent fiscal year, AVB generated $2.2 billion of revenue, $1.3 billion of EBITDA, and
Funds from Operations (FFO) of $1.2 billion. Its current Market Cap is $22.8 billion, and its
Enterprise Value is $29.8 billion (LTM EV / EBITDA of 22.1x and P / FFO of 19.6x).
We project a revenue CAGR of 6% over the next five years in the Base Case, with EBITDA and
FFO growing at 7-8% annualized rates (vs. consensus forecasts of 3-4% annualized growth).
Investment Thesis: Currently, the market views AvalonBay as a company with limited upside
and significant downside because of rising interest rates, a substantial risk of real estate price
declines in coastal markets, and an inability to raise rents above market growth rates – but each
part of this view is incorrect.
1 of 3 http://breakingintowallstreet.co
First, rising interest rates help the company because they make mortgages more expensive,
discouraging home ownership, and approximately 83% of AVB’s Debt is fixed-rate with an
average maturity of ~10 years. Even with a Cost of Debt of 5%, far above its current 3% level,
the company would still be undervalued by ~10% in the Base Case of our DCF.
There is a legitimate risk of a recession, but it is more likely to affect the single-family owned
home market because home prices have risen far more quickly than wages (e.g., Northern
Virginia, where inflation-adjusted wages have declined since 2010 but where home prices have
risen by over 20%). In many of AVB’s markets, even highly-paid engineers at companies such as
Google and Facebook would struggle to pay for a home with less than 30% of their income.
Historically, AVB’s rental revenue has never declined by more than 2% per year, even in 2009 –
2010 (when it increased by ~2% each year) and 2001 – 2002. With fairly conservative Cap Rates
assigned to each segment, AVB’s NAV per Share is in the $180 – $190 range; even if Cap Rates
everywhere increased by 0.5%, the company would simply trade in-line with its NAV per Share.
Finally, consensus estimates for 3-4% growth significantly underestimate AvalonBay’s projected
revenue and NOI by assuming minimal contributions from Development. But the company’s
Development pipeline is significant (~14% of Gross RE Assets) and accounts for 4% extra
revenue CAGR over 5 years. In the Base Case, our Year 5 revenue is 10-15% above consensus.
The company’s Development potential increases its implied share price by approximately 10%,
its ability to raise rents at the top end of its guidance increase its implied share price by another
10%, and the limited impact of rising interest rates boosts its implied share price by another 5-
10%; together, these factors imply that the company is 20-30% undervalued.
Catalysts: The company reported record Development deliveries of $1.9 billion in FY 17;
assuming a one-year stabilization at a 6.0% – 6.5% average yield in FY 18, these initial deliveries
plus ongoing Development in the future will boost the company’s implied share price by ~10%.
We also believe the company can increase rents in Established Communities above its
guidance, resulting in total same-store rental growth of 3% in FY 18 (home price growth will
outpace wage growth, and interest rates will increase, making renting more attractive).
Finally, the company recently announced plans to expand into new markets, such as Denver,
South Florida, and Baltimore; specific projects will be announced within the next year.
Construction costs in these markets are likely to be lower than those in established markets,
further supporting the company’s targeted Development Yields.
Valuation: We valued AVB with a Net Asset Value Model based on a segment and geographic
split for its 12-month forward NOI, with Cap Rates ranging from 4% to 5% in established coastal
markets and 5% to 7% for development/redevelopment properties.
At 0.5% differentials to these Cap Rate estimates, the NAV per Share was between $160 and
$210, with the most likely outcomes between $180 and $190.
The DCF, based on 10-year Unlevered FCF projections, stock issuances for 25% of total capital
costs, Terminal FCF Growth Rates of 0.6% – 1.6%, and Discount Rates of 4.2% – 5.0%, produced
implied share prices in the $140 – $240 range. The company appears undervalued by 40% in the
Upside Case, 20-25% in the Base Case, and overvalued by 10% in the Downside Case.
The Public Comps (U.S.-based residential REITs with over $5 billion in Gross RE Assets) also
point to AVB being undervalued; despite EBITDA and FFO growth 2-3x above the set median,
the company trades in-line with the median EV / EBITDA and P / FFO multiples of the set. The
Precedent Transactions produce a mixed view, with AVB’s multiples above the set medians in
some cases and below them in others.
Risk Factors: If there is a recession, and same-store rents fall by 1-2% per year over the next
two years before recovering, the company’s implied share price could decline by ~10%.
Development underperformance, which we simulate with a 5-year average Development

completion time vs. the normal 3-year period and stabilized yields closer to 5.0% rather than
6.0% – 6.5%, would also reduce the company’s implied share price by ~10%.
Some of the company’s markets, such as Downtown LA, have experienced rising concessions
due to unit oversupply, so lower NOI margins also represent a risk factor; if NOI margins were
consistently 2% below our forecast over 5 years (68% vs. 70%), the company’s implied share
price would be ~10% lower.
In the worst-case scenario, if all the events above come true, then the company’s stock price
could potentially fall to $130 within the next year (a ~20% loss). But that is extremely unlikely,
and we could hedge against these risks by purchasing put options with $145 – $150 exercise
prices, limiting our losses to 10-12%, or by setting a stop-loss or stop-limit order in that range.
We could also hedge against these risks by longing multifamily REITs in different geographies,
such as the Sunbelt or Midwest, or ones that focus on acquisitions rather than development;
we could short a broader multifamily/real estate index fund or ETF.

Access The Rest of The Real Estate Course

Uploaded by

Copyright:

Available Formats

Access The Rest of The Real Estate Course

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Access The Rest of The Real Estate Course

Uploaded by

Copyright:

Available Formats

Access the Rest of the Real Estate Course

Recommendation: We recommend longing AvalonBay [AVB], a leading multifamily REIT that

Company Background: AvalonBay [AVB] is a development-focused REIT with a major presence

Development underperformance, which we simulate with a 5-year average Development

You might also like