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Equity Residential (EQR), AvalonBay Communities Inc (AVB): Make Money From Your Rent Increase – Buy These REITs

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As the economic recovery steadily marches on, young adults have accounted for “about 45% of net new jobs since 2010.” These younger workers are less likely to buy homes, in part because of job instability, and in part because of the substantial debt many are already carrying from college loans. Many young professionals gravitate toward apartments. Three Real Estate Investment Trusts (REITs) are well-positioned to make the most of this shift in living: Equity Residential (NYSE:EQR), AvalonBay Communities Inc (NYSE:AVB) and UDR, Inc. (NYSE:UDR). Given the macro fundamentals, these companies are great investments.

Market choice

All three companies focus their capital in coastal markets and big cities, where the population is often more transient and the homes more expensive. Since homes are less affordable, more people choose to rent – given these markets’ strong rental proclivities, focusing capital in them is a smart allocation. That said, these firms have done a good job of diversifying geographically – they aren’t just focused in one geographic area.

Equity Residential (EQR)By contrast, Essex Property Trust Inc (NYSE:ESS), for example, only operates on the West Coast. While the company pays a dividend similar to Equity Residential (NYSE:EQR), AvalonBay Communities Inc (NYSE:AVB), and UDR (about 3%) and demonstrated great EPS growth ($1.24 in 2011 more than doubled to $3.41 in 2012), I am less sanguine about its prospects due to its over-reliance on the West Coast. All it takes is one natural disaster or one local economic recession to really harm Essex Property Trust Inc (NYSE:ESS)’s cash flow.

A single natural disaster, however, will not do nearly as much damage to UDR, AvalonBay, or Equity. For example, UDR, Inc. (NYSE:UDR) took a hit when Hurricane Sandy damaged two of its apartment complexes in Manhattan, but due to the company’s geographic dispersion, earnings were not drastically affected.

Development, expansion, and acquisition

AvalonBay Communities Inc (NYSE:AVB) and Equity Residential (NYSE:EQRrecently finished the purchase of the Archstone portfolio of apartments. Both have opted to keep elements of the portfolio (including several development parcels) and to sell certain properties for solid short-term gains. This is a big expansion; AvalonBay and Equity sold other non-core assets and took on additional debt to raise the funds for this purchase. Even so, their Debt/Equity ratios are still very reasonable – particularly for REITs (Equity Residential’s Debt/Equity ratio is 0.6; AvalonBay’s is 0.7; UDR, by way of comparison, has a Debt/Equity ratio of 1.2).

AvalonBay Communities Inc (NYSE:AVB) wins the new development contest, with 30 new apartment communities under construction for a total expected cost of $2.4 billion and another $3.6 billion of planned construction, which will commence in the next few years.  Equity Residential (NYSE:EQR) anticipates about $800 million in development through calendar year 2013, and UDR is working on a $1.2 billion development and redevelopment pipeline which will deliver over the next three years.

AvalonBay Communities Inc (NYSE:AVB) and Equity Residential (NYSE:EQR) plan to acquire additional properties this year; UDR is focusing its capital strictly on redevelopments and developments. Given the excellent revenue increases UDR is achieving on its redevelopments (for example: the 15% rental-rate increase at the Westerly in Marina del Rey, Calif., the 12% increase at the Rivergate in New York’s Manhattan and the 21% increase at the 27 Seventy Five in Costa Mesa, Calif.), this is a wise use of capital.

Financials

Occupancy was roughly even for all three companies at the end of Q1 2013 (95.5% at UDR, a little over 96% at AvalonBay Communities Inc (NYSE:AVB), and 95% at Equity). UDR reported a solid same-store net operating income (NOI) growth of 6.3% for Q1 2013, including a 5.4% increase in revenue and a 3.4% increase in expenses. AvalonBay reported a 4.9% increase in same-store revenue and a 3.3% increase in expenses, while Equity Residential (NYSE:EQR) reported a 5.1% increase in same-store revenue and an expense increase of under 3%.

AvalonBay and Equity both took a pretty steep dive in earnings per share (EPS) and funds from operations (FFO – I will define the term a little further down) for Q1 of 2013, but that was due to the costs of their joint venture to acquire the Archstone portfolio. I expect EPS and FFO to stabilize for the rest of the year, and the high- quality apartments in the Archstone portfolio will accrete additional earnings in the long term.

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