Is AvalonBay's 2003 earnings growth sustainable?

Largely no. The 67.5% increase in net income to common stockholders came mainly from $161.0M of gains on property sales and a $23.4M gain at a joint venture. Core metrics weakened: same-store NOI fell 8.3%, and FFO per diluted share dropped to $3.27 from $3.55. Management expects gains to decline in 2004 as it sells fewer assets.

How exposed is AvalonBay to the weak job markets?

Significantly in Northern California, which accounted for about 31% of Established Community rental revenue and saw rental revenue fall 7.6% and average rents fall 8.9%, tied to technology-sector job losses. The Northeast, about 34% of that revenue, saw a 3.7% revenue decline tied to financial-sector job losses. Management expects stabilization only if modest job growth returns in 2004, with a three- to six-month lag before operating results improve.

What are the main near-term refinancing and liquidity risks?

The $500M unsecured credit facility matures in May 2004, and management expects to renegotiate rather than use the one-year extension, though this is not assured. Debt maturities are modest, with $190M due in 2004 (including $125M of unsecured notes repaid in February 2004). About $87M of tax-exempt variable-rate debt had credit enhancements that expired in February 2004 and were replaced with interest rate caps. Operating cash flow fell to $239.8M from $307.8M.

Why is the company selling assets, and what does that mean for future earnings?

AvalonBay sold twelve communities (3,634 apartment homes) for about $404M in net proceeds to capture value created over the cycle, as buyers paid historically high prices. Sold properties reduce revenue, NOI, and FFO, while the proceeds fund development and debt reduction. The company plans lower disposition volume in 2004 and expects to increase development and acquisitions, subject to capital market conditions.

AVB 10-K FY2003 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 5, 2004. Cited figures are marked; the original filing is the authoritative source.

AvalonBay Communities (AVB) enters 2004 as a high-quality apartment REIT whose earnings were flattered in 2003 by large one-time gains, while the underlying core business softened.

Net income available to common stockholders rose 67.5% to $260.8 million^a ($3.73 diluted EPS), but this was driven by $161.0 million of gains on community sales and a $23.4 million share of a joint venture sale gain. Net operating income from the 131 current communities fell 0.4% to $405.4 million, and Established Communities NOI (same-store) dropped 8.3%, as weak job markets in Northern California and the Northeast pushed rental rates down (average rent per occupied home fell 4.5%) and concessions roughly doubled. FFO per diluted share declined to $3.27 from $3.55 in 2002 and $3.95 in 2001, which is the more relevant measure of recurring earnings power.

Management describes 2003 as late in the cycle, with rents resetting lower, and guides to a transition year in 2004: Established Communities revenue down as much as 2.0% and NOI down up to 4.0%, with stabilization expected as job growth returns. The company pivoted in 2003 from acquisitions to dispositions, selling twelve communities for about $404 million^b in net proceeds, and plans to reduce sales and increase development and acquisitions in 2004.

Leverage is moderate, with debt at 39.9% of total market capitalization, and liquidity is adequate with $247.6 million^c available under a $500 million unsecured credit facility at February 27, 2004. Near-term items to watch include the facility's May 2004 maturity, $125 million of unsecured notes repaid in February 2004, and the York Hunter construction litigation.

02—Key points

Key Highlights

Reported net income available to common stockholders of $260.8M ($3.73 diluted EPS), up 67.5%, but driven mainly by $161.0M of gains on community sales rather than operations.
FFO per diluted share fell to $3.27 from $3.55 (2002) and $3.95 (2001), signaling weaker recurring earnings power.
Established (same-store) Communities NOI declined 8.3%; Northern California rents fell 8.9% and Northeast rents fell 3.6%, with concessions per move-in up about 105% to $848.
Total revenue grew 3.4% to $609.7M, but NOI for the total portfolio was flat-to-down (-0.4% to $405.4M) as development communities offset core weakness.
Management guided 2004 Established Communities revenue down up to 2.0% and NOI down up to 4.0%, calling 2004 a transition year.
Strategy shifted to net disposition in 2003 ($453.9M disposition program), with plans to scale back sales and increase development and acquisitions in 2004.
Liquidity is adequate: debt-to-total market capitalization of 39.9%, $247.6M available under the $500M credit facility, which matures in May 2004.

03—Questions

Frequently Asked Questions

Is AvalonBay's 2003 earnings growth sustainable?
Largely no. The 67.5% increase in net income to common stockholders came mainly from $161.0M of gains on property sales and a $23.4M gain at a joint venture. Core metrics weakened: same-store NOI fell 8.3%, and FFO per diluted share dropped to $3.27 from $3.55. Management expects gains to decline in 2004 as it sells fewer assets.
How exposed is AvalonBay to the weak job markets?
Significantly in Northern California, which accounted for about 31% of Established Community rental revenue and saw rental revenue fall 7.6% and average rents fall 8.9%, tied to technology-sector job losses. The Northeast, about 34% of that revenue, saw a 3.7% revenue decline tied to financial-sector job losses. Management expects stabilization only if modest job growth returns in 2004, with a three- to six-month lag before operating results improve.
What are the main near-term refinancing and liquidity risks?
The $500M unsecured credit facility matures in May 2004, and management expects to renegotiate rather than use the one-year extension, though this is not assured. Debt maturities are modest, with $190M due in 2004 (including $125M of unsecured notes repaid in February 2004). About $87M of tax-exempt variable-rate debt had credit enhancements that expired in February 2004 and were replaced with interest rate caps. Operating cash flow fell to $239.8M from $307.8M.
Why is the company selling assets, and what does that mean for future earnings?
AvalonBay sold twelve communities (3,634 apartment homes) for about $404M in net proceeds to capture value created over the cycle, as buyers paid historically high prices. Sold properties reduce revenue, NOI, and FFO, while the proceeds fund development and debt reduction. The company plans lower disposition volume in 2004 and expects to increase development and acquisitions, subject to capital market conditions.

04—Continue

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