Why did net income fall in 2006 even though operations improved?

Net income available to common stockholders fell 14% to $269.7M because 2006 had far fewer asset sales. Gains on sale of communities dropped to $97.4M from $195.3M in 2005. Operating performance improved, as shown by the 9.1% growth in Established Community NOI and the 16% rise in FFO per share, but FFO excludes these one-time gains.

What is the outlook for apartment rents and operating costs in 2007?

Management expects continued but more moderate growth, with Established Community rental revenue up 5.0% to 6.5% and NOI up 5.5% to 7.5%. Operating expenses are expected to rise 3.5% to 5.0%, driven by utility, payroll, insurance, and property tax increases. Management cites modest net new supply, low home affordability, and continued but slower job growth as supports for demand.

What are the most significant legal and regulatory risks disclosed?

The main litigation is Equal Rights Center v. AvalonBay, filed in September 2005, which alleges that communities violate Fair Housing Act and ADA accessibility requirements. It covers 100 communities, seeks compensatory and punitive damages, and asks for injunctive relief that could require structural modifications. The company cannot estimate potential losses. A separate January 2007 Fair Labor Standards Act suit alleges unpaid overtime to leasing consultants. Terrorism insurance backing under TRIEA expires December 31, 2007, and its renewal is uncertain.

How is AvalonBay funding its growth and how levered is it?

Growth is funded through a mix of retained cash flow, asset dispositions (2006 sales of $261.9M gross, with 2007 sales projected at $150M to $200M), the $650M credit facility, unsecured notes, and equity. At year-end 2006, debt-to-total market capitalization was 22.3%, and total debt was $2.83B. Interest rate risk is modest: a 100 basis point rise in variable rates would add about $3.0M in annual interest cost. Management also reports $1.9x fixed charge coverage on an incurred basis.

AVB 10-K FY2006 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 1, 2007. Cited figures are marked; the original filing is the authoritative source.

AvalonBay Communities (AVB) closed 2006 with strong operating momentum, driven by a tight apartment market in its high barrier-to-entry coastal and Northeast markets.

Established Community rental revenue grew 6.8% and net operating income grew 9.1%, with Q4 2006 NOI up 10.9%, the strongest operating quarter since 2001. Diluted EPS was $3.57^a and net income available to common stockholders was $269.7 million, down 14% from 2005 mainly because 2006 had fewer asset sales and smaller gains. FFO per diluted share rose to $4.38 from $3.77 in 2005, a 16% increase, and the company raised its quarterly dividend 9% to $0.85 for Q1 2007.

Management guides to more moderate 2007 growth: Established Community revenue growth of 5.0% to 6.5% and NOI growth of 5.5% to 7.5%, with operating expenses rising 3.5% to 5.0%. The company is expanding development, with $1.0 to $1.3 billion^b of new starts planned for 2007, 17 communities under construction representing 5,153 homes, and Development Rights for about 14,185 homes. Balance sheet activity included $500 million of new unsecured notes, the repayment of $150 million of notes, and a January 2007 equity offering of about $594 million after the company joined the S&P 500.

Debt-to-total market capitalization was 22.3%^c at year-end. Key risks include rising construction costs, a pending Fair Housing Act and ADA accessibility lawsuit covering 100 communities, a new Fair Labor Standards Act overtime suit, the 2007 expiration of TRIEA terrorism insurance backing, earthquake exposure in California, and the Fund's leverage and capital-call dependencies. Development and acquisition activity remains sensitive to capital markets and interest rates.

02—Key points

Key Highlights

Established Community rental revenue rose 6.8% and NOI rose 9.1% in 2006, with Q4 NOI up 10.9%, the strongest operating quarter since 2001.
FFO per diluted share rose to $4.38 from $3.77 (up about 16%), while GAAP diluted EPS fell to $3.57 from $4.21 due to lower gains on asset sales ($97.4M gain on sale of communities vs. $195.3M in 2005).
Quarterly common dividend raised 9% to $0.85 per share for Q1 2007, up from $0.78; full-year 2006 dividends declared totaled $3.12 per share.
2007 guidance: Established Community revenue growth of 5.0% to 6.5%, NOI growth of 5.5% to 7.5%, and expected new development starts of $1.0 to $1.3 billion.
Development pipeline of 17 communities under construction (5,153 homes, about $1.32 billion total capitalized cost) plus Development Rights for 54 communities (14,185 homes, about $3.6 billion).
January 2007 issuance of 4.6 million shares at $129.30 (about $594M net) following S&P 500 inclusion, plus $500M of new unsecured notes in September 2006.
Balance sheet remains conservative: debt-to-total market capitalization of 22.3%, fixed charge coverage of 1.90x (incurred basis), and a $650M unsecured credit facility with $612M available at January 31, 2007.

03—Questions

Frequently Asked Questions

Why did net income fall in 2006 even though operations improved?
Net income available to common stockholders fell 14% to $269.7M because 2006 had far fewer asset sales. Gains on sale of communities dropped to $97.4M from $195.3M in 2005. Operating performance improved, as shown by the 9.1% growth in Established Community NOI and the 16% rise in FFO per share, but FFO excludes these one-time gains.
What is the outlook for apartment rents and operating costs in 2007?
Management expects continued but more moderate growth, with Established Community rental revenue up 5.0% to 6.5% and NOI up 5.5% to 7.5%. Operating expenses are expected to rise 3.5% to 5.0%, driven by utility, payroll, insurance, and property tax increases. Management cites modest net new supply, low home affordability, and continued but slower job growth as supports for demand.
What are the most significant legal and regulatory risks disclosed?
The main litigation is Equal Rights Center v. AvalonBay, filed in September 2005, which alleges that communities violate Fair Housing Act and ADA accessibility requirements. It covers 100 communities, seeks compensatory and punitive damages, and asks for injunctive relief that could require structural modifications. The company cannot estimate potential losses. A separate January 2007 Fair Labor Standards Act suit alleges unpaid overtime to leasing consultants. Terrorism insurance backing under TRIEA expires December 31, 2007, and its renewal is uncertain.
How is AvalonBay funding its growth and how levered is it?
Growth is funded through a mix of retained cash flow, asset dispositions (2006 sales of $261.9M gross, with 2007 sales projected at $150M to $200M), the $650M credit facility, unsecured notes, and equity. At year-end 2006, debt-to-total market capitalization was 22.3%, and total debt was $2.83B. Interest rate risk is modest: a 100 basis point rise in variable rates would add about $3.0M in annual interest cost. Management also reports $1.9x fixed charge coverage on an incurred basis.

04—Continue

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