After Birmingham, Ala., Colonial Properties Trust opened things up last week, Alexandria, Va.-based AvalonBay Communities and Chicago-based Equity Residential issued releases last night that detailed second-quarter earnings that were less than expected.

A charge of $0.28 per share from abandonment of certain development rights pulled AvalonBay’s second-quarter profits down, but its revenues rose 0.1 percent to $222.14 million from 2008. Its net operating income (NOI) fell $17.67 million from $127.33 million, while its funds from operations (FFO) decreased to $71.82 million from $97.85 million during the same period in 2008.

“If you back out the $0.28 impairment from the revised guidance, you end up with a mid-point essentially in line with Wall Street expectations,” says Alexander Goldfarb, associate director of equity research of REITs for New York-based Sandler O'Neill + Partners.

Equity’s second-quarter report showed FFO declining to $168.7 million from $185 million last year. It attributed this decline to the negative impact of lower-total NOI and a non-cash charge of $11.1 million, reflecting the impairment in the value of a land parcel. It did have a positive impact of about $0.03 per share due to lower interest expense, higher interest, and other income. Its NOI fell from $126.6 million to $96.6 million, which it attributed to lower property sales volume and lower NOI in 2009. Its total revenues declined to $505.2 million from $513.3 million in the corresponding period last year.

A number of other REITs still haven’t reported yet (though Denver-based AIMCO will be out this week). When they do, here’s what Goldfarb and his peers will be watching:

1. Market Conditions.
No one is arguing that the multifamily market has had a good year. “We know job loss is bad for apartment demand,” says Andrew J. McCulloch, an analyst for Green Street Advisors, a Newport Beach, Calif.-based consulting and research firm. “How are those job losses affecting rents on the ground? That’s what we want to know.” 

Rod Petrik, managing director at St. Louis-based Stifel, Nicolaus and Co., a regional brokerage and investment banking firm, thinks things could get a lot worse. “A year ago, if you told me we would lose 6 million jobs, I would have told you apartment occupancy would be in the mid 80 percent range, and it's not,” he says.

But as Avalon and Equity showed, things are weakening. And the second quarter could be a gauge of just how bad. “The second quarter is traditionally the strongest leasing period, and so I’m anxious to see how well you get through it,” Petrik says. “Obviously, the national economy is having an impact.”

Ultimately, Green Street expects a cumulative NOI decline of 15 percent on average for the apartment REITs through 2011. This year, NOI is expected to fall 5 percent to 7 percent, with a similar performance expected for 2010.  Prior to 2Q results, NOI had only fallen a few percentage points. That means there’s a lot of room before the bottom. “Rents will be down across the country, but it will vary widely depending on the market,” McCulloch says. “The reported results will continue to get worse throughout this year and next year, as leases are rolled to lower market rents.”

2. Balance Sheet Management.
Last quarter, analysts were abuzz that the apartment REITs would issue equity raises. Three months later, only Houston-based Camden Property Trust followed suit. 

“You have only seen Camden raise equity, which is a surprise to me,” McCulloch says. “I would expect more of the apartment REITs to pull the trigger between now and the end of the year, but there’s not a gun to their heads because Fannie and Freddie continue to provide abundant and attractively priced debt.”

Though not as many REITs announced new Fannie Mae and Freddie Mac credit facilities in the second quarter as in earlier months, the analysts still say agencies offer a fertile source of liquidity. “I think they’ll continue to layer on agency debt, maybe for the next six to 12 months,” Goldfarb says. “It pushes out maturities.”

That’s because they can use money from those facilities to buy existing debt. “I think the apartment REITs have been pretty disciplined in raising the cheapest money available to them,” Petrik says. “A lot of balance sheet maneuvering has been going into buying existing debt at discounts to face value.”

But there are some issues that come with these facilities, namely from the rating agencies. “Once you get over a half billion [in agency debt] they start running into some issues with the credit rating agencies,” Petrik says.

That’s one reason why REITs may look closer at the unsecured markets. That’s actually the preference of firms like AvalonBay anyway.

3. Dispositions, Acquisitions and Development.
In today’s conference call, executives from AvalonBay mentioned that they thought there was a way to take advantage of Fannie and Freddie without opening credit facilities and adding leverage. The way is simple: Sell properties (where buyers will probably finance through Fannie and Freddie). “I think REITs will continue to be much more active on the disposition front than the acquisition front near-term,” McCulloch says. 

And, in fact, some REITs may sell more than they initially imagined in 2009. AvalonBay targeted $150 million in sales, but added $100 million to that expectation today. AvalonBay was one of only two REITs, along with Memphis, Tenn.-based Mid-America Apartment Communities, to make buys so far this year. Analysts don’t expect to hear much more talk of acquisition activity, especially with limited distress opportunities. “People are still focused on the preservation of capital,” Goldfarb says.

McCulloch agrees. “You may see a one-off acquisitions here or there,” he says. “But I don’t think you’re seeing a lot of distress just yet or pricing attractive enough for REITs to re-enter the market. And if you were seeing it, I don’t think the REITs as a sector have padded their balance sheets enough yet to go on the offensive in a big way.”

But eventually Petrik sees REITs being buyers. Camden has commented that it has interest in distressed assets and both Mid-America and AvalonBay have funds, McCulloch adds.

AvalonBay also commented on its call today that it will look at new development with construction costs falling, no new product on the way in many markets, merchant builders going out of business, and an expected surge in demand by 2012. Petrik estimates land costs are down 50 percent and hard costs are down 15 percent.

“If AvalonBay wants to build in suburban Massachusetts, they write a check,” Petrik says. “They don’t have to put together a package and go through some loan committee.”