AvalonBay Communities doesn’t have a secret weapon. If all goes well, the Alexandria, Va.-based REIT might begin construction this year on the 444-unit, garden-style Avalon Green II community in Greenburgh, N.Y., after 15-years-plus of steering the property through joint ventures and the permit and entitlement process. Nor is the company particularly magical. In its main boardroom at corporate headquarters, there is a Tandberg-6000 dual screen unit for video conferencing and pictures of several of the company’s new and notable high-rise developments. But there is no economic crystal ball, no all-seeing eye absconded underneath black cloth to be summoned by its multifamily masters. Yet here is AvalonBay in 2009: fortified in 16 core high-barrier-to-entry markets with 50,292 units under management across 178 properties. Though property fundamentals have taken a hit, average occupancy is at 96 percent and net operating income this year is forecast to be $539 million. Then there’s the balance sheet. Boasting the lowest leverage (debt as a percentage of assets) of any multifamily apartment REIT at 44 percent, AvalonBay has ample room to access and assume secured debt, and that’s not counting the $830 million already raised in 2008 against 16 existing assets. The company has an untapped $333 million equity investment fund, has accessed only $124 million of a $1 billion line of unsecured credit maturing in 2011 after a one-year extension, and has $66 million of cash on hand. Out of all the multifamily firms who lay claim to be prepared to takeadvantage of developing market opportunities, AvalonBay seems comparatively, transparently, and enviably at full strength.
“AvalonBay is our only overweight stock in the sector, and that overweight is driven by strength of balance sheet,” says New York City-based investment firm Barclays Capital analyst Ross Smotrich, who has been following AvalonBay and its predecessor companies since before the firm’s initial public offering in 1993. “That strength is conservative leverage levels, access to liquidity, unused lines of credit, and the further financing opportunities available across their asset base. It is a balance sheet built with financial flexibility.”
Envy them if you will, but AvalonBay didn’t become recession-resistant overnight. The company was made that way over 15 years of systematic, conservative, and, at times, almost boring balance-sheet management governed by one central strategy. “The guiding principle for financial management at AvalonBay is that we want to have continuous, uninterrupted access to cost-effective capital,” says Tom Sargeant, a 23-year AvalonBay veteran who has guided the firm as its CFO since 1995. Sargeant was treasurer of Avalon Properties from its formation in 1993, and prior to that, worked for real estate clients as a certified public accountant for Arthur Andersen.
A would-be journalist-turned-accounting major at the University of South Carolina, Sargeant is still specific about his selection of words and the relative weight of those words. He returns to the guiding maxim frequently as both litmus test and enabler of all things tactical and strategic at AvalonBay, and iterates the mantra in a patient, measured, economical cadence that belies his Southern heritage. Continuous … uninterrupted … cost-effective … capital.
Patient Perseverance
Sargeant is quick to point out that cost-effective capital has rarely meant the cheapest or most ubiquitous money available. Case in point: AvalonBay’s historic preference for unsecured debt. Normally coming with a 25 to 50 basis point interest premium over its asset-secured brethren, unsecured debt nonetheless has provided AvalonBay with a tactical advantage on the disposition front and in today’s lending environment: a quality-laden apartment portfolio with approximately 77 percent of its assets debt-free and ripe for as-needed securitization or opportunistic sale.
“Balance sheet flexibility is paramount to financial management as you build a cost-effective capital stack,” Sargeant explains. “Having many choices means you are not forced into doing any certain transaction. You could argue that secured debt has historically been a lower cost capital, but it is less flexible. In times like today when the only option is secured debt, if you have taken that option all along and have already secured your assets, you have no place to go. You can’t access additional debt.” Sargeant says the use of unsecured debt additionally allowed AvalonBay to quickly gain a disposition market premium on unencumbered assets when condo players made their asset-flipping run at multifamily apartment conversions until the foreclosure crisis. The unsecuritized portfolio model likewise assisted in clearing out a record $650 million in AvalonBay dispositions last year at a weighted average cap rate of 5.1 percent. In fact, during one of the worst multifamily transactional years on record that saw deal flow fall off by 63 percent, AvalonBay still generated approximately $288 million in (GAAP) gains and realized an unlevered internal rate of return of 14.1 percent.
