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AvalonBay Communities CEO Says There are a few “Risks that are Worth Watching”

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Highlights for the quarter for AvalonBay Communities Inc. include the core FFO growth of 4.1%, which was $0.03 per share above the midpoint of our Q3 outlook. According to Tim Naughton, chairman and CEO of the REIT, the company increased the midpoint of the full-year 2018 outlook by $0.03 to $9 per share.

“Same-store revenue growth came in at 2.3% and the same-store NOI growth was 3.1% for the quarter,” he said on the Q3 call. “The midpoint of the range for same-store performance, revenues, expenses and NOI, remain unchanged from our mid-year updated outlook.”

He added that the company did provide additional ranges for a revised same-store basket that excludes the New York JV assets, assuming that deal closes prior to the end of the year as expected.

As for development, he said that the REIT has completed $315 million in new development for the quarter at an average initial projected yield of 6.2% and now has completed $740 million at a 6.4% projected yield for the year. “We also started two new communities totaling just over $200 million in Q3. And lastly, we raised $170 million of external capital through the sale of one community at an average cap rate of just under 4.5%.”

He then turned to the fundamentals, where he said that “the U.S. economy is very healthy currently with the GDP growth running around 3.5%, corporate profits surging by double digits, labor markets one of the tightest we’ve seen so far this cycle, and the household wealth recently reaching record highs before the recent pullback in the equity markets. The economy is being driven by both the business sector and the consumer. Strong business and consumer sentiment is translating into increased levels of capital investment and household formation, both of which are good signs for the economy in the housing market over the next few quarters.”

While these and most other leading indicators are still pointing up, he said, there are some potential risks that are worth watching, including rising geopolitical tensions, the threat of trade wars, and the normalization of interest rates through continued Fed tightening. But, overall, “it appears we’ll have a solid macro environment in which to operate over the next few quarters.”

He pointed to a favorable macro environment that supports apartment fundamentals, which are showing signs of renewed strength with several drivers of rental demand turning up, including young-adult job growth, which is running above 2% again; wage growth reaching a cyclical high; and housing affordability actually hitting a cyclical low; all positive trends for apartment demand. “These drivers are all further supported by demographics as the young-adult age cohort, or those under 34, is projected to experience decent growth for the next five years and not peak until 2024.”

In the supply side of the equation, he says “It appears we’re beginning to see some early signs of relief in supply, as both permits and starts have been declining in our markets for most of the year. In fact, over the last two quarters, on a seasonally adjusted basis, starts and permits are down by over 20% in the prior two quarters. This is probably mostly due to construction cost inflation that we’ve been talking about and it’s been averaging in the high-single-digit range over the last year, with some regions like the Bay Area even reaching double-digit growth.”

He added that with rent growth generally averaging 2% to 3% over the last year, projected yields on prospective deals have deteriorated by 25 basis points to 50 basis points over the last year, so depending upon the market. “It stands to reason then that this would begin to have an impact on new development investment, and that seems to be occurring in our markets and to some extent nationally.”