AvalonBay Communities: Limited Space For A Further Price Increase - AvalonBay Communities, Inc. (NYSE:AVB)

June's U.S. job data boosts confidence in AVB's performance, but it also dims hope for a Fed rate cut in July, which would have helped AVB.

AvalonBay Communities (AVB) is a publicly traded real estate investment trust that invests in apartments. As of 2019, AVB owns nearly 80,000 apartment units in New England, the New York City metropolitan area, the Washington, D.C. metropolitan area, Seattle, and California. Since January 2019, AVB share price has surged by 18%, which is quite a success considering the overall stock market decline in the US and globally. What is the market outlook for residential apartments in the US? How will that impact AVB's price movement in the near future?

All residential apartments in AVB's portfolio are located in the following five areas: New England, the New York City metropolitan area, the Washington, D.C. metropolitan area, Seattle, and California. Rents in these regions have been growing at a rapid speed. For example, the average rent for an apartment in Washington is $2,131 in 2019, a 3% yoy increase. In California, it is $1,381, also a 3% yoy increase. In Manhattan, the average rent for one apartment is $4,137, a 2% increase compared to 2018.

Such a scene is not only unique in large cities. From the sec­ond quar­ter of 2018 to the same pe­riod this year, monthly rental prices na­tion­wide shot up 3%, with many small met­ros seeing big­ger in­creases such as Wilm­ing­ton, N.C. and Hunts­ville, Ala. Forces from both the supply and demand sides are driving the rents up.

From the demand side, the US jobless rate, which is holding steady at 3.6%, is currently at a half-century low. According to the Labor Department's latest report, the US economy added 224,000 jobs in June 2019, marking the 105th straight month of gains. Continuous job growth spurs more people to move into urban and suburban areas, driving up demands for residential apartments.

From the supply side, al­though apart­ment con­struc­tion is now at a level highest in the past 30 years, con­struc­tion hasn’t kept pace with pop­u­la­tion growth. What's more, most of that new sup­ply tar­gets high-in­come residents, and the mar­ket for lower-cost rentals is still extremely tight. The mismatch between supply and demand boosts the performance of apartment REITs.

In addition, apartment REITs can be buoyed by home affordability. In recent years, housing has become less affordable, which has been a positive catalyst for apartment owners.

As mentioned above, 224,000 new jobs were added in June 2019. In May, this figure is 75,000. Such a bounce in employment growth soothes investors' concerns to some extent, meaning that in the short run, we won't see the economic performance drastically decline. Despite that, long term downside risks like global trade uncertainties still remain existent.

In two meetings in June, the Fed chairman Jerome Powell had hinted at the possibility for a rate cut in recent weeks to prevent poorer economic activities in the latter half of 2019. Now, the June job report which exceeds most people's expectations reduces the probability that the Fed will cut its rate in July.

On one hand, the strong job market boosts investors' confidence in AVB's performance. On the other hand, the Fed's rate cut plan threatens the stock's rally. REITs are particularly sensitive to interest rate movements; as rates rise, investors expect higher returns from their income-oriented investments, so rising rates typically put pressure on REIT prices. If a rate cut does not happen this year, AVB's performance will see greater pressure in the new macroeconomic environment.

AVB'srecent P/E ratio of 22.84x, compares to 23.95x for Equity Residential (EQR), and 23.69x for Essex Property Trust (ESS); which are two other residential REITs that serve as peers. In the short run, there may still be room for AVB's price to go up, due to the growing job market and the fact that AVB's current valuation slightly falls behind its peers. However, in the long run, the space for such an increase can be quite limited. Macroeconomic uncertainties like global trade disputes still put America's future growth at risks. If the Fed does not inject more liquidity into the market in 2019, chances are high that a slowdown in the economy will happen sooner and the market of residential apartments is particularly sensitive to those macroeconomic shifts. If investors choose to buy AVB at this moment, the returns that it will deliver may not be very satisfactory. As a result, investors are recommended against buying AVB now or holding it for a time period longer than one month.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seekingalpha.com

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