Real Estate Agencies

There have been a number of reports highlighting Avalon Bay’s newest strategy of seeking to grow through acquisition of B class assets. There is a good likelihood the strategy will be misunderstood, especially given their “mysterious new research effort.” The reality is AVB may be abandoning their previously successful core strategy in an effort to become a clone of EQR. Anyone following EQR knows the mix isn’t always magic.

AvalonBay, known for developing high end apartments in mostly high barrier to entry markets is now signalling a change in direction, as entitlements are getting too hard to obtain and the market is flooded with capital seeking institutional assets. The higher end of the market used to be the sustained province of AVB and a number of other developers, and is vastly more crowded now, especially with the emergence of Archstone, a direct competitive threat. Given the nature of how markets are beginning to display sustainable rent growth, AVB is now poised to spend money acquiring assets in secondary locations with what they hope will be an accretive future. 

There are really two strong points to share here. First, in many submarkets, “B” class assets have actually outperformed over “A” and benefit from having a much broader range of prospective customers. Rent gains have been less volatile and those firmly entrenched in that sector have done surprisingly well. Secondly, a “B” is only a “B” in the right location. In many instances, merchant builders produced spectacular buildings in “C” quality locations, hoping for a renaissance of development nearby to take hold and boost their property results. That does happen, but it’s a 5 year process at best and certainly heading into this past recession, quite a few projects that started out as a “C” stayed that way. If AVB has any hope of making this play into the “B” space a success, they’re looking at a different kind of business, residents they typically do not service and a much slower growth trajectory. 

AVB is good at what they do, and at the top of the market, they are hard to beat. Resident satisfaction and internal management seems to have really figured out how to create a stable resident environment. What they’re failing at is understanding that “B” class units are a commodity business, one counter to their core strengths and not ultimately helpful to either their earnings or share price. 

Long time followers of this company cannot help but be concerned about their newly announced strategy to go after “B” units and I suspect their sense of picking assets is going to follow a deep and expensive learning curve, one that will depress earnings until they return to their core business on the “A” side of the submarket.