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Company Perspectives:
AvalonBay Communities, Inc. is in the business of developing, redeveloping, acquiring and managing luxury apartment communities in the high barrier-to-entry markets of the United States.
AvalonBay Communities, Inc. is a real estate investment trust (REIT) that develops, owns, and operates luxury apartment communities in 11 states and Washington, D.C. The company's portfolio (as of February 1, 2003) consisted of 137 apartment complexes containing 40,179 rental units. Another dozen projects were also under construction, representing an additional 3,400 apartments. The REIT, based in Alexandria, Virginia, is committed to pursuing the luxury rental niche in urban areas, such as New York City and the San Francisco Bay area, where it is difficult to build new apartment complexes due to the scarcity of land and restrictive regulations. Management hopes to establish the AvalonBay name as a recognizable brand. Regional offices are maintained in San Jose, California; New Canaan, Connecticut; Boston, Massachusetts; Chicago, Illinois; Newport Beach, California; New York, New York; Woodbridge, New Jersey; and Seattle, Washington. In addition to real estate AvalonBay has invested in three technology companies to promote the development of technology and services that can be used to improve the operating performance of its real estate holdings. The most important of these enterprises is Realeum, Inc., provider of an on-site property and leasing automation software system.
Avalon's Postwar Origins
AvalonBay was the result of a 1998 merger between Avalon Properties, Inc. and Bay Apartment Communities. The history of Avalon, however, grew out of real estate ventures launched by legendary Dallas real estate man Trammell Crow. Crow was born in Dallas in 1916, the fifth of eight children. Following his graduation from high school he went to work for the Mercantile Bank in Dallas while studying law and accounting in evening classes at Southern Methodist University. Crow ultimately became a Certified Public Accountant. In 1941, nine months before Pearl Harbor, he joined the Navy as an ensign and was assigned to finance. Through the war years he rose to the rank of Commander, and years later expressed the importance of his time in the service: "I think those years in the Navy were worth a couple of M.B.A. programs to me." After being discharged he established Trammell Crow Company and soon became a major force in real estate. In 1948 he completed his first development project, a warehouse in downtown Dallas. He developed the Dallas Market Center in 1957, a structure that would influence subsequent marts around the world. Crow also was credited with originating the atrium concept for modern buildings. In the late 1960s his company opened its first offices outside of Dallas and a few years later opened its first international office. By 1971 Forbes recognized Crow as the largest private real estate operator in the United States. In the 1980s his company, which encompassed a number of industries, sought to become a truly national real estate enterprise. As part of this effort Trammell Crow Residential was established to do business in the apartment sector. It was a decentralized operation with a large number of divisions that were run independently by local management.
In 1993 executives from some of Trammell Crow Residential's most profitable divisions began to discuss among themselves ways to raise new capital to grow their businesses. Talk of selling properties to existing real estate investment trusts (REITs) was soon abandoned in favor of combining the divisions to create their own trusts. REITs had been originally created by Congress in 1960 as a way for small investors to become involved in real estate in a manner similar to mutual funds. REITs could be taken public and their shares traded just like stock and also were subject to regulation by the Securities Exchange Commission. Unlike stocks, however, REITs were required by law to pay out at least 95 percent of their taxable income to shareholders each year, a provision that severely limited the ability of REITs to raise funds internally. During the first 25 years of existence, REITs were allowed to own real estate only, a situation that hindered their growth. Third parties had to be contracted to manage the properties. Not until the Tax Reform Act of 1986 began to change the nature of real estate investment did REITs begin to gain widespread usage. Tax shelter schemes that had drained potential investments were shut down: Interest and depreciation deductions were greatly reduced so that taxpayers could not generate paper losses in order to lower their tax liabilities. The Act also permitted REITs to provide customary services for property, in effect allowing the trusts to operate and manage the properties they owned. Despite these major changes in law, REITs were still not fully utilized. In the latter half of the 1980s the banks, insurance companies, pension funds, and foreign investors (in particular, the Japanese) provided the bulk of real estate investment funds. That period also witnessed overbuilding and a glutted marketplace, leading to a shakeout in the marketplace. With real estate available at distressed prices in the early 1990s REITs finally became an attractive mainstream investment option. For many real estate firms, converting to REITs allowed them to escape massive levels of debt and to recapitalize. As a result, dozens of real estate companies began to go public in 1993.
Avalon Properties' Forms as a REIT in 1993
Avalon Properties grew out of the Trammel Crow Residential Mid-Atlantic and Northeast Groups. The lead executive was Richard L. Michaux, a managing partner at Trammel Crow Group. He came to real estate with a background far different from the vast major majority of his colleagues in the industry. A graduate of the United States Naval Academy in 1966, he went on to serve in a nuclear submarine. According to National Real Estate Investor, "Spending days on the sub taught him to be quick on his feet with numbers, to get things done on-time under pressure and to expect quality." After his term of service he earned a Master's Degree in Business Administration from the University of North Carolina at Chapel Hill. He worked in real estate with Sea Pines Company in Hilton Head Island, South Carolina, Burke Centre PUB, and Virginia-based Ryan Homes, and then joined Trammell Crow Residential, where he became responsible for residential development in the Mid-Atlantic, Northeast, and Midwest regions.
Avalon Properties, Inc. was incorporated in the state of Maryland as a REIT. Its initial public offering (IPO) was underwritten by a consortium of brokerage firms led by Kidd, Peabody & Co. Avalon's portfolio consisted of 22 multifamily communities, with a total of 7,044 apartment homes, located in Connecticut, Massachusetts, Maryland, New Jersey, New York, and Virginia. The company also had three communities under construction and held options on 14 parcels of land for possible development. In addition, Avalon managed 18 outside properties, totaling more than 4,500 units. Avalon's offering was completed on August 24, 1993, raising $400 million. From these proceeds the REIT paid off approximately $250 million in debt, leaving it with outstanding loans of less than $110 million.
Avalon was uniquely positioned in the Northeast, the only apartment REIT doing business in an area that stretched from Boston to Virginia. As Michaux explained to the Wall Street Transcript in a 1994 interview, "There are very high barriers to entry in the Northeast. There are no other national developers there. The regional developers are largely out of the apartment business right now, and we see an opportunity to buy land and build apartment communities that should have better than average returns. That comes from having a first look at almost everything that happens in the Northeast."
Avalon was especially interested in the New York City metropolitan region. In 1994 it broke ground on its first project in Westchester County, north of the city. During the 1980s the area had lost a large number of rental apartments to cooperative conversion, and because of restrictive state legislation, developers were disinclined to build new complexes. From Avalon's point of view, however, such difficulties merely presented an opportunity to develop high-yield luxury communities, even if it required several years before a project might come to fruition. Avalon also continued to develop projects in its other core markets, as well as engaging in more acquisition activity than management had anticipated. To help fund these purchases, the company regularly shed assets that no longer fit its upscale profile.
Bay Communities Comes Aboard in the Late 1990s
Most of the acquisitions were single apartment complexes, but in 1997 Avalon completed a major transaction, paying $196 million for properties owned by Trammell Crow Residential-Midwest, an operation with which Michaux was well familiar, having served as the Group's managing partner. Avalon added luxury apartment communities in Chicago, Minneapolis, St. Louis, Cincinnati, and Indianapolis, plus contracts to manage a number of other properties, which were likely acquisition candidates. Moreover, Avalon now had a toehold in new high barrier-to-entry markets, part of the REIT's strategy of becoming America's dominant player in the luxury sector. The next step in achieving this goal took place a year later when Avalon and a REIT with a similar mission on the West Coast, Bay Apartment Communities, Inc., decided to merge their businesses.
Bay was formed as a REIT in 1994, assuming the assets of San Jose-based Greenbriar Development Company, which was founded in 1978. At the time of the offering the company's portfolio consisted of 14 complexes containing nearly 3,500 apartments. The IPO raised more than $200 million. Like Avalon, Bay operated in high barrier-to-entry markets, in particular pricey Silicon Valley. After going public Bay opened several new complexes but proved to be especially adept at acquiring older apartment buildings located in tight markets and re- developing them. Bay also expanded beyond the northern California market, moving into southern California and the Pacific Northwest. With two-thirds of its properties located in the San Francisco Bay area, Bay prospered during the 1990-boom years of the high technology sector of the economy. Because of increasing rents, Bay was able to provide shareholders with an average annual return of 25 percent per year, while Avalon returned 17 percent each year.
Bay's chairman, Gilbert "Mike" Meyer and Avalon's Michaux had known each other for many years and had for some time discussed the possibility of merging the two REITS. Because the two companies shared similar strategies and goals a merger made sense, allowing them to better compete in the future than if they had elected to go it alone. Although essentially a merger of equals, under terms of the deal, Avalon, America's fifth largest apartment REIT, was merged into Bay, the sixth largest REIT, in a deal valued at $2 billion. The resulting company, renamed AvalonBay Communities, instantly became the second largest apartment REIT in the country, trailing only Chicago-based Equity Residential. Although Bay's San Jose offices would be kept as a regional headquarters, the new company would be run out of Alexandria, Virginia, with Michaux serving as the chief executive officer, in charge of integrating the two companies and running day-to-day affairs. Meyer would remain in San Jose to focus on the company's strategic visions and to be involved in development projects.
Over the course of the next year Michaux guided AvalonBay through a transition period, which proved to be more difficult than anticipated. Michaux told National Real Estate Investor in a 1999 interview that melding a West Coast company and an East Coast company was a challenge: "In the end, while the cultures appeared to be similar, each company had a long history of operating with a set of beliefs and values that were, at least from a bi-coastal standpoint, interpreted somewhat differently. It took us a while to understand a West Coast take on the same kind of value system that we had on the East Coast. ... It took some time to learn how to talk to each other, to figure out what each meant by 'spirit of caring' or 'sense of integrity'."
With the transition behind it, the REIT was free to pursue a long-term goal of branding the AvalonBay name in the luxury apartment marketplace. Prospects for ongoing growth appeared promising in light of the aging U.S. population. One of the fastest growing segments of the apartment rental market was empty-nest householders who increasingly preferred to live in a luxury apartment than to maintain a house. Moreover, because AvalonBay concentrated on mature markets, such as the New York City area, it could be assured of a consistent demand for apartments.
Michaux stepped down as CEO in February 2001, replaced by the company's president and chief operating officer, Bryce Blair. In January 2002 Blair also would succeed Michaux as chairman of the board. He was well seasoned, having worked with Michaux for nearly 20 years. A Harvard Business School graduate in 1985, he immediately went to work for the Northeast Group of Trammell Crow Residential. He then joined Avalon when the REIT was formed, becoming a senior vice-president for development, acquisitions, and construction, a title he would retain following the merger with Bay. Blair took charge of AvalonBay at a time when a softening economy resulted in flat earnings for the company, but there was every reason to believe that AvalonBay remained well positioned to enjoy long-term prosperity.
Principal Subsidiaries: Avalon Development Services, Inc.; AvalonBay NYC Development, Inc.; Bay Asset Group, Inc.; Bay Development Partners, Inc.
Principal Competitors: Apartment Investment and Management Company; Archstone-Smith Trust; Gables Residential Trust.
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