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Morningstar | Aimco's Portfolio of Class B Apartments Outperforms in 2Q

Apartment Investment and Management Co. produced strong operating fundamentals that came in above our expectations for the quarter, but missed our funds from operations forecast due to the timing of certain costs. We don't see anything coming out of Aimco's results that would cause us to materially alter our view or change our fair value estimate of $43 and no-moat rating. Occupancies were up 40 basis points to 96.3%, and rate growth was solid at 2.8%, leading to same-store revenue growth of 3.2%, which beat our 1.4% estimate for the quarter. However, expenses were also high in the quarter at 3.3%, so same-store net operating income also came in at 3.2%, which beat our 1.4% estimate for the quarter. The company’s diversified portfolio was led in NOI growth by West Coast markets San Francisco and Los Angeles, which were up 6.3% and 5.9%, respectively, while East Coast markets with lower job growth like Philadelphia and New York had negative NOI growth at 5.0% and 2.7%, respectively. Aimco reported pro forma funds from operations of $0.61, missing our estimate due to higher general and administrative costs than we expected as the company paid out incentive compensation benefits to personnel in the quarter. The company narrowed 2018 FFO guidance, but we are still within its new range of $2.40 to $2.48 for the year.

Aimco has increased the average rent on its units by 7% over the past year. Internal growth accounts for 3.2% of the growth, but the other 4% comes from changing the portfolio mix through external growth. The company has sold out of markets with lower rents and bought or developed assets in higher-rent markets. However, the switch to higher rents doesn't equate to an increase in quality. By the company's own metrics, the percentage of the portfolio that it classifies as Class A apartments has fallen to 50% from 53% a year ago. That decision has benefited the company in 2018, as Class B assets are producing NOI growth 100 basis points higher than Class A assets, largely due to the high level of supply of Class A product being built in many markets relative to Class B, though this varies by market as Aimco noted that Class A is currently outperforming Class B in Los Angeles. While the high amount of Class B product in Aimco's portfolio differentiates it from its apartment REIT peers and led to strong growth this quarter, we are worried that a decrease in portfolio quality is shortsighted. Despite the high current supply, Class A apartments should outperform over the long run, and their cap rates should rise at a lower rate in the event of an economic downturn. We like that Aimco increased its average rents 7% for the year, but we would like to see it come from a combination of organic internal growth, improving market exposure, and improving asset quality.