Apartment Income REIT has significantly slimmed down the portfolio of multifamily buildings it owns over the past decade to just its best assets. The company invests in metropolitan markets with solid demographic trends that allow the company to maintain high occupancies and pass along consistent rent increases. Demand for apartments depends on economic conditions in their markets like job growth, income growth, decreasing homeownership rates, high relative cost of single-family housing, and attractive urban centers. Apartment Income's portfolio is typically more suburban than its multifamily REIT peers, which has put it at a slight disadvantage over the past economic cycle but should favor growth in the company as millennials move from the urban centers out into the suburbs over the next few years. The company regularly recycles capital by selling noncore assets or markets and uses the proceeds to fuel targeted acquisitions with strong growth prospects, a strategy that has improved the company's performance over the past few years.

Apartment Income has significantly simplified and streamlined its portfolio and strategy over the past decade. While the company has decreased its portfolio from over 300 properties at the end of 2008 to 96 properties in the current portfolio, the company owns approximately the same number of assets over that time frame in the 8 markets it currently considers to be its core markets. The company's exit from markets with lower growth prospects has increased the portfolio's expected average growth. The company completed the sale of the last of its affordable living and asset management businesses in 2018, segments with limited growth prospects that the company has been trying to exit for years. In 2020, Apartment Income spun off its development pipeline and lease-up portfolio into its own company so that the remaining company could focus on the highest-quality assets. These efforts have brought Aimco's portfolio closer to its peers in terms of both asset quality and market exposure. While the company still has a differentiated portfolio from its peers, we expect it to have similar internal and external growth opportunities.

We assign a no-moat rating to Apartment Income REIT. While Apartment Income has a portfolio that averages B+ in quality, the initial rents and rent increases the company achieves on its properties compared with the initial capital investment produce returns that are below WACC, leading us to conclude that they do not quantitatively support a moat for the company.

Strong rental rates and rent growth are supported in markets with the demographics to support them. As average income levels in a metropolitan area increase, rents grow as tenants can afford higher housing costs. Dense populations with a propensity to rent support high occupancies in large apartment buildings. Metropolitan areas attract more people to area with sustained economic and job growth, which leads to occupancy growth in apartment buildings. The apartment manager can drive higher rent growth on existing tenants once an apartment building reaches a fully stabilized occupancy level as they know that the marginal tenant who would move out from higher rent increases can be replaced by the excess demand for the units. Properties distinguish themselves as being high-quality living spaces by offering better amenities, better services, higher quality finishes, larger floorplans, and other desirable features and they generate additional demand in any market that further support higher rents and larger occupancy/rent increases. Additionally, properties located in desirable submarkets with easy access to transportation, are near business districts, provide food and entertainment options, and have low crime statistics see higher demand that can translate to higher rents and higher growth. However, there are few barriers to entry to the residential market, and much of the demand in Apartment Income's markets is absorbed by supply growth of multifamily properties. Additionally, Apartment Income's portfolio of apartment communities faces competition from other property types such as the single-family homes, the single-family home rental market, condominium ownership, and other housing options. The company’s ability to set high initial rents and pass along high rent increases is kept in check by the relative affordability of other types of housing that residents might consider.

Apartment Income concentrates on owning assets in suburban and select urban submarkets of major metropolitan areas that feature high incomes, dense populations, and positive job and income growth. The company’s West Coast properties in particular are in markets that should see several years of job and income growth above the national average, which should lead to higher rent growth. On average, the company owns B+ quality assets, which supports market average rents for the apartment units. The company also regularly makes capital improvements and redevelops its portfolio to maintain the portfolio’s quality and keep it competitive in the market. Despite the positive demand drivers present in Aimco's markets and assets, intense competition for high-quality assets in strong markets drove up the initial capital investment on the company’s portfolio. Additionally, the high supply growth present in many of the company’s markets and the ever-present competition from alternative housing options keeps rent growth in the low- to mid-single-digits. As a result, the company acquired its portfolio at low initial cap rates and the realized internal growth rate isn’t high enough to exceed the company’s WACC.

We use an adjusted ROIC calculation to determine if a company historically has shown or is forecast to have the characteristics of an economic moat. After adjusting the ROIC calculation to use maintenance capital expenditures instead of accounting depreciation, we calculate that over the past few years Apartment Income has averaged an adjusted ROIC approximately 220 basis points below our 7.1% WACC. While the adjusted ROIC rises over our forecast horizon as the assets stabilize from recent transactions and developments, it does not exceed our WACC estimate for the company. This affirms our view that Apartment Income's portfolio should be assigned a no-moat rating.

We are increasing our fair value estimate to $47.50 per share from $44 after incorporating second-quarter results and adjusting our near-term forecasts to account for a better-than-anticipated recovery from the pandemic. Our fair value estimate implies a 4.3% cap rate on our forward four-quarter net operating income forecast, 23 times multiple on our forward four-quarter funds from operations estimate, and 3.5% dividend yield based on a $1.64 annualized payout.

The rent, occupancy, and margin assumptions drive total company annual same-store NOI growth averaging 4.4% across our 10-year forecast. We expect continued acquisition and disposition activity as Apartment Income recycles capital, repositions its portfolio, and improves the overall quality of its assets. We currently project $200 million of dispositions a year at an average cap rate of 5.75% and $100 million-$200 million of acquisitions at 5.25% cap rates as the company looks to recycle lower-quality assets to fund the acquisition of higher-quality assets. We no longer expect the company to fund a development pipeline.

We estimate Apartment Income's net asset value to be approximately $39 per share. We use NAV as an assessment of the firm’s potential private-market value, essentially viewing the firm as a portfolio of assets. To calculate the NAV, we use recent asset transactions to assign a cap rate to each segment of the portfolio, apply the cap rates to arrive at gross asset value for the company’s real estate, put a multiple on the company’s non-real estate assets, add the non-income producing tangible assets, then net out the company’s liabilities (excluding corporate overhead considerations). We find NAV to be a useful data point in gauging the underlying value of the firm, especially as the likelihood for realizing this value through potential asset sales, recapitalization, or mergers and acquisitions activity.

The percentage of people renting has increased in urban, coastal markets due to favorable demographic trends such as falling homeownership, rising relative cost of single-family housing, and urban gentrification, which has created more demand for multifamily assets. The Millennial generation is the driving factor behind many of these trends, which may reverse as they collectively age and acquire enough capital to own single-family homes. If these trends were to reverse, that would negatively impact apartments, and this could happen quickly since most leases run for only 12 months.

Employment opportunities in the company's core markets generates demand for Apartment Income's portfolio. As a result, the portfolio is sensitive to any changes to the economies of these markets. While Apartment Income has a diversified portfolio, specific markets are sensitive to potential downturns to industries that are concentrated in those markets. The Northern California market is affected by the technology industry, and Washington, D.C. is affected by government employment. A downturn to these industries will affect the economies of these markets, leaving Apartment Income's portfolio exposed to falling demand for its assets.

While supply has been more concentrated in the urban centers of Apartment Income's core markets, the suburbs are still affected by high supply. We expect the current level of supply to be absorbed by demand growth and help moderate the market but recognize that increased new supply will pressure operations and asset values.

The company may face environmental, social, and governance, or ESG, risks that would negatively affect the portfolio or cashflows. These include properly maintaining the safety of the buildings across the portfolio, paying a competitive wage to employees, and accounting for the future impact of climate change.

We give Apartment Income REIT a Standard capital allocation rating. In our opinion, the company’s balance sheet is sound, its capital investment decisions are fair, and its capital return strategy is appropriate.

We view Apartment Income's balance sheet as sound. While we project 2021 net debt/EBITDA to be roughly 9.6 times, which is above the company's long-term target, we believe this metric will improve to industry average levels over the next few years as the apartment market recovers.

The company’s capital investment decisions are fair, with Apartment Income growing predominantly through internal growth and acquisitions after spinning off the company's development pipeline in 2020. While the handful of acquisitions the company has made in recent years have been at a slight premium to the company average, they looked to enhance average portfolio quality and thus improve company growth and reduce risk to the portfolio over time.

We assess the company’s capital return strategy as appropriate, as Apartment Income has averaged a dividend payout ratio of 75% of normalized funds from operations the past several years. We think this is an appropriate level for a REIT, and while the payout ratio increased in 2020 we believe the company will return to this level in the future as operations return to a prepandemic level.

Terry Considine has been the company's chairman and CEO since the former company's (Aimco) IPO in 1994 and has 45 years of experience investing in real estate, having contributed the apartment business of his other company, Considine Companies, to the founding of Aimco. His experience in the real estate industry and experience as a CEO at three prior REITs provides him a wealth of expertise on running a multifamily REIT, but we think that one individual acting as both chairman and CEO is not good company governance as it has the potential to create conflicts of interest. Additionally, his continued position as the CEO of the Considine Companies has the potential to distract him from focusing on the operations at Aimco and addressing issues as they arise. The rest of the management team has been with the company for at least a decade and has extensive knowledge of the real estate industry.

While Apartment Income has performed mostly in line with its peers during the current economic cycle, long-term performance for the company has lagged due to fallout of the great financial crisis. At the outset of the financial crisis, the company found itself over-leveraged and over-extended in many low-quality markets and properties. Aimco sold over $4 billion in lower-quality assets in noncore markets, which improved the overall quality of the portfolio but was done at a cyclically low point for asset prices. The sales resulted in major gains that required special dividends be paid in stock at a time of depressed stock prices, diluting equity for shareholders. The company had to cut the dividend, restructure the organization to preserve capital, and reduce elevated leverage levels.

The company has since embarked on a strategy of repositioning the portfolio into core-market with better demographic trends and higher-quality assets that support higher NOI growth. This includes the recent decision in 2020 to split Aimco into two companies, Apartment Income REIT focused on owning a high-quality, stabilized portfolio of multifamily assets and a new Aimco focused on developing and leasing up new multifamily assets before selling them off. However, while leverage has come down since the 2008 financial crisis, it is still above its peers and where we think the company should be. We expect leverage to be a focal point for management as it seeks to promote organic internal growth while being prudent with capital allocation decisions for external growth opportunities.