TCN - Invitation Homes: Not Very Inviting Right Now

2023-12-06 10:44:18 ET

Summary

• Invitation Homes is analyzed in comparison to Tricon Residential, with Invitation being more appealing from a fundamental perspective.
• Invitation has a straightforward story for investors and a better balance sheet than Tricon.
• However, Invitation's current valuation fully reflects these considerations, leaving no margin of safety or potential for outsized appreciation or yield.

Summary

In this report, I continue my dive into the US single-family rental ("SFR") universe with an analysis of Invitation Homes ( INVH ). Compared to Tricon Residential, which I initiated coverage on back in November, Invitation is more appealing from a fundamentals perspective. It has a much more straightforward story for investors (e.g., no multi-family rental, development, or large asset management business), and has a significantly better balance sheet than TCN. However, Invitation's current valuation fully reflects these considerations and then some, leaving no margin of safety or potential for outsized appreciation or yield. Due to the rich valuation and attractive alternative in TCN, I am giving Invitation a Sell rating. My Sell rating reflects my opinion that there is no reason to own Invitation, and any potential returns are inadequate to compensate for its risk.

History

Invitation Homes' roots trace back to 2005 when Arizona entrepreneur Dallas Tanner and others formed the Treehouse Group. This venture initially focused on buying mobile home parks around Phoenix, but it quickly pivoted to single-family homes ("SFHs") when prices crashed in the GFC. In 2011, Treehouse merged with Dallas-based Riverstone Residential. The following year, Blackstone acquired the merged entity, rebranded as Invitation Homes, and provided substantial capital for expansion.

Invitation was also an early pioneer of single-family rental securitizations, which played a critical role in helping the newly institutionalized asset class scale. Blackstone took Invitation public in 2017, the second-largest REIT IPO in US history, raising ~$1.8Bn. Later that year, it merged with Starwood Waypoint Homes, another significant player in the single-family rental industry. In November 2019, Blackstone sold its remaining shares in Invitation.

Since Blackstone's exit, Invitation has continued growing its portfolio through SFH acquisitions and the creation of several JVs.

In October 2020, Invitation Homes created a joint venture with Rockpoint Group to purchase $1Bn of single-family homes in the Western US, Southeast US, Florida, and Texas. In March 2022, it announced another JV with Rockpoint , which it expects to purchase $750MM of SHFs in the same geographies but targeting higher-end properties than the first JV. In November 2021, Invitation formed an SFH rent-to-buy JV with Pathway Homes.

In addition to the Rockpoint and Pathway JVs, Invitation has a relatively small stake in a JV with FNMA that it inherited through the Starwood transaction.

While not a JV, Invitation entered a "strategic relationship" in July 2021 with the third-largest homebuilder in the US, Atlanta-based Pulte. Pulte was projected to design and build ~7,500 new homes in the next five years for sale to Invitation Homes.

Business Overview

Portfolio / Operating Performance

Invitation currently owns ~84,700 homes, ~80% of which are in the Sun Belt. The average home size across the portfolio is ~1,880 sqf with 3 bedrooms and 2 bathrooms, and AMR is ~$2,300.

From Q4 '21 to Q2 '23, the total home count was stable as it recycled capital, selling non-core properties at ~1.5-4.0% cap rates and acquiring new homes for ~5.1-6.0%. In Q3 '23, Invitation acquired an 1,870-home portfolio for a 5.5% cap rate (n.b., expected to grow into the 6s within a year) and 387 individual homes for a 6.0% average cap rate. The 387 acquired homes were effectively funded by selling 397 wholly-owned homes at a 4% average disposition cap rate . NOI has grown at a ~7.1% CAGR from Q4 '21 - Q3 '23.

The performance of Invitation's portfolio has been as strong as expected for an SFR platform in recent quarters. Occupancy has remained high at 97-98%, with +6% annualized AMR growth. The last 5 quarters' operating performance for the same store portfolio as of Q3 can be seen in the table below. It is interesting to note the deceleration in new lease rent growth, which indicates a combination of (1) Invitation having eliminated much of its loss-to-lease and (2) a deceleration in market rent growth.

Financials

The chart below shows that Invitation has managed to deliver mid to high single-digit FFO/Core FFO/AFFO per share growth through '22 and '23. YTD AFFO per share is up ~7% from the comparable period in '22 (n.b., ~10% for FFO and ~6% for Core FFO). This is a function of the solid operating performance discussed above and the REIT's predominantly fixed rate and long-dated debt profile, which insulated it from much of the impact of interest rate hikes.

As we see below, +99% of Invitation's debt is fixed or swapped to fixed, and its average interest rate is ~3.8%. Leverage is <6x EBITDAre and D/GAV is <30%.

Its weighted average term to maturity is ~5.2 years, with a well-staggered maturity profile (see below). Because it faces no maturities until 2026 (assuming extension options are exercised), I did not feel the need to apply an interest rate MtM adjustment to my valuation.

The combination of strong operating performance and well-structured debt profile has enabled Invitation to raise its dividend twice in this period, +29% in Q1 '22 and +18% in Q1 '23 (n.b., ~27% dividend CAGR), while maintaining healthy ~60-70% payout ratios.

Valuation

INVH currently trades at ~19x '23E FFO / ~23x '23E AFFO (n.b., ~12% premium to my NAV estimate, ~5.5% implied cap rate).

My NAV estimate of ~$30/share (n.b., implying ~11% downside) is based on a 6.0% cap rate (n.b., in line with Q3 acquisitions, excluding the 1,870 home portfolio acquired at ~5.5%) and NTM NOI of ~$1.56Bn (n.b., ~10% higher than LTM, ~9% implied CAGR Q3 '23 - Q3 '24). It also includes a positive adjustment of ~$109MM, my estimated value of the management business based on 8.0x LQA management fee revenue. This is identical to the property management and development multiple I used for Tricon , rather than the 12.5x asset management multiple. I took this approach as INVH's management business is far smaller and less developed than TCN's, and to implicitly account for the related overhead (n.b., using 8x results in a materially identical value as if I were to assume a similar margin to the rental business).

While it could be argued that 5.5% is an appropriate cap rate given the recent portfolio acquisition at that price, this would still imply INVH is trading basically at NAV. It generally takes a lot for me to be comfortable paying full value for a REIT's NAV, let alone a premium. It can make sense when a REIT has a large acquisition pipeline, a significant mark-to-market opportunity, or some other such catalyst. INVH has a relatively small pipeline of ~240 homes for Q4 and ~600 for FY24 and a modest loss-to-lease of 6-8%. While these metrics should support strong growth over the next year, I do not see them as insufficient to overcome the ~12% premium to NAV.

Risks

Property Tax Expense Growth

In its Q3 earnings call, Invitation's management called out what it expects to be a material increase in property tax expense:

While the fundamentals that have favored housing are well known to us, we originally anticipated property tax millage rates in both Florida and Georgia would decline to at least partially offset some of the unprecedented home price appreciation that's occurred there. Based on the property tax bills we've received or expect to receive during the fourth quarter, that's not been the case and causes us to now expect full year same-store property tax expense growth of approximately 10% to 10.5%.

This is a significant development, with Florida and Georgia collectively representing ~45% of Q3 revenue. If local governments in other jurisdictions follow suit, this could pose a serious risk to NOI margins.

Home Ownership Affordability Mean Reversion

US SFR operators are benefitting from a significant undersupply of housing and a large affordability gap favoring renting vs buying a home. The affordability gap is primarily a function of elevated home prices and high mortgage rates. Home prices surged during COVID as demand for space, particularly in less urban areas, soared. This was enabled by the low interest rates of '20 and '21. While home prices have normalized somewhat, there is still a wide bid/ask spread in many markets. Meanwhile, mortgage rates have exploded. In their Q3 earnings call, Invitations management estimated that renting a home was ~$1,100 per month more affordable than buying in its markets.

If sellers capitulate, causing home prices to decline and interest rates to fall (n.b., likely in this scenario as homeowner distress would correlate with a recession), this affordability gap may narrow, softening SFR fundamentals in the medium to long term.

Valuation

As discussed above, Invitation is currently trading at a ~12% premium to NAV (n.b., or exactly at NAV under a more generous cap rate assumption). As a result, its performance should broadly track the underlying performance of its portfolio and the SFR market. Without a significant margin of safety, any adverse developments in the SFR market, such as those discussed above, pose a significant risk to the shares.

Catalysts

As there is no apparent undervaluation, I see few, if any, discrete catalysts for Invitation. I expect SFR fundamentals to hold for the foreseeable future (though this could change very quickly) and for Invitation's shares to track its operating performance. The only credible catalyst I see is an acceleration in acquisitions. Of course, these acquisitions need to be accretive and thus would likely require a significant correction in home prices. As discussed above, a home price correction would present challenges to Invitation; however, buying homes at very low/distressed prices could help offset the resulting weakness in the rest of the portfolio.

Comparison to Tricon

Among the 3 main US SFR REITs (TCN, INVH, and AMH), INVH is the largest. Its average home size is significantly larger than TCN's but slightly smaller than AMH's. Its AMR is the highest of the 3, partly due to its higher exposure to the more expensive Western and Southwestern US markets.

Based on my analysis of Tricon and Invitation, I see several puts and takes for each.

• Scale / Efficiency: Despite Invitation's far greater scale, Tricon's SFR segment displays higher NOI margins (n.b., ~60% LTM average for Invitation vs ~69% for Tricon). Some of this is likely due to Tricon's lower turnover rates, though it could also be a function of cost allocation.
• Management Business: Tricon's Strategic Capital business is a much more significant component of its overall business and strategy than Invitation's JV management agreements. This is positive for Tricon as it provides a lower-risk revenue stream and a slight diversification benefit. However, it complicates the business model, which might make it less attractive to investors seeking pure-play SFR exposure.
• Geographic Exposure: Tricon has ~10% points more exposure to the Sun Belt than Invitation (n.b., ~90% vs ~80% for Invitation). This is a point in favor of Tricon.
• Leverage: This is the most significant difference between the two. Invitation's leverage of 5.5-5.7x EBITDAre is significantly lower than Tricon's ~8-12x (see my Tricon report for details). Invitation has virtually no floating rate exposure and no near-term maturities, while Tricon has ~27% floating rate exposure and ~45% of its total proportionate debt maturing in '24 and '25. Overwhelmingly, this is a point in favor of Invitation. The only way to spin this a positive for Tricon is that it is better positioned for an outsized FFO/AFFO per share uplift when rates come down. I have also factored in an interest rate MtM adjustment for Tricon's upcoming maturities in my valuation.

As discussed above, I do not consider Invitation's current valuation compelling. This is especially true with Tricon trading at a ~20% discount to my target price (n.b., despite the ~13% rally since my initiation report) with a mid-teens loss-to-lease, the imminent launch of its next JV, and large development pipeline.

While I like the fundamentals of the US SFR market, I do not have enough conviction to make a pure market bet, which is exactly how I see Invitation at current prices. It would have been the clear pick over Tricon heading into the recent rate hike cycle, with its largely fixed rate and long-dated debt profile. However, with the market having already priced in Invitation and Tricon's relative strengths and weaknesses, and the rate picture beginning to change, Tricon is my current preference in the SFR space. I plan to cover AMH in an upcoming report.

Conclusion

I continue to like the SFR space, particularly in the US Sun Belt, for its attractive supply/demand dynamics and demographic tailwinds. So far, I have covered Tricon and Invitation Homes, and I plan to look at American Homes 4 Rent next. For now, Invitation is the more attractive pick on fundamentals. Its revenue management seems much more aggressive than Tricon's, and its balance sheet is far superior. It is also much more of a pure SFR play than Tricon, with the latter having small but significant development, multi-family, and asset management businesses. However, the market has realized this and priced Invitation accordingly. I am giving Invitation a Sell rating purely for its valuation, with shares fairly priced at best. The yield is unappealing, and the price appreciation potential is inadequate to compensate for the risk profile. As I mentioned earlier, this rating reflects my belief that there is no use case for Invitation in my current portfolio.

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