2023-06-22 12:26:09 ET
Summary
- American Homes 4 Rent has outperformed the Real Estate Select Sector SPDR ETF over the last 12 months, but is currently trading at a high price-to-FFO ratio.
- American Homes 4 Rent has grown its FFO per unit every single year since its formation, at an average annual rate of 13.2%.
- The REIT has a strong business model and consistent growth, making it an attractive investment option, but investors should wait for a lower entry point.
- American Homes 4 Rent offers a lower dividend yield than most REITs but has a lower payout ratio and a stronger balance sheet.
American Homes 4 Rent ( AMH ) has outperformed the Real Estate Select Sector SPDR ETF ( XLRE ) by a wide margin over the last 12 months, as the former has gained 5% whereas the latter has declined -7%. The REIT has exhibited an outstanding performance record and currently enjoys positive business momentum. However, it is trading at a markedly high price-to-FFO ratio of 21.6 , which is far higher than the median FFO multiple of 12.7 of the REIT sector. While I will analyze why the REIT is not overvalued, investors should probably wait for a lower entry point in order to enhance their future returns.
Business overview
American Homes 4 Rent is an internally managed REIT that was formed in Maryland, in 2013. The trust engages in acquiring, developing, renovating and operating single-family homes as rental properties. It has nearly 58,000 single-family properties in more than 30 sub-markets of metropolitan statistical areas in 21 states and currently has a market capitalization of $14.5 billion.
The properties of American Homes 4 Rent have an average age of 17 years and a strong occupancy rate of 97.1%. The REIT has broad geographic diversification and its properties are located primarily in areas characterized by high economic growth.
American Homes 4 Rent has a strong internal development program, which results in consistent and predictable growth. The company aims to grow its portfolio without relying heavily on equity financing and has become one of the largest homebuilders in the country.
Thanks to its solid business strategy and the superior characteristics of the markets in which it operates, American Homes 4 Rent has exhibited an outstanding performance record. To be sure, the REIT has grown its FFO per unit every single year since its formation, at an average annual rate of 13.2%. The company has somewhat decelerated in the last few years but still it has grown its FFO per unit by 7.8% per year on average over the last five years.
Moreover, American Homes 4 Rent currently enjoys positive business momentum. The demand for single-family homes is high thanks to a persistent housing shortage and a housing affordability crisis. The REIT is ideally positioned to benefit from these conditions, as it provides a simple and accessible way for residents to enjoy single-family living.
In the first quarter, American Homes 4 Rent grew its revenue 12% over the prior year's quarter and its FFO per unit by 8%, from $0.38 to $0.41, thus exceeding the analysts' estimates by $0.01. Notably, the REIT has not missed the analysts' estimates for 20 consecutive quarters while its results have come markedly close to the analysts' consensus in most of these quarters. This is a testament to the strength and the reliability of the business model of the trust, particularly given that the above period includes the coronavirus crisis and the latest economic slowdown.
In the latest conference call , management reaffirmed its guidance for FFO per unit of $1.58-$1.64 this year. Given the remarkably consistent performance of the REIT, analysts seem to trust its guidance and expect FFO per unit of $1.63, towards the upper limit of the guidance. If the company meets the analysts' estimates, it will grow its FFO per unit 6% this year. This is certainly a satisfactory performance, particularly given the economic slowdown that has resulted from the aggressive interest rate hikes executed by the Fed. Even better, analysts expect the REIT to grow its FFO per unit by another 7% in 2024 and by 4% in 2025, to new all-time highs.
Valuation
As mentioned in the introduction, American Homes 4 Rent is currently trading at a forward price-to-FFO ratio of 21.6. This is an eye-opening valuation level for a REIT, as the median price-to-FFO ratio of the sector is only 12.7. It is thus natural that most investors will conclude that American Homes 4 Rent is overvalued right now.
However, this is not true. Thanks to its strong business model and its reliable growth trajectory, American Homes 4 Rent has traded at an average price-to-FFO ratio of 22.6 over the last eight years. In other words, the market has always rewarded this reliable REIT with a premium. The stock is now trading at a 4% discount compared to its average historical valuation and hence it is not overvalued.
On the other hand, investors should realize that a discount to historical valuation is warranted due to the multi-year high interest rates prevailing right now. High interest rates significantly reduce the present value of future cash flows and hence they tend to exert pressure on the valuation of stocks. To cut a long story short, American Homes 4 Rent appears approximately fairly valued right now and hence investors should probably wait for a more opportune entry point. A relatively attractive entry point would be the strong technical support at $32. Such a stock price would correspond to a price-to-FFO ratio of 19.6, which would be attractive for this high-quality REIT.
Dividend
American Homes 4 Rent froze its dividend between 2014 and 2020 and hence it has grown its dividend for only 3 years in a row. It is also offering a dividend yield of only 2.5%, which is approximately half of the median dividend yield of 4.9% of the REIT sector. The inferior yield of the REIT is especially important in the current investing environment, as high inflation erodes the real value of the portfolios of investors and high interest rates make it possible to identify many securities with much higher yields.
On the bright side, American Homes 4 Rent has a payout ratio of 61% , which is much better than the median payout ratio of 75% of the REIT sector. Moreover, the REIT has one of the strongest balance sheets in the REIT universe. Its interest expense consumes 45% of its operating income, whereas many REITs have seen interest expense consume most of their operating income lately due to the surge of interest rates since early last year. Furthermore, American Homes 4 Rent has net debt (as per Buffett, net debt = total liabilities - cash - receivables) of $4.6 billion , which is only 32% of the market capitalization of the stock. Overall, American Homes 4 Rent is offering a much lower dividend yield than most REITs, but it has a lower payout ratio and a much stronger balance sheet.
Final thoughts
American Homes 4 Rent has an exceptional performance record, as it has grown its FFO per unit at a meaningful rate every single year since its formation. Thanks to its solid business model, the REIT is on a reliable growth trajectory and hence it should be on the radar of most investors. However, the REIT seems to be fairly valued right now and is offering a lackluster dividend yield. Therefore, investors should probably wait for an approximate 10% correction of the stock before purchasing it.
For further details see:
American Homes 4 Rent Is A High-Quality REIT But Wait For A Lower Entry Point