2023-06-27 18:02:28 ET
Summary
- Shares of single-family residential REIT American Homes 4 Rent are down 20% over the past 18 months, as higher mortgage rates and an inverted yield curve have troubled the market.
- However, higher mortgage rates have altered several dynamics in the real estate market, funneling would-be homebuyers into renters.
- With the capacity to build 14,000+ homes on already purchased land, and the likely ability to raise rents higher than historical norms, American Homes merited a deeper dive.
- An investment analysis follows in the paragraphs below.
People get rid of plenty when they move--sometimes they're changing not just places but personalities .”? Colson Whitehead.
Today, we take a deeper look at a fairly unique housing play that is navigating rising mortgage rates. The shares have made a nice little run over the past few months despite ongoing challenges in the housing sector. Can the rally continue? An analysis follows below
Company Overview:
American Homes 4 Rent ( AMH ) is a Las Vegas-headquartered, Maryland-domiciled real estate investment trust ("REIT") focused on the acquisition, construction, and management of single-family homes as rental properties. Its portfolio includes 57,736 single-family properties (not held-for-sale) located in over 30 markets across 21 states, as well as 2,688 properties as part of joint ventures. American Homes commenced operations in 2012 and went public in 2013, raising net proceeds of $703.5 million at $16 per share. From an outward-facing perspective, it rebranded to AMH in January 2023.
Shares of AMH trade just below $35.00 a share, equating to an approximate market cap of $14.3 billion.
The REIT is capitalized by two classes of common shares and one class of units. The 361.1 million publicly traded Class A common shares bestow economic interest and one vote per share. The 0.6 million privately held Class B shares bestow economic interest, convertibility into Class A shares, and 50 votes per share. Founder B. Wayne Hughes – who was also a co-founder of Public Storage ( PSA ) – and his family own all the B shares and control 19.9% of the voting power of the REIT. Noncontrolling interests own 50.8 million units in the operating partnership, which are entitled to economic interest. For the avoidance of doubt, per share metrics refer to Class A shares.
Approach:
The REIT acquires homes, typically through the Multiple Listing Service [MLS] or through its nationwide network of homebuilders, that were built after 2000, have at least three bedrooms and two bathrooms, are priced between $250,000 and $600,000, and are located in markets with above-average median household incomes, steady population growth, and strong rental demand. Renovations, if necessary, generally take between 20 to 90 days. The location of its top 20 markets is geographically diverse, with its largest concentration found in the South and Southeast.
Furthermore, American Home, through its AMH Development Program, purchases land and builds homes for rent with plans to construct 2,200 to 2,400 single-family rental structures in 2023, making it the leading such builder in the U.S. and 39th largest homebuilder overall. Once land upgrade requirements have been met, per-unit construction typically takes four to six months. These developments are generally cookie-cutter neighborhoods with each property coming with a fenced-in private yard and access to "amenity centers" to promote community. The constructed properties have a lower cost to maintain than MLS purchased properties, as well as homes acquired from homebuilders; thus, generating higher net operating income ((NOI)). Reflecting an increasing area of focus given the current real interest rate environment, management currently boasts a land pipeline north of 14,000 units.
All rental properties, including the JVs, are internally managed.
From this approach, the REIT’s portfolio generates average monthly rent per unit of ~$2,000, with an average size of just under 2,000 sq. ft. The average age of its homes is 17 years.
When American Homes recycles properties, it attempts dispositions at cap rates (NOI / property value) around 3% and purchases in the upper 5% to 6% range. Its AMH Development Program cap rates are typically 6% or slightly higher.
Market
Most single-family residential REITs speak of significant tailwinds in their industry, all a function of the steep rise in mortgage rates that are driving Americans towards renting. These "positive" trends include an extremely low level of existing homes for sale, as current homeowners are locked into their low mortgage rates from the pandemic or pre-pandemic period. To illustrate, a homeowner with a $400,000 mortgage at 3.5% pays ~$2,100 a month. If he or she were to make a lateral move, the same $400,000 mortgage at 7.0% would require a monthly payment of over $2,900. Obviously, many other factors affect the economics of a move, but paying $800 more per month for the same mortgage acts as a strong disincentive to putting up a "For Sale" sign. As such, there is very little supply on the market, funneling would-be homebuyers towards renting.
Higher mortgage rates also influence the cost-to-own vs. rent analysis. Thanks to historically low interest rates over the past decade, this evaluation leaned slightly but consistently towards home ownership. Now, with the spike in mortgage rates, this assessment lands squarely on renting. According to an analysis performed by John Burns Real Estate Consulting in May 2023, rental payments are estimated to be 26% cheaper compared to monthly home ownership costs across American Homes’ top twenty markets. This undercurrent provides plenty of room for single-family residential REITs to increase rents annually above the ~2% to ~4% norm realized in the first two decades of the 21st century.
Furthermore, Millennials have taken over the mantle of the "bulge bracket" generation from the Baby Boomers, and they are entering their prime single-family residential years, likely creating greater demand for real estate, be it lease or purchase.
And it does not appear as if homebuilders will fill the perceived shortage, with permits for single-family homes down 30% in the first four months of 2023 versus the same period in 2022, with 2021 expected to be the peak year (at 1.12 million single-family permits) for the next half decade.
As some validation that these tailwinds are causing a rise in rental activity, American Homes cites its web traffic, which is attracting new users at a 20% greater clip 1Q23 versus 1Q22.
However, with higher interest rates, single-family residential REITs and private equity are applying the brakes and have become net sellers of properties. Case in point: Invitation Homes (INVH), the largest owner of single-family residences, purchased only 194 homes in 1Q23 versus disposing of 297, reducing its portfolio to 83,010 homes. Also, according to Redfin (RDFN), purchases by real estate investors fell 48.6% 1Q23 versus 1Q22.
Furthermore, from an investment standpoint, the inversion of the yield curve has driven many yield seekers into short-term government securities. Why receive a relatively lower monthly disbursement from a REIT when a better one (in many cases) can be had from a one-month T-bill?
American Homes was not immune from the real estate or stock market dynamics, disposing of 666 residences in 1Q23 while purchasing only 312 homes (including 299 constructed through its AMH Development Program) after buying 960 net homes in 1Q22. Owing to perceptions regarding the impact of inflation and the inverted yield curve, its stock is down 20% from its all-time high set on the final day of 2021.
1Q23 Financials & Outlook
These moves away from the MLS and homebuilder channels came to light when the REIT announced its 1Q23 financials on May 4, 2023, posting core funds from operation (Core FFO) of $0.41 per share, and Adj. funds from operations ((AFFO)) of $0.37 per share on revenue of $397.7 million versus Core FFO of $0.38, and AFFO of $0.35 per share on revenue of $356.1 million in 1Q22, representing increases of 9%, 7%, and 12%, respectively. Adj. EBITDAre, which adjusts for gains and losses on property sales but not recurring capital expenditures, was $212.0 million, up 14% from $186.1 million in 1Q22. These improvements were a function of 8% higher rent in its same-home portfolio, a greater number of properties to be occupied (year-over-year), and a slightly higher occupancy rate, with average occupied days percentage rising from 96.2% in the prior year period to 96.3% in 1Q23.
In line with its plans to construct ~2.300 homes in FY23, American Homes delivered 466 new units to its wholly owned and JV portfolios through its AMH Development Program in 1Q23. Through this channel and other capex, the REIT expects to invest ~$900 million in FY23, funded by cash flow, portfolio dispositions, a secondary offering completed in 1Q23, and debt.
Management reiterated its FY23 forecast of Core FFO of $1.61 a share, core revenue growth of 6% and core operating expense growth of 9.75%, and core NOI growth of 4%.
Balance Sheet & Analyst Commentary:
As of March 31, 2023, American Homes held cash and equivalents of $255.6 million against total debt outstanding of $4.4 billion (with a weighted average interest rate of 4.0%) for net leverage – consisting of net debt and preferred stock to TTM Adj. EBITDAre – of 5.4. Access to additional capital is not an issue, with $1.25 billion of undrawn capacity on its revolving credit facility, as well as 70% of its core NOI properties unencumbered. Moody’s recently upgraded its debt to Baa2. The weighted-average term to maturity of its debt is 12.1 years, and that is with $950 million due in 2024. The cash position was primarily funded through the settlement of eight million shares of AMH from a forward purchase agreement reached in 1Q22, which raised net proceeds of $298.4 million.
The REIT pays a quarterly distribution of $0.22 a share for a current yield of 2.5%. American Homes has a $300 million share repurchase program in place, of which it has expended $34.9 million but made no purchases in 1Q23.
Street analysts are a mixed bag on American Homes, featuring two buy and six outperform ratings against eight holds. Their median price objective is $34 per share.
Verdict:
In the current economic environment of high mortgage rates and stubbornly elevated (or slightly subdued) real estate prices, the REIT’s land improvement channel is the only one that is open for business. This operating flexibility and the rent-versus-own equation provide it with a clear path to growth. Rent inflation should remain elevated over historical levels for the next two to three years.
However, with targeted cap rates of ~6%, projected NOI growth of 4%, and a 2.5% yield, it is challenging to get excited about American Homes 4 Rent REIT when a three-month treasury bill yields 5.3%.
If we were meant to stay in one place, we’d have roots instead of feet …” -Rachel Wolchin
For further details see:
American Homes 4 Rent: Not The Right Time In The Cycle