Real Life Monopoly: Avoid The 3 T’s

I used to own a portfolio of around a dozen duplexes that were located along an entire block. It took me around ten years to accumulate the rentals, but once I did, I felt as though I had won a game of “real life” Monopoly.

One of the most exciting things that I did as a landlord was collecting rent. Since I lived close to the rentals, I would visit the tenants on the first Saturday of every month to collect rent, usually in cash, and to chit chat about sports or local news.

Of course, because I was a landlord, the tenants would always tell me about property issues, such as broken toilets, roof leaks, or loud neighbors. I would most always leave with something that I had to resolve, and of course that took more time out of my busy schedule.

When I finally sold the properties, I did well, because I had fast-tracked the amortization schedule for my loan (15 years) and used cost segregation to reduce my tax liabilities.

However, when you add up all of the time and money I spent on the rentals, the best part of the deal (at least for me) was using the real estate as a tax shield, versus rental income. A few days ago I posted this on Twitter:

The American Dream

The American Dream can mean different things to different people. It could be landing a dream job, graduating from college, or retiring early. But owning your own home is one of the most famous parts of the American Dream.

However, owning a home has been getting harder and harder as rising labor and material costs have pushed up building costs.

Regulatory constraints have also been limiting the supply of homes. Because of this sustained supply shortage, America is currently short of millions of houses (2-6 million, depending on who you ask).

Unfortunately, the situation won’t be improving any time soon. High inflation and mortgage costs have made home buying more unaffordable than ever. Also, new construction levels are likely to drop in the near future.

The replacement cost of single-family housing has been increasing and is likely to continue to increase in the foreseeable future due to the constrained supply and increasing building costs.

Meanwhile, the U.S. population continues to grow, so the demand side will remain robust for a while. Combining this constrained supply and robust demand, the housing prices will keep trending upward until further notice.

The U.S. housing shortage won’t be resolving any time soon. As a matter of fact, existing home inventory has been steadily dropping in the past 10 years. The trailing twelve month average national existing home inventory was 2.8 M in 2011, but now it’s below 1 M.

Single Family real estate investment trusts (“REITs”) are a great investment choice to take advantage of this trend. As home ownership gets more expensive, more people will be interested in renting houses. Also, rental rates will keep on increasing as well.

As we discuss in the REIT Roadmap for 2023, published exclusively at iREIT, we believe that current trends may present significant growth opportunities in the upcoming year, although this may be partially offset by squeezed margins due to higher property taxes.

Avoid the 3 T’s – 2 Single Family Rental REITs

American Homes 4 Rent (AMH) and Invitation Homes Inc. (INVH) are two major players in the space. They own and rent a large portfolio of single family houses. With the ongoing housing shortage and robust demand, their portfolio value and cash flow should continue to grow.

American Homes 4 Rent

American Homes 4 Rent is a REIT that focuses on acquiring, developing, renovating, leasing, and operating single-family homes as rental properties. They are the largest integrated single-family rental building, covering more than 30 different markets and owning more than 57,000 properties.

AMH properties are in high demand, as demonstrated by a Same-Home Average Occupied Days of 97.1%.

AMH uses a strong technology driven operating platform and integrated development program to continuously optimize their portfolio and platform.

They have built up more than 10 years of operating data and analytics that help them optimize their revenue, and their team of local market experts provide strong insights and superior customer service. Also, the standardized floor plans and durable finishes enable them to control their expenses effectively.

AMH has a strong balance sheet and favorable capital structure. Their net debt and preferred shares to adjusted EBITDAre is 5.9x, and fixed charge coverage is 4.1x. Unencumbered core NOI percentage is 69.5%. AMH has $1.6 B liquidity available to them, and their maturity schedule is well managed over the next several years. The majority of their debt matures after 2026.

Following their portfolio improvements and growth, their revenue and cash flow has been growing substantially. AFFO (adjusted funds from operations) growth in the past 5 years has been 7.75% per year (5-year CAGR), and FFO growth has been 6.99% per year (5-year CAGR). Growth is expected to continue at a similar level, with FFO forecasted to increase about 9% in 2023.

And AMH has managed costs effectively, so this increasing cash flow has translated into a substantially higher revenue and growing dividend. The dividend growth rate in the past 5 years has been 29.2% per year (5-year CAGR). Their dividend is very safe at this point, demonstrated by a cash dividend payout ratio of 36.42% and AFFO payout ratio of 52.94%.

This REIT currently offers a 2.4% dividend yield and a decent valuation. iREIT calculates a 10% margin of safety at its current price.

Invitation Homes

Invitation Homes is a leading owner and operator of single-family homes for lease, offering high-quality homes in desirable markets around America. They are in 16 different markets with over 80,000 homes.

They have posted very consistent and industry leading growth in the past several years. Invitation Homes’ average annual NOI growth from 2017 to 2021 has been 6.1%, and I expect the trend to continue as supply and demand dynamics remain favorable.

Invitation Homes has been growing through strategic investment, and they have been strengthening their business relationships with home builders and other investment groups. A couple of examples include investment in Pathway Homes, a JV with Rockpoint, and a strategic relationship with PulteGroup, Inc. (PHM).

Invitation Homes invested in homes (acquired 328 homes through 3Q2022) and the technology platform of Pathway Homes, and will earn property management fees from this investment.

The JV with Rockpoint will also generate asset management and property management fees. PulteGroup is the nation’s third-largest homebuilder, and Invitation Homes expects to buy 7,500 new homes over a five-year timeframe that Pulte will design and build.

Invitation Homes maintains an investment grade balance sheet with $1.8 B of liquidity, and they do not have debt maturing prior to 2025. The majority of their debt is unsecured and at a fixed rate. This strong balance sheet and strong liquidity will allow them to grow and keep building relationships with their partners.

Currently, Invitation Homes is substantially undervalued by the market. Looking at their valuation metrics, the current P/AFFO ratio of 23.84x and P/FFO of 16.56x are about 25% lower than their 5-year average values.

Also, iREIT’s rating tracker shows that the margin of safety for Invitation Homes is at 17%, giving it a buy rating. The company also pays a relatively safe 3.0% dividend.

Risks…

As many of us know at this point, Federal Reserve is determined to bring inflation back to its desirable 2% range, even if the sustained high interest rates trigger a recession.

The interest rate hike has resulted in mortgage rates shooting up, and the high mortgage rate has been causing a recession in the real estate markets different metropolitan areas in the U.S. Overall, U.S. house prices has been declining.

Even though I don’t believe this is long-term trend, single family REITs may experience a negative impact from this real estate market recession. Their portfolio value may decrease, and the rental rates may decrease as well (or at least it won’t increase as much as they would like).

High inflation and interest rates may also cause a broader, more sustained recession. Company layoffs may cause the unemployment rate to rise sharply, and the housing market will see a negative impact from the struggles in the overall economy.

This might make the operating climate more difficult for these two REITs, resulting in more vacancies or defaults on the portfolio of American Homes 4 Rent and Invitation Homes.

We Like This Sector

Owning a home is a goal for many people, but has been becoming increasingly difficult due to rising building costs and constrained supply. House prices basically have been steadily going up since 2010, and the past two years have been brutal for home buyers.

As owning a house is becoming difficult, the home rental market has been becoming bigger and bigger. More than likely, the demand for rental house market will remain robust for the foreseeable future.

Single family REITs are great investment options to ride such trends. Their portfolio value will naturally increase over time, and their income will increase as overall rental rate increases.

The two REITs mentioned in this article are perfectly positioned to take advantage of the trend. Our REIT Roadmap for 2023 shows a strategy for how to fit these single family rentals into your portfolio.

Thank you for reading and commenting!