In mid-February of 2022, several weeks prior to the launch of the HAUS ETF, Invitation Homes (INVH), the largest owner/operator of single-family rental (SFR) homes in the US disclosed on its fourth quarter 2021 earnings conference call that a whistle blower lawsuit had been filed against the company in the state of California. Our understanding is that California law allows private individuals to file whistle blower lawsuits against corporations and to potentially share in the damages (typically in the range of 15-25%), subject to court approvals.
The suit alleges that INVH renovated thousands of homes across 18 cities (over a multi-year period) and failed to pay permitting fees and commensurate incremental property taxes related to the renovated homes. The California attorney general opted not to pursue the case but passed it along to the individual cities involved to evaluate. As of this writing, ten cities have declined to move forward on the case and the remaining eight are still pending.
Irrespective of the outcome at the municipal level, the whistleblower is proceeding with the suit in state court and INVH has requested that the venue be moved to the Federal court. Commentary from at least one independent third-party expert has conjectured that the liability associated with not properly permitting work on upwards of 7,000 housing units under question could be in the range of $10,000 per unit or $70.0 million. This estimate does not include any assumption for incremental property taxes nor does it take into consideration the larger risk that the behavior was systemic and could potentially impact a larger percentage of the portfolio across multiple states. [1]
Leading up to the “creation basket” transaction for HAUS on March 1, 2022, the SFR sub-sector represented approximately 12% of the investable universe with larger market capitalization name, Invitation Homes (INVH) representing just under 8% and its smaller peer American Homes 4Rent (AMH) approximating 4.2% of the sub-sector weight. (Based on FTSE NAREIT All REIT Index Weightings at 12/31/21. The FTSE NAREIT All Equity REITs Index is a market capitalization-weighted, free-float adjusted index of US equity REITs. All tax-qualified REITs having more than 50% of total assets in qualifying real estate assets other than mortgages secured by real property are included in the index). In creating the SFR basket for HAUS, we elected to take an overweight stance on the sub-sector with an allocation of 14%. The constituent breakdown was 6.80% to AMH and 5.66% to INVH. The end result was taking a meaningful position in the sub-sector driven by a highly attractive fundamental outlook, while also deemphasizing the sector bellwether even though its common shares had underperformed its residential peers by a consider margin as a result of the litigation discussed above
More recently, the share price of INVH has recovered a meaningful amount from the time of its mid-February disclosure, having traded from the low-$37/share range back up to $41/share. We have not received any additional clarity on the lawsuit, however there is an expectation that a settlement is a higher probability outcome than a trial and this outcome could come by the end of the third quarter. [1] (This outcome predicated on an assumption of no additional adverse announcements.) With the recent recovery in INVH’s share price, we have trimmed the position moderately, and it is no longer a Top 10 holding of the fund.
It is our belief and perspective that legal matters such as the one recently announced by INVH warrant a “tactical” classification within our portfolio construction methodology as the ebb and flow of news related to the legal proceedings can trump the operating fundamentals on the ground. It is also during these periods of potentially heightened stock specific volatility that we rely upon the collective backgrounds and wisdom of our team and their experience in the industry. As we consider the risk that the accusations made against the company could have slipped beyond the financial controls and best practices that we believe to be in place, we are emboldened by the leadership and independence of the company’s board of directors as well as the stewardship demonstrated to date by the senior management team
We are comfortable that our current portfolio positioning in INVH fairly captures the near-term volatility and risk that could result from the dissemination of additional information related to the lawsuit. We are also confident that the quality and scale of the INVH portfolio, which was painstakingly accumulated over the past two decades, coupled with the platform and operating synergies of the organization provides a buffer to the extent that we see a material dislocation in stock price versus underlying property value and thus we have the flexibility to proactively add to our stock position as warranted.
Investors should consider the investment objectives, risks, charges and expenses carefully before investing. For a prospectus or summary prospectus with this and other information about the Fund, please call (800) 693-8288. Read the prospectus or summary prospectus carefully before investing.
Footnotes:
[1] Mizuho Securities USA LLC: REITS Research, March 3, 2022 – Invitation Homes Inc.; By Haendel St. Juste and Vikram Malhotra