“Inflation rose 9.1% in June, even more than expected, as consumer pressures intensify” – CNBC 7/13/2022
“Rising Inflation ‘Bad News for Everyone’ as Food and Fuel Costs Soar” – Bloomberg 7/20/2022
“Central Banks Grapple With Dual Threat of Slowing Growth, Rising Inflation” – WSJ 5/21/2022
Rent versus own? Single Family Rental vs. Apartment vs. Home Ownership?
What is the right answer? Well as we analyze 2Q earnings from the various Residential REITs that have reported so far, one common theme resonates through all of the results: Rental income continues to rise which should translate into higher dividend income payments to shareholders.
Why should the average investor care? In times of volatility in the face of the headlines that CNBC and Bloomberg report every single day, REITs have typically been that sector that investors turn to. NAREIT consistently reports that in times of rising interest rates and inflation, REITs tend to outperform the broader markets.
NAREIT March 2022 Update
From their March 2022 update (https://www.reit.com/news/blog/market-commentary/how-rising-interest-rates-have-affected-reit-performance), NAREIT reported that:
1. Historically, REITs have performed well during periods of rising long-term interest rates with average four-quarter return in periods with rising rates of 16.55% compared to 10.68% in non-rising rate periods from the first quarter of 1992 to the fourth quarter of 2021
2. REITs posted positive total returns in 85% of periods with rising Treasury yields from the first quarter of 1992 to the fourth quarter of 2021. The average four-quarter return in periods with rising rates for REITs is 16.55% compared to 10.68% in non-rising rate periods
3. REITs outperformed the S&P 500 in half of the periods when Treasury yields were rising from the first quarter of 1992 to the fourth quarter of 2021
Increases In Interest Rates Impacting Housing Markets
What about the housing markets? We have seen several interest rate increases by the Federal Reserve this year which has led to mortgage rates literally doubling year-over-year. That significant move in interest rates has made the cost of that mortgage much more expensive. Let’s be honest. The housing market is dramatically different today than it was just a few months ago. Many of those “hot” cities are no longer seeing multiple offers on properties where sales prices have been pushed above asking prices.
Institutions To Increase SFR Holdings
We saw data from Yardi Matrix and Metlife published on August 1st where “Recent research by MetLife Investment Management (MIM) estimated that institutions own some 700,000 single-family rentals in 2022, about 5 percent of the 14 million SFRs nationally. MIM forecasts that by 2030, institutions will increase SFR holdings to 7.6 million homes, more than 40 percent of all SFRs. Institutional acquisitions of SFRs in communities of 50 or more units soared in 2021 to $2.5 billion, according to Yardi Matrix. Institutional portfolio growth is currently focused on build-to-rent (BTR) projects or acquiring portfolios from smaller owners. BTRs are on track to deliver far more units in 2022 than in any previous year. More than 25,000 units are under construction and nearly 4,300 were already delivered in the first half of 2022, meaning the industry will easily surpass 2021’s record-high 7,705 deliveries. (https://www.yardi.com/news/press-releases/institutional-investment-in-single-family-rentals-is-on-the-rise-reports-yardi-matrix/)
This significant data highlights how young the Single Family Rental space is. With only 3 publicly traded REITs in the space (Invitation Homes, American Homes 4 Rent, and Tricon Residential), this is a sector that is seeing extreme growth and innovation across multiple channels. We have seen several reports highlighting Generation Z’s demand for single family rental properties as well as increased demand for these properties from folks who don’t want to buy a house.
In a 60 Minutes interview on March 20th, Gary Berman (CEO of Tricon Residential) said “we have an incredible amount of demand for what we do…in any given week, we might have two or 300 homes available for renting and we get about 10,000 leasing inquiries a week.” (https://www.cbsnews.com/news/rising-rent-prices-60-minutes-2022-03-20/)
Think about that for a second. We are talking about a 500 – 1 ratio of inquiries to home availability. In that same interview, Daryl Fairweather (Chief Economist at Redfin) stated that “We are not building enough housing for everybody who needs a place to live. We built fewer homes in the 2010s than in any decade going back to the 1960s, and at the same time millennials are the biggest generation and they're entering into home-buying age…The government has estimated that we are short about 4 million homes in this country, and that number is likely growing, especially since the pandemic.”
What about that selloff in the stock market? For potential homeowners who had their down payments tied up on Wall Street, well they saw their nest eggs take a significant hit during the 2Q which may have indirectly caused a slowdown in home purchase activity.
Opportunity On The Horizon
So let’s add up all these pieces. Rising interest rates and inflation plus a tattered housing market means what exactly? OPPORTUNITY!!
With second quarter earnings season now more than 50% completed for the residential REIT sub-sectors, we have been pleasantly surprised with reports thus far. The apartment group has been a primary beneficiary of the rising affordability gap in the housing sector driven by the precipitous rise in home prices over the past year coupled with the rise in mortgage rates. This dynamic has caused the economics of renting a housing unit to far outweigh the cost of homeownership. One apartment REIT commented on their 2Q earnings call that the rent proposition in their portfolio was 50% cheaper than owning a home in their respective markets. This 50% number compares to a historic difference of roughly 35% according to management comments. With homeownership currently out of reach for so many households, residential landlords have the benefit of higher retention rates within their portfolios (ie. Fewer moveouts and tenant turnover) along with higher overall occupancies and an ability to push rents higher on renewals of existing leases and on new leases due to market rents moving higher. This phenomenon has been a recurring theme throughout the residential sector for the past three or four quarters.
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