The August 10th earnings report from small-cap REIT, Tricon Residential (TCN) completed earnings season for the single-family rental triumvirate, which is anchored by industry leaders, Invitation Homes (INVH) and American Homes 4Rent (AMH). The earnings period was accentuated by strong portfolio operating metrics across the board which led to companies also increasing operating performance expectations for the balance of the year. This performance was driven by rising portfolio rents, low resident turnover and greater affordability from renting compared to purchasing a home. Companies held back from raising guidance expectations for full year earnings, or funds from operations (FFO) as they moderated external growth plans associated with purchasing large quantities of homes directly from the multiple listing services (MLS) due to low inventory levels and a belief that pricing will improve later in the year as home values moderate and market rents move higher.
Putting single-family rental (SFR) results into the context of the residential universe, we note that they did not generate quite the velocity of property operating income growth as their multi-family peers, but did outperform the results achieved by manufactured housing. The key differential across the three sub-sectors came down to blended lease spreads which were materially higher for many of the apartment companies, in the range of 12-16% compared to a strong, but more pedestrian 8-10% for the SFRs.[1]
Looking at operating results across the SFR universe, we note that AMH and TCN reported same-store net operating income (NOI) growth of 10.2% and 10.5% respectively, with INVH leading the pack at 12.4%. In a testament to the overarching strength of SFR fundamentals, occupancy in the period remained very high (97-98%) for all three companies even as they pushed rental rates on both new leases and renewal leases. Blended rental rate growth was more nuanced across the group with INVH turning in the best performance at just under 12.0%, followed by AMH at close to 10% and TCN at 8.4%.[2]
At the company level, INVH presents a conundrum for investors in that they continue to achieve peer-leading operating results from their large, young and diversified portfolio of high productivity homes. However, they also have the highest level of regulatory/legal risk due to the well-documented whistle-blower law suit in California which has also made them a lightning rod for progressive leaning lawmakers and media outlets looking for a convenient scapegoat upon which to lay blame for the worsening affordability gap in housing. On the company’s 2Q22 earnings webcast, management highlighted the supply/demand imbalance in the U.S. housing market and attributed their strong results in part to strong employment and population growth in their core markets led by millennial households that are attracted to the convenience and affordability of the SFR lifestyle which includes amenities like home offices and pet-friendly properties, which are hard to find in a traditional multi-family setting. While the company is benefiting from record low resident turnover in the period and year to date (YTD), the recurring challenges posed by labor and other inflationary pressures drove same-store operating expenses up 6.4%.[3]
As we parse the information gleaned from AMH during their end of period report, the macro view highlighted a housing deficit in the U.S. which is in the range of 3-5 million units. The other major topic of discussion was capital allocation. The company announced that they plan to “temporarily scale back” home purchases on the MLS as they anticipate buying opportunities will improve later this year and into early 2023. The company is starting to see MLS inventories come off of their historic lows and they expect these levels to build in the second half of the year. Management also anticipates that small portfolios and homebuilders with excess inventory could fuel future acquisitions as we see a reset in pricing. The company noted their roots in the housing recession of 2011/2012 and believes that a dislocation in home prices from current lofty levels could pose an attractive opportunity for external growth.[4]
TCN was the anomaly as it relates to external growth in the quarter. While the larger peers hit the pause button on acquisitions, TCN reported a record quarter for home purchases and found the rising cap rate environment conducive to allocating capital. A few distinctions relating to TCN may have contributed to the differing outcome. TCN is a materially smaller company and has the luxury of being able to “fish in a smaller pond” for opportunities. They also utilize joint venture funds as their primary outlet for investing, and these venture structures add incremental fees which increase returns on their capital. TCN also operates with a bit more leverage in their deals and has a unique business model in which they not only have access to cash flow and financing to fund growth, but also a legacy portfolio of non-core assets which are monetized for growth. The company commented on their earnings call that they are currently purchasing homes for capitalization rates of approximately 5.5% and these modestly higher yields are driven by rising NOI at the properties coupled with a moderation in home values.[5]
In summary, we are impressed by the high occupancy levels and strong blended lease rate growth achieved by the SFR constituents during the quarter. We also note that a widening affordability gap between renting and owning a single-family home has helped the industry maintain record low resident turnover and solidify market rent growth well into 2023. In terms of the reduced acquisition levels announced by industry behemoths INVH and AMH, we view this as disciplined capital allocation and an example of growth deferred, not growth lost. If these industry leaders are correct and home inventory levels rebuild from near historic lows, the opportunity to buy at more attractive yields should come to fruition in future quarters. It also appears that the challenging environment for homebuilders, with margins getting squeezed by high land values and input costs, coupled with record low affordability may also present an opportunity for large SFR companies to purchase new home inventory at attractive prices. As we have recently stated in several forums, it is our view that a reset in the for-sale housing market will lead to “stronger for longer” fundamentals in single family rentals.
Definitions:
Cash Flow - The net balance of cash flowing into and out of a business at any specific point in time.
Foot Notes:
[1] Goldman Sachs Research: Residential REITs 2Q22 Review; August 16, 2022 by Chandni Luthra
[2] Company Financials: 2Q22 Earnings Results Invitation Homes, American Homes 4Rent and Tricon Residential
[3] Company Financials: Invitation Homes – 2Q22 Earnings Results and webcast
[4] American Homes 4Rent – 2Q22 Operating Results
[5] Tricon Residential – 2Q22 Operating Results
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