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Why This Under-the-Radar Stock Is a Hidden Buy in Today's Stock Market

By Anne Burdakin – Jun 6, 2020 at 11:37AM

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The change in real estate patterns brings long-term investment opportunity.

Although the COVID-19 pandemic will eventually pass, the rumble of fundamental change in real estate is unmistakable. The health crisis has meant working remotely, job loss, and awareness of infection vulnerability in densely-populated urban areas. These are all factors in deciding where to live. If you add in the scarcity of homes to buy and the resultant high prices, the equation changes even more.

Leasing activity for suburban single-family homes has increased in recent weeks for Invitation Homes (INVH 0.09%) and competitor American Homes 4 Rent, according to The Wall Street Journal. The Journal elaborated, "Rental executives say some recent move-ins chose to rent instead of buy given the economic uncertainty. Others have leased houses to get out of apartment buildings, given the contamination risks associated with close living."

With almost 80,000 homes for lease in 16 markets across the country, Invitation Homes is the largest single-family landlord in the United States, making it uniquely positioned to take advantage of leasing demand growth. The majority of its properties are located in the western U.S. and Florida, in areas with rapid household growth. In each region, Invitation Homes concentrates its inventory in safe neighborhoods close to schools and business districts. This sets the company up for solid long-term growth.

Single-family home demand is met by leasing

A number of people relocating in the current environment ordinarily might prefer to buy rather than rent, but the scarcity of homes for sale has pushed prices up. Many consumers don't want to buy such an expensive asset that may be overvalued at the moment. Also, household formation is strongest in the 20 to 35 year-old range, and that generation has been squeezed financially. Having, for example, $50,000 available for a down payment may not be feasible for many households. 

A slowdown in construction is contributing to the shortfall in homes available for purchase, which is also working in leasing's favor. "We're still going to have the fundamental lack of supply to meet normal household formation," said Invitation's Chief Executive Dallas Tanner. "There are 65 million people between the ages of 20 to 35 coming our way." 

Indeed, demographics point to continued growth in single-family leasing demand over the next decade. Millennials are starting to build families and want more space, particularly a yard or garden. The work-from-home trend is likely to continue after the pandemic, which will drive demand for homes with separate quiet space, such as home offices. And many consumers must defer home purchases due to high student loan debt.

Invitation Homes targets high-income customers in markets with high real estate prices, such as Northern California, Southern California, Seattle, Tampa, and similar regions. "The residents we serve, on average, came into the pandemic with two wage earners per household, generating income of almost $110,000 that covered rent obligations by five times," Tanner said on the company's recent earnings call.

Cute kid helping his family move in.

Image Source: Getty Images

Solid earnings results

Invitation Homes released its first-quarter 2020 earnings report on May 6. Total revenue increased 3.3% year over year to $450 million, while total property operating and maintenance expenses increased 4.1% to $167 million. Net income attributable to shareholders increased 141% to $50 million, while net income per diluted common share more than doubled to $0.09.

Additionally, core funds from operations (FFO) and adjusted funds from operations (AFFO) per share increased 4.4% and 5.1% year over year to $0.34 and $0.29, respectively. These metrics assist us in evaluating a real estate investment trust's (REIT) financial performance more accurately because they strip out non-cash depreciation and amortization expense. Additionally, AFFO accounts for recurring capital expenditures such as painting projects or roof replacements, more accurately reflecting a REIT's cash generated or dividend-paying capacity.

Same-store average occupancy was 96.7%, up slightly year over year. Same-store renewal rent growth of 4.3% and same-store new lease rent growth of 1.7% drove same-store blended rent growth of 3.4%.

Chief Operating Officer Charles Young said, "Stepping back, we believe that our turnover should perform better in difficult environments compared to other residential sectors, as our residents stay longer, renew more often and are typically families that demonstrate stickier behavior with respect to housing choices."

Average rents are trending upward even through the coronavirus. Invitation Homes recorded same-store new lease rate growth of 3.2% in March, followed by growth of 1% in April. The company makes looking at properties more attractive to virus-conscious prospective residents by utilizing its smart-home technology and keyless entry systems, minimizing human contact.

Is the trend a ripple or a tidal wave?

On May 21, the National Association of Realtors reported sales of existing homes fell 17.8% month to month in April, while the supply of homes for sale fell 19.7%, driving up prices. According to Lawrence Yun, chief economist for the Realtors, "This could be a short-term shock from the use of common rooms or elevators in condos, or it could be a long-term trend of people wanting to buy away from the cities and in the suburbs."

Leasing a single-family home in a desirable area has always been an attractive option for a variety of reasons. The COVID-19 pandemic likely will have a lasting effect on real estate. Americans may place an even greater value on space and distance from neighbors. Since Invitation Homes is the largest single-family home landlord in the country, many of them will likely consider an Invitation property.

The trend seems to favor Invitation Homes, but what about investing in the company?

The share price is down about 7% year to date, having been caught in the coronavirus downdraft in the market. Invitation Homes stock closed at $27.73 on Thursday: in the upper half of its 52-week range.

The growth in FFO and AFFO are attention-getting indicators of Invitation Homes' financial strength. The stock's current dividend yield is 2.16% -- paltry compared to the average REIT yield of 5%, but still respectable.

I like this stock because it's a stable company in prime markets at the right time. Demographic changes were shifting demand toward single-family home leasing already, but I think the coronavirus effects on jobs and the need for more personal space will increase demand significantly.

Invitation Homes is an under-the-radar stock for now, but if my reasoning is correct, it won't be for long. The company is out ahead of a major trend, which is definitely the sweet spot. Buyers of Invitation Homes stock right now should be long-term investors with a high tolerance for risk. The company may be a bit overlooked at the moment, but as demographic change and new consumer needs evolve in real estate, investors should be well rewarded.

Anne Burdakin has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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