One of the hottest institutional investing strategies is single-family rentals. Institutions are deploying capital into this space as the fundamentals are incredibly attractive at the moment.
Recently, homebuilder Lennar (LEN 3.38%) teamed up with Centerbridge Partners and Allianz AG to launch a venture called Upward America. The concept is to launch single-family build-to-rent properties in high-growth markets.
American Homes 4 Rent (AMH 2.70%) and Invitation Homes (INVH 2.50%) are already in the single-family rental business. How will this affect their business?
One of the best potential returns out there
The single-family rental business is in nirvana right now. Capitalization rates for single-family rentals have hovered between 6% and 8% for the past several years. Cap rates describe the income of a property (basically rental income less the operating expenses of the property) divided by the price of the property.
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While a 6% to 8% income yield is attractive in itself, home prices have been appreciating at double-digit percentage rates. According to the S&P Case Shiller CoreLogic National Home Price Index, home prices rose over 10% last year. So add the cap rate to the home price appreciation, and you have a highly attractive return. Note that cap rates ignore leverage, so the returns are even higher when debt is introduced into the equation.
Despite COVID-19, occupancy and collections are both strong
American Homes 4 Rent and Invitation Homes are real estate investment trusts (REITs) that specialize in single-family home rentals. Both companies experienced high occupancy rates in 2021, with American Homes 4 Rent at 97% and Invitation at 96%. Despite the coronavirus pandemic, both companies have been collecting over 96% of billed rent.
Upward America will be capitalized enough to deploy $4 billion in capital. While that sounds like quite a lot of money, it doesn't necessarily translate into a lot of houses. Last year, Lennar's average selling price was $395,000, so we are talking just over 10,000 homes. American Homes 4 Rent's portfolio is 53,584 properties, so at scale, this joint venture will still be pretty small compared to American Homes 4 Rent. Invitation Homes' portfolio is even larger, at over 80,000 homes.
The new venture isn't going to upend the supply of rentals
To put Upward America's 10,000 homes into perspective, last year approximately 811,000 new homes were sold in the United States, according to the Census Bureau. According to the National Association of Realtors, there was a record low of just over a million homes for sale as of the end of February. This new venture isn't going to make any dent in the supply and demand dynamics of the single-family rental market. Demand is overwhelming supply at the moment. Lennar and Centerbridge probably won't be the last to enter this market, either. With mid-single-digit cap rates and double-digit asset price appreciation, the space will only see more new entrants.
American Homes 4 Rent trades at just over 28 times fiscal year 2020 adjusted funds from operations (FFO) per share. Since American Homes 4 Rent is a real estate investment trust (REIT), FFO per share is a better measure of profitability than earnings per share. Invitation trades at close to 30 times 2020 Adjusted FFO per share. Both multiples will appear high for a REIT, but remember that their asset portfolio is appreciating at a 10% clip. This won't show up in the book-value-per-share number, but it will show up as these companies sell off properties.
Prices for both stocks are up about 50% over the past year, and that is even after factoring in the headaches of COVID-19-related forbearance. The underlying business model of these companies is attractive enough to draw in competitors. Investors who like the single-family rental space, but don't want to buy a duplex, might find these two stocks interesting.
