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Got $500? Buy This Stock and Relax

By Brent Nyitray, CFA – Nov 3, 2021 at 11:44AM

Key Points

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How to invest in residential real estate without the headaches of property management.

One of the best-performing asset classes this year has been residential real estate. If you look at the latest numbers out of the Federal Housing Finance Agency, home prices are rising at an 18.5% annual clip. While many investors might want to get involved in owning rentals and reaping that home price appreciation, it is generally capital-intensive to buy a property, get a mortgage, and rent it out. However, there is another way to create that sort of payoff: American Homes 4 Rent (AMH -0.52%)

Picture of a house for rent

Image source: Getty Images.

American Homes 4 Rent is scaling up a historically fragmented industry

American Homes 4 Rent is a single-family rental real estate investment trust (REIT). It buys houses and rents them out. In many ways, this is one of the oldest businesses out there. Historically, single-family rentals were a mom-and-pop business where a landlord would have one or two properties, and would handle the property management issues themselves. Because maintenance like landscaping or minor repairs was such a local issue, single-family rentals weren't done at a national level. Enter Big Data. American Homes 4 Rent added the layer of data analysis that gives the company a leg up in the competitive residential real estate market, analyzing employment trends, home price appreciation trends, and supply and demand to determine the best places to place its bets. 

The balance sheet understates the value of the portfolio

American Homes 4 Rent had 54,785 properties in 22 states as of June 30, 2021. Some of the company's biggest markets include Atlanta, Dallas, and Charlotte. The average size of a property is just under 1,987 square feet and was purchased in 2014. The average book value is $189,129, which works out to approximately $95.18 per square foot. The overall median price per square foot in the U.S. is $123, according to the National Association of Realtors. The accounting rules don't allow companies to mark up their portfolio as the value rises, so there is some extra value in American Homes 4 Rent's balance sheet. 

For example, Atlanta is its biggest market. It owns 4,977 homes there with an average square footage of 2,165. With the median price per square foot of $252, you can estimate the average home value to be approximately $546,580, and the total value of the company's properties to be $2.72 billion. Each Atlanta property is carried on the books at $185,301 (before depreciation), which gives a book value of $922 million, which means there is $1.8 billion in "hidden value" on the balance sheet. Atlanta is only 9% of the portfolio, and other metropolitan statistical areas like Phoenix have been growing much faster. 

Between income and appreciation, the company is generating stellar returns

Last year, American Homes 4 Rent had $634 million of net operating income. If you divide that number by American Homes 4 Rent's real estate assets of $8.9 billion, you get an approximate rate of return of 7.1%. While this isn't exactly the same thing as a cap rate, it is close enough. Add that 7.1% rate of return to the typical home price appreciation of 18.5%, and you are looking at over a 25% return. Returns like that are hard to come by in this market. 

Last year, the company generated $367 million in adjusted funds from operations (AFFO) per share, which works out to be $1.20 a share. Since American Homes 4 Rent is a REIT, AFFO per share is a better measure of earnings capacity than earnings per share. At current levels, American Homes 4 Rent is trading at just under 34 times FFO. This is elevated compared to most REITs, but it probably should trade at a premium multiple, given the hidden value in the company's property portfolio. Given the supply and demand imbalance in the real estate market, along with the fact that almost all mortgages in the US are government-guaranteed, it is hard to envision another 2008 scenario. But that would be the biggest risk, along with a major economic slowdown and another eviction moratorium. 

Investors who want to get involved in single-family rentals but don't want to get calls about leaking pipes at 2 a.m. might want to take a look at this stock.

Brent Nyitray, CFA has no positions in 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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