The term "housing recession" is being discussed more and more in the business press. As the Federal Reserve has hiked the federal funds rate, mortgage rates have doubled since the beginning of the year, driving down affordability. House price inflation has remained sky-high during the past year, but recent data from the government shows that prices fell 0.6% on a national basis.
Meanwhile, construction remains depressed, and the quantity of homes for sale remains low. How would a housing recession affect American Homes 4 Rent (AMH 1.82%)?
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American Homes 4 Rent is consolidating a historically fragmented business
American Homes 4 Rent is a real estate investment trust (REIT) that invests primarily in single-family rental homes. The company owns 58,715 single-family homes in 22 states. Its biggest markets are Atlanta, Dallas, Phoenix, Charlotte, North Carolina, and Nashville, Tennessee, which have been some of the strongest real estate markets in the U.S. Many of these locations have benefited from people leaving expensive states like New York and California.
American Homes 4 Rent focuses on purchasing single-family properties based on a granular analysis of each city and neighborhood. Historically, single-family rentals weren't considered a scalable business because there aren't great economies of scale. American Homes 4 Rent intends to disrupt and consolidate what is largely still a mom-and-pop business.
Rental increases generally lag home price increases
The company has had strong increases in rental growth, with properties on average seeing a 9.3% increase in rent compared to a year ago. Given that home prices rose 17.7% during the same time period, rents should be expected to keep rising. As a general rule, rents do follow home price appreciation, but with a lag. According to at least one study, rental inflation lags home price inflation by 21 months (or almost two years). So even if home price appreciation slows to nothing, rental inflation still has to catch up.
The fundamentals for the rental business remain strong
In fact, the rapid decline in home affordability has probably pushed many would-be home buyers back into rentals. Vacancy rates for rental properties remain at multidecade lows. This means that landlords have the upper hand in rental negotiations, which bodes well for rent increases.
US Rental Vacancy Rate data by YCharts.
If home prices do go into a decline, what does this mean for American Homes 4 Rent's portfolio of properties? Unless the decrease in prices translates into declines in rent, it probably doesn't mean much. First of all, American Homes 4 Rent carries its properties on its balance sheet at book value -- in the simplest terms, what it paid for the property, plus some capitalized expenses, minus accumulated depreciation. In other words, as prices have risen, the carrying value of American Homes 4 Rent's portfolio has not gone up commensurately. In fact, the actual value of the portfolio should be well in excess of carrying value since the average home in the company's portfolio was bought in 2015. Home prices have appreciated a lot since then.
Overall, the supply-and-demand situation for housing in the U.S. isn't conducive to major price declines. The National Association of Realtors estimates the under-building gap to be somewhere between 5.5 and 6.8 million homes. Because rents lag home price appreciation by almost two years, any decline in home prices should not affect rental inflation in the near term.
