After a torrid run, residential real estate prices are beginning to level off (and even decline in some cases) as the Federal Reserve hikes rates. The Fed's rate cuts in the early days of the pandemic triggered a double-digit percentage increase in real estate prices, with some areas hitting 30% annual growth.
The rise in home prices and mortgage rates made housing unaffordable for large swaths of the American population, and buyers are pulling back. How will falling real estate prices affect single-family rental real estate investment trusts (REITs) like American Homes 4 Rent (AMH +2.37%)?
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American Homes 4 Rent benefited from price growth in its markets
American Homes 4 Rent is a REIT that invests in single-family homes and rents them out. The company owns almost 59,000 properties in 21 states. Historically, the single-family rentals market was highly fragmented and dominated by landlords with a small number of properties. American Homes 4 Rent was one of the first REITs to successfully scale single-family rentals. The company has exposure to some of the metropolitan statistical areas that had the fastest home price appreciation during the pandemic rally, including Phoenix, Atlanta, Charlotte, Dallas, and Nashville.
NYSE: AMH
Key Data Points
According to some indexes, these hot markets like Phoenix and Dallas are now exhibiting price declines, at least on a quarter-over-quarter basis. Does this mean that American Homes 4 Rent will start reporting lower earnings? Well, it could be an issue down the road, but in the near term, plateauing home prices should be a nonissue. Given that rents typically lag the price of buying a home by around 21 months, the day of reckoning is likely still a long way off.
Rents lag home prices by almost two years
The reason for the lag is that rents get reset annually at the fastest. Even if home prices increase by 20%, landlords are reluctant to set rents on renewals that high. Often landlords will wait until the tenant vacates before adjusting the property's rent to match the market. This means most of American Homes 4 Rent's properties are at sub-market rents. Even if real estate prices stagnate or fall slightly, American Homes 4 Rent's properties still have plenty of catching up to do.
Housing supply and demand tilts in American Homes 4 Rent's favor
The biggest driver of home price appreciation has been the dramatic under-building since the real estate bubble burst in 2006. According to the National Association of Realtors, there is a housing gap of between 5.5 million and 6.8 million units. This amounts to several years' worth of housing starts. Rental vacancy rates are also at multidecade lows. Simply put, the supply and demand dynamics support higher rents going forward and a period of flatlining real estate price appreciation won't change that.
US Rental Vacancy Rate data by YCharts
American Homes 4 Rent is guiding for 2022 funds from operations (FFO) per share to come in between $1.52 and $1.56 per share. REITs tend to use FFO per share over earnings per share because depreciation and amortization are subtracted from revenue under generally accepted accounting principles (GAAP), but aren't an actual cash cost. This means earnings per share tend to understate the cash-flow generating capacity of the company.
At current levels, American Homes 4 Rent is trading at 20.7 times 2022 guided FFO per share. This is a reasonable multiple given that the company is a leader in the single-family rental REIT space and has a lot of upside in rents resetting to market. The company also pays a 2.2% dividend yield.
Overall, a stagnating real estate market won't impact rental inflation for American Homes 4 Rent over the near term. In the meantime, rents remain well supported by the supply-and-demand situation. Single-family rentals should remain one of the better asset classes over the next few years as other asset classes get dinged by rising rates.
