Goldman Sachs analysts recently put out a report that predicts a 2008-style real estate correction for some areas of the United States that saw outsized home price appreciation which hasn't been accompanied by similar growth in wages. The investment bank's report mentioned San Diego, Phoenix, San Jose, and Austin as the four metropolitan areas most likely to experience a big drop in home prices as a result.
If the report is accurate, does this mean big problems for single-family real estate investment trust (REIT) American Homes 4 Rent (AMH 1.82%)?
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American Homes 4 Rent is consolidating the single-family rental market
American Homes 4 Rent is a REIT that focuses on owning and renting single-family homes (many REITs in its category tend to focus on developing apartment buildings). Historically, single-family rental properties were a highly fragmented industry dominated by small "mom-and-pop" type landlords who owned one or two rental properties. For a long time, the conventional wisdom was that single-family rentals were not a scalable business and there were no economies of scale. American Homes 4 Rent has proven that the business model does work.
At the end of September 2022, American Homes 4 Rent had a total of 58,961 single-family properties in 22 states, including 1,057 properties for sale. The company's biggest geographic market is Atlanta, followed by Dallas, Charlotte, and Phoenix. Phoenix accounts for 3,399 properties, which represent 5.9% of American Homes 4 Rent's portfolio. American Homes 4 Rent doesn't have exposure to the other markets mentioned in the Goldman Sachs report (San Jose, San Diego, and Austin).
The company does have exposure to some top-performing markets such as Charlotte, Nashville, Jacksonville, and Tampa. So if home prices do collapse in Phoenix, what happens to American Homes 4 Rent? First of all, it should have no impact on book value per share as the company doesn't "write up" the value of its real estate holdings as prices rise. Most of American Homes 4 Rent's portfolio was bought on average about seven years ago, so there is a lot of home price appreciation that doesn't show up on the balance sheet.
Vacancy rates are still extremely low in Phoenix
As a general rule, rents lag home price appreciation by about 21 months. This is because rents reset annually, at most, and they only get reset to market value once a tenant vacates the apartment. Very few landlords will increase a tenant's rent by 20% even if home prices are up by that amount. Given that Phoenix only accounts for about 6% of American Homes 4 Rent's portfolio, any potential decline in rental inflation will have only a small impact on earnings. The Phoenix rental market is still extremely tight, with a rental vacancy rate below 4%, which is the tightest market in 20 years. We could see home prices decline and rents move very little, as landlords have little incentive to cut prices.
American Homes 4 Rent is guiding for 2022 funds from operations (FFO) to come in between $1.52 and $1.56 per share. REITs tend to use FFO to describe earnings instead of earnings per share as reported under generally accepted accounting principles (GAAP). This is because depreciation and amortization is a big cost under GAAP but isn't an expense a company would write a check to pay. This means that earnings per share under GAAP tends to understate the cash flow of the company.
American Homes 4 Rent pays an annual dividend of $0.72 per share, which means that the payout ratio (dividend divided by FFO per share) is below 50%. This is extremely low for a REIT and indicates that even if rental appreciation in Phoenix did stall out, the dividend is well covered and shouldn't be at risk for a dividend cut.
