REIT Rankings: Single-Family Rentals
Single-Family Rental Sector Overview
Amid the coronavirus pandemic, residential REITs – particularly the traditionally countercyclical single-family rentals – have proven to be a source of relative shelter for investors and are one of just six property sectors in positive territory in 2020. In the Hoya Capital Single-Family Rental Index, we track the three single-family rental REITs (SFRs) which account for roughly $25 billion in market value: Invitation Homes (INVH), American Homes 4 Rent (AMH), and Front Yard Residential (RESI). These REITs collectively own nearly 150,000 single-family rentals, primarily in the Sunbelt region.
The U.S. housing industry continues to be the unexpected leader of the post-pandemic economic recovery, a stark contrast from its role as a “provocateur” during the Financial Crisis. Single-family rental REITs comprise roughly 1-2% of the “Core” REIT ETFs. SFR REITs also represent 3% of the Hoya Capital US Housing Index, the benchmark that tracks the GDP-weighted performance of the US Housing Industry. Single-family rental REITs – along with their residential REIT sector peers (Apartments and Manufactured Housing REITs) have been some of the most significant beneficiaries of the lingering housing shortage, producing same-store NOI growth that has been consistently above the REIT sector average for the past decade.
Single-family rentals have become the default “starter home” as rising home prices have stretched affordability over the past decade. Fueled by the maturing millennial generation, the 2020s were already poised to be a decade of “suburban revival” and behavioral changes in the post-coronavirus have provided an added spark. Whether they’re renting or owning, the maturing millennial generation will enter the single-family housing markets in full-force in the 2020s in a quantity and magnitude not seen since the young boomers began to flock to the suburbs the late 1970s. Record-low mortgage rates, however, have pulled some move-up buyers into the ownership markets.
Single-family rental REITs concentrate on markets that have experienced the strongest economic growth during the post-recession recovery, most notably in the Sunbelt region. Ironically, the distress in the aftermath of the “housing bubble” hit this region particularly hard, which facilitated the rise of institutional rental operators like these SFR REITs. The Sunbelt is expected to benefit from an added tailwind amid the ongoing out-migration out of the high-density “shutdown cities.” As discussed in Apartment REITs: Urban Exodus, lockdown policies have plunged these coastal economies into an uncontrolled tailspin, backtracking a two-decade-long trend of urban revival. Outside of these troubled markets, however, national rental markets have been remarkably resilient throughout the pandemic.
Millions of renters were impacted by coronavirus-related economic shutdowns, but the combination of direct cash infusions and enhanced unemployment insurance as part of the $3 trillion stimulus package have proven to be an effective short-term bridge despite the moratorium on evictions that some experts projected would result in pain for the housing sector. SFR REITs reported rent collection that was less than 2 percentage points below last year’s rate, one of the strongest collection rates across the REIT sector, as tracked in our real-time Rent Collection Tracker. As discussed on our various reports, the “essential” property sectors – housing, technology, and industrials – have been minimally affected by missed rents and have generally been able to maintain or even increase their dividend distributions this year.
Leasing trends are the metrics that we watch most closely as forward-looking indicators not only for the SFR REIT sector but also for the housing industry as a whole. Encouraging, blended rent growth averaged 3.2% year over year, driven by a strong 3.7% rise in new lease rates and a 3.0% rise in renewal rates. As was the case in the apartment REIT sector, rental rates were negatively impacted by (overly) generous pandemic-related concessions including rent-freezes on renewed leases that were offered by AMH, in particular. Even more encouragingly, same-home occupancy increased to record-high levels at 97.2% while turnover rate dipped to record-low levels.
Deeper Dive: Single Family Rental Fundamentals
As noted above, single-family rental REITs were born from the last economic crisis when a cascade of subprime foreclosures enabled a new class of institutional rental operators to emerge by buying distressed properties in bulk. The roughly $5 trillion US single-family rental market remains highly fragmented with large-scale institutional rental operators owning 250k out of the estimated 15 million SFR rental units across the US, or roughly 1.5% of the existing SFR stock. The average SFR owner manages just 1-2 properties and the average SFR monthly is $1,100 per month, but REIT portfolios skew towards the higher-end of the quality spectrum. The presence of institutional SFR operators this time around, interestingly, has served as a downside buffer to prevent the type of housing market distress seen during the GFC.
The simple laws of supply and demand have been at the root of the recent strength in the U.S. housing market. New home construction – particularly in the single-family category – has been historically depressed over the last decade, a result of the substantial and far-reaching fallout from the financial crisis on the residential construction industry. The United States is building homes at a rate that is less than 50% of the post-1960 average after adjusting for population growth. The slow, grinding recovery in New Home Sales over the last decade only got us back to levels seen in 1996, indicating that there is simply not the supply overhang that magnified the housing market downturn during the financial crisis. Residential fixed investment as a share of GDP remains near historically low levels, a function of underinvestment in both new home construction and existing home repair and renovation.
We continue to note the trend of “built-to-rent” as a growing share of total housing starts. As discussed in our recent Homebuilder report, we view the growing build-to-rent market as a key and growing source of relatively steady demand that is less impacted by near-term economic conditions or mortgage rates and expect the synergistic relationship between SFR institutional operators and homebuilders to continue to strengthen. Relative to apartment buildings where each property can have several hundred units, geographical fragmentation makes it more difficult to acquire a substantial number of units to achieve scale. Density within markets, therefore, is especially critical for SFR REITs and under the stabilized ownership model, market density is essential to achieving efficiencies in leasing, acquisition, and maintenance.
On that point, despite the challenges of maintaining and managing a portfolio of unique single-unit properties spread across a wide geographical area, single-family rental NOI margins are only slightly below the typical apartment REIT. At scale, typical operating margins for SFR REITs are around 65% compared to an average of around 70% for apartment REITs. SFR REITs generally spend more on maintenance and turnover costs, but do not have to incur common area expenses, which average around 20% at apartment REITs. Annual turnover rates of single-family rentals average roughly 30% compared to the 50% rate for apartments and the roughly 10% rate for manufactured housing units. Property taxes, which are generally linked to home values, are the single largest (and growing) expense item for SFR REITs.
Finally, you can’t introduce the SFR sector without mentioning the enormous impact of real estate technology in enabling the formation and fueling the future growth of the sector over the next decade. The “prop-tech” industry includes data and technology companies including Zillow (Z), Redfin (RDFN), CoreLogic (CLGX), and RealPage (RP) that have helped to streamline the buying, selling, and managing of real estate properties which have enabled the “institutionalization” of the single-family rental market, which we see as a positive development for both renters and investors alike. The availability of technologies like virtual house tours and the increased adoption of entirely digital relationships between renters/homebuyers and landlords/brokers have proven to be especially critical amid the CV-19 disruptions.
Stock Performance of SFR REITs
Despite concerns over their renter’s ability and willingness to pay rent – a concern that we continue to believe is unwarranted at the moment given the WWII levels of fiscal stimulus that continue to filter through the U.S. economy – single-family rental REITs have been among the best-performing real estate sectors in 2020. SFR REITs are higher by 2.4% in 2020 compared to the 14.5% decline on the broad-based Vanguard Equity REIT ETF (VNQ). The S&P 500 ETF (SPY), however, has gained more than 11% in 2020 while the Nasdaq 100 (QQQ) has surged a mind-blowing 42% this year.
After trading in lockstep for most of the past three years, the performance of Invitation Homes and American Homes have diverged over the past two years, a reflection of their distinct geographical footprints. After delivering superior performance last year, Invitation Homes has been impacted by their heavy exposure to West Coast markets which have been hit particularly hard by the coronavirus outbreak and concerns over rent control policies and outmigration in California. After initially surging following the announcement of the since-terminated acquisition by Amherst Residential, Front Yard Residential has been a notable laggard this year, but has rebounded in recent weeks as the company plans to internalize its management, a governance structure viewed as more shareholder-friendly than the externally-managed model.
One of the youngest REIT sectors, single-family rental REITs emerged in the wake of the housing crisis and became a full-fledged NAREIT sector beginning in 2015, the same year that data centers garnered recognition as a REIT sector. Following two straight years of strong performance between 2016 and 2017, single-family rentals had a tough year in 2018 amid concerns over operating efficiencies, but bounced back with total returns of more than 45% in 2019. From 2015 through the end of 2019, the single-family rental sector produced compound annualized total returns of 14.1% per year compared to the 8.4% annual returns from the broad-based REIT index.
Below, we present our framework for analyzing the REIT property sectors based on their direct exposure to the anticipated CV-19 effects as well as their general sensitivity to a potential recession and impact from lower interest rates. Single-family rental REITs rank in the medium-/low-risk category from Covid-19 with the primary risk factor coming from the economic effects from job losses on the tenant bases’ ability to pay rent, which we believe is offset in the short and medium run by the stimulus package and over the longer run by the tailwinds associated with the “suburban revival” and reacceleration across the broader U.S. housing industry.
SFR REIT Valuations & Dividend Yield
Relative to other REIT sectors, single-family rental REITs appear moderately expensive based on Funds From Operations (“FFO”), but more attractive after factoring in forward-growth expectations. Below, we illustrate that SFR REITs are the fourth most “expensive” REIT sector based on Free Cash Flow. In our recent report, “The REIT Paradox: Cheap REITs Stay Cheap“, we discussed our study that showed that lower-yielding REITs in faster-growing property sectors with lower leverage profiles have historically produced better total returns, on average, than their higher-yielding and higher-leveraged counterparts. SFR REITs currently trade at an estimated 5% premium to their private-market implied Net Asset Value (“NAV”).
Dividend cuts have been a major theme across the REIT sector this year with 64 of 170 equity REITs reducing or eliminating their dividends since the start of the pandemic, as tracked in our Coronavirus Dividend Cut Tracker. The SFR REIT sector was not entirely immune, as small-cap Front Yard Residential slashed its dividend back in May and plans to “hold off a little bit longer until we see how this year plays out.” As these REITs mature, we expect their payout ratios to rise to levels in line with other REIT sectors.
Based on dividend yield, single-family rental REITs rank near the bottom of the REIT universe, paying an average yield of 1.5% compared to the REIT sector average of 3.2%. SFR REITs payout just 39% of their available cash flow, however, so these firms have greater potential for dividend growth and reinvestment than other property sectors. Core FFO growth has averaged nearly 10% per year over the last five years powered by the combination of robust external growth and solid same-store NOI growth, a growth rate that is behind only the manufactured housing and cell tower REIT sectors.
Key Takeaways: The Burbs Are Back
The suburbs are back. Amid the coronavirus pandemic, residential REITs – particularly the traditionally countercyclical single-family rentals – have proven to be a source of relative shelter for investors. The U.S. housing industry continues to be the unexpected leader of the post-pandemic economic recovery, a stark contrast from their role as provocateur during the Financial Crisis. Fueled by the maturing millennial generation, the 2020s were already poised to be a decade of “suburban revival” and behavioral changes in the post-coronavirus world have provided an added spark. Despite the pandemic-related headwinds, SFR REITs reported near-perfect rent collection and strong rental growth. Single family rentals have become the default “starter home” as rising home prices have stretched affordability. We continued to see real estate technology as the wild-card that could facilitate another decade of robust external growth from institutional SFR operators.
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Disclosure: I am/we are long AMH, ZG, INVH, RDFN, CLGX, RLGY, RP. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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