Single-Family Rental REITs: The 'Burbs Are Hot
Summary
- The 'Burbs are back - and hotter than ever. Single-Family Rental REITs have been one of the top-performing property sectors over the past year amid a COVID-driven "suburban revival."
- Single-Family Rental fundamentals are among the strongest in the REIT sector. SFR REITs reported near-perfect rent collection, record-high occupancy rates, and rent growth eclipsing 5% in their recent reports.
- Quieting the critics that questioned their ability to operate efficiently, SFR REITs have been leaders in using Property Technology (PropTech) to reduce costs, increase renter satisfaction, and fuel accretive growth.
- Surging home values can be a headwind, however, as investment yields compress when rent growth can't keep pace with price appreciation. Rising interest and mortgage rates could benefit these SFR REITs.
- Even before COVID ignited the suburban revival, the 2020s were already poised to be a strong decade for the U.S. housing industry, fueled by record-low housing supply and robust demographic-driven demand.
- This idea was discussed in more depth with members of my private investing community, Hoya Capital Income Builder. Learn More »
REIT Rankings: Single-Family Rentals
(Hoya Capital Real Estate, Co-Produced with Colorado Wealth Management)
Single-Family Rental Sector Overview
The 'Burbs are back - and hotter than ever. Single-Family Rental REITs have been one of the top-performing property sectors over the past year amid a COVID-driven "suburban revival" that has resulted in some of the strongest fundamentals across the REIT sector. In the Hoya Capital Single-Family Rental Index, we track the two single-family rental REITs (SFRs) Invitation Homes (INVH), American Homes 4 Rent (AMH), as well as Canadian-listed Tricon Residential (TCNGF). Together, these three companies collectively own more than 150,000 single-family rentals, primarily in the Sunbelt region.
Fueled by the combination of COVID-related factors and the long-term secular tailwinds of limited supply and demographic-driven demand, the U.S. housing industry continues to be the unexpected leader of the early economic recovery, a stark contrast from its role as a "provocateur" during the Financial Crisis. The intensifying housing shortage has been particularly acute in the faster-growing Sunbelt regions and in suburban markets, which have seen an extra boost in demand from the ongoing out-migration out of the high-density "shutdown cities." The bifurcation in fundamentals between urban and suburban-focused REITs was on full display over the last quarter.
Single-Family Rental REITs concentrate on these Sunbelt markets that have experienced the strongest economic growth during the post-GFC recovery and in the early post-pandemic recovery. As discussed in Apartment REITs: Tale of Two Americas, lockdown policies have plunged several high-density coastal rental markets - NYC, L.A., San Francisco - into distress, backtracking a two-decade-long trend of urban revival. Outside of these troubled markets, however, national rental markets - particularly in the SFR category - have been remarkably resilient and have built strength over the last nine months.
Aided by WWII levels of fiscal stimulus - and policies that prioritized support for the U.S. housing markets - SFR fundamentals are as strong as they've been since the sector emerged in the early 2010s from the ruins of the Great Financial Crisis. SFR REITs reported near-perfect rent collection, record-high occupancy rates, and accelerating rent growth. 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. Blended rent growth averaged 5.2% year over year in the fourth quarter, driven by a strong 8.7% rise in new lease rates, the strongest quarter on record for new lease growth.
While property-level fundamentals are undoubtedly stellar - and getting even stronger into 2021 - could the housing market be "too strong" for SFR REITs? 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 - a pattern that now appears unlikely to repeat itself during this current crisis.
Surging home values can be a headwind for SFR REITs as investment yields compress when rent growth can't keep pace with price appreciation. The Case Shiller Home Price Index showed that home values rose more than 10% year over year in December, the strongest rate of growth in more than a half-decade.
Home price appreciation is a double-edged sword for SFR REITs, and the lack of distress in the "traditional" acquisition channel has forced SFR REITs to get creative with external growth plans. AMH has led this shift towards internal development through ground-up homebuilding, and we see the lines between homebuilders (XHB and ITB) and SFR REITs becoming increasingly blurred over the next decade.
As discussed in our recent Homebuilders report, we view the build-to-rent market as a key and growing source of relatively steady housing 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.
SFR REITs continue to plow ahead with growth plans as AMH expects to invest between $1.2 billion and $1.6 billion of total capital into its combined growth program this year, adding approximately 3,500 homes to its wholly-owned and joint venture portfolios, including 1,900 to 2,200 homes is expected to deliver through its AMH development program.
This internal development accounts for half of AMH's acquisitions with the remaining 50% split between its National Builders Program (buying new homes from homebuilders) and traditional acquisitions of existing homes. INVH - which sources the majority of its acquisitions through traditional channels - expects to acquire at least $1 billion in homes this year between its joint venture and wholly-owned portfolios.
Quieting the critics that questioned their ability to operate efficiently, SFR REITs have been leaders in using Property Technology (PropTech) to reduce costs, increase renter satisfaction, and fuel accretive growth. SFR REITs have leveraged emerging technologies like virtual house tours, Smart Homes, and digital relationships between renters and property managers which have proven to be especially critical amid the COVID-19 disruptions.
These REITs have also tapped into the "iBuying" industry to source acquisitions through relationships and direct investments into companies like Opendoor (OPEN) and Zillow (Z) and leverage data from CoreLogic (CLGX), Black Knight (BKI), and Redfin (RDFN) to source accretive acquisition opportunities.
Stock Performance of SFR REITs
One of the newest REIT sectors, single-family rental REITs have produced excellent total returns relative to other REIT sectors in their short history. From 2015 through the end of 2020, the SFR sector produced compound annualized total returns of 15.5% per year compared to the 6.9% annual returns from the broad-based REIT index. Riding the tailwinds of the red-hot U.S. housing industry, SFR REITs were also one of just six REIT sectors that ended 2020 with positive total returns as SFR REITs gained 6.0% in 2020 compared to the -8% decline on the FTSE Nareit All Equity REITs Index.
Following their strong performance last year, SFR REITs have paused in early 2021 amid a broader sector rotation out of last year's outperformers and into the more COVID-sensitive property sectors. After trading in lockstep for the past half-decade, the performance of the three SFR companies has diverged over the past two years, a reflection of their distinct geographical footprints and external growth strategy. The Sunbelt-heavy focus of American Homes and Tricon Residential delivered superior performance in 2020 while Invitation Homes' exposure to the West Coast markets which have been impacted by concerns over rent control policies and outmigration in California.
Deeper Dive Into the SFR Industry
Despite the recent trend towards "institutionalization" of the single-family markets, the $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. These three SFR companies own a combined 150,000 SFR units in the US and INVH and AMH are the two single-largest SFR owners in the United States. The average single-family rental 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.
Single-family rental REITs comprise roughly 1-2% of the "Core" REIT ETFs and 3-4% 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 mounting shortage of housing units in the United States, and as a result, have produced same-store NOI growth that has been consistently above the REIT sector average for the past decade.
Single-family rentals, which combine the benefits of single-family living with the best parts of the multifamily experience, have become the default "starter home" for millions of Americans. Fueled by the maturing millennial generation - the largest age cohort in American history - 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 and pulled some of this single-family housing demand forward. 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 in the late 1970s.
This booming demand, however, comes at a time of historically low housing supply. 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. In the 2010s, the United States built homes at a rate that was 50% below the post-1960 average after adjusting for population growth.
As a result, housing inventory fell to a record low of 1.04 million units in the latest Existing Home Sales report, down by 25.7% year-over-year – a record decline. Properties remained on the market for just 21 days in January while the month's supply of available homes stood at just 1.9 months, also historic lows.
We continue to believe that the two large SFR REITs are uniquely positioned to benefit from the broader trend of institutionalization within the single-family housing industry - a trend that we believe is in the very early innings - and one that we see as a positive development for both renters and investors alike. SFR REITs aren't the only institutional operators, however, as several private equity firms have amassed similarly large SFR portfolios including Petrium (Progress Residential), Cerberus (First Key), and Amherst (Main Street) - several of which have flirted with REIT conversions.
Scale is a key competitive advantage for these large institutional SFR owners, and 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 is especially critical for SFR REITs for achieving efficiencies in leasing, acquisition, and maintenance.
We estimate that 500-1,000 units per market are needed to achieve minimum scale, but that 2,000 units or more are needed to reach a "critical mass" whereby the REIT can localize operations within that market and achieve cost efficiencies on par with apartment REITs.
Initially, in a phase we call SFR 1.0, the SFR REIT business model depended on the bulk acquisition of distressed properties, and REITs used foreclosures as a primary source of new home acquisition. In SFR 2.0, the business model evolved into a stabilized ownership model, focused on achieving efficiencies and growing via one-off acquisitions. In SFR 3.0, we see SFR REITs mirroring the model of the larger apartment REITs with internal development teams capable of supplementing the acquisition-fueled external growth channels.
Single-Family Rental REIT Dividend Yields
SFR REITs are quintessential "Growth REITs" with relatively low dividend yields but with a high potential for dividend growth. Based on dividend yield, single-family rental REITs rank near the bottom of the REIT universe, paying an average yield of 1.9% compared to the REIT sector average of 3.4%. SFR REITs pay out just 42% of their available cash flow. Dividend growth has averaged more than 20% per year over the last five years, however, powered by the combination of robust external growth and solid same-store growth.
The SFR sector was largely immune from the wave of dividend cuts that swept across the REIT sector last year. Invitation Homes and American Homes were two of the 52 equity REITs that increased their dividend last year, and both firms have again boosted their payouts in early 2021. Before being acquired by Petrium last year, however, small-cap Front Yard Residential did reduce its dividend - one of 67 equity REITs to do so last year. INVH currently has a dividend yield of 2.3%, followed by TCN at 1.8% and AMH at 1.3%.
Investors also have a few additional options for investing in the SFR sector. American Homes has a suite of five preferred issues with call dates ranging from May 2021 to September 2023. These preferreds offer an average yield of 5.9% but trade at an average 5% premium to par value. Preferred stocks generally offer more downside protection, but in exchange, these securities offer relatively limited upside potential outside of the limited number of “participating” preferred offerings that can be converted into common shares.
Single-Family Rental REIT Valuations
Relative to other REIT sectors, single-family rental REITs appear moderately expensive based on Funds From Operations ("FFO"), but appear more attractive after factoring in forward-growth expectations. While SFR REITs are the sixth most "expensive" REIT sector based on 2021 consensus FFO multiples, these REITs have consistently delivered FFO growth towards the top of the REIT sector. SFR REITs currently trade at an estimated 10% discount to their private-market implied Net Asset Value ("NAV").
Despite the recent successes, critics continue to question the long-term viability of the REIT model for SFR ownership, particularly if home price appreciation continues to outpace rent growth. This can create a problematic situation for SFR REITs: Future acquisitions become less accretive as REITs are forced to pay higher prices for the same cash flow. Meanwhile, property taxes and other expense items are generally tied to rising home values. Aided by the PropTech efficiencies discussed above, INVH continues to see accretive acquisition opportunities with acquisitions with cap rates in the mid-5% range while it has historically sold properties with cap rates between 1-3%.
The Bull and Bear Thesis For SFR REITs
Below, we outline the bullish case for Single-Family Rental REITs.
Below, we outline the bearish case for Single-Family Rental REITs.
Key Takeaways: The Burbs Are Back
Single-Family Rental fundamentals are stronger than ever as the 'Burbs are back - and better than ever. SFR REITs reported near-perfect rent collection, record-high occupancy rates, and rent growth eclipsing 5% in their recent earnings reports. While we continue to see very favorable supply/demand dynamics in the single-family rental REIT sector over the next decade, the wild card will be whether or not these REITs can crack the code to unlock sustainable and accretive external growth which has been harder to come by over the last half-decade. We continued to see real estate technology as the wild-card that could allow the SFR REITs to drive property-level efficiencies and help to fuel external growth via acquisitions.
Unlike other REIT sectors, we believe that rising interest and mortgage rates could be a benefit to these SFR REITs both on the demand-side (housing affordability) and on the acquisition-side (slower home price appreciation). Even before COVID ignited the suburban revival, the 2020s were already poised to be a strong decade for the U.S. housing industry, fueled by record-low housing supply and robust demographic-driven demand, but SFR REITs still must continue to execute and innovate to capture their share of the economic value from these secular tailwinds.
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Disclosure: Hoya Capital Real Estate advises an Exchange-Traded Fund listed on the NYSE. In addition to any long positions listed below, Hoya Capital is long all components in the Hoya Capital Housing 100 Index. Index definitions and a complete list of holdings are available on our website.
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This article was written by
Alex Pettee is President and Director of Research and ETFs at Hoya Capital. Hoya manages institutional and individual portfolios of publicly traded real estate securities.
Alex leads the investing group Learn more.Analyst’s Disclosure: I am/we are long HOMZ, AMT, ARE, AVB, BXMT, DRE, DLR, EFG, EQIX, FB, FR, MAR, MGP, NLY, NHI, NNN, PLD, REG, ROIC, SBRA, SPG, SRC, STOR, STWD, PSA, EXR, AMH, CUBE, ELS, MAA, UDR, SUI, CPT, NVR, EQR, INVH, ESS, PEAK, LEN, DHI, HST, AIV, MDC, ACC, PHM, TPH, MTH, WELL. 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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