Single-Family Rentals: PropTech Revolution

Summary

• The positive reverberations from the post-pandemic "housing boom" are now being felt across U.S. rental markets as single-family housing rents are suddenly soaring at the fastest rate on record.
• Riding the rental revival, Single-Family Rental REITs are the single-best performing property sector since the end of 2019, gaining another 25% this year following strong earnings results and recent updates.
• Mirroring the surge in suburban home values amid a historic housing shortage, SFR REITs have reported double-digit rent growth in recent months while occupancy rates continue to set record highs.
• 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.
• Short on Supply, High on Demand. While the fast-growing SFR REITs appear pricey compared to other REIT sectors, valuations remain compelling compared to other PropTech disruptors in the housing ecosystem.
• This idea was discussed in more depth with members of my private investing community, Hoya Capital Income Builder. Learn More »

Photo by Mark Lucey/iStock via Getty Images

REIT Rankings: Single-Family Rentals

(Hoya Capital Real Estate, Co-Produced with Colorado Wealth Management)

Single-Family Rental Sector Overview

Single-Family Rental REITs have recorded the strongest performance of the REIT sector since the end of 2019 as the positive effects from the post-pandemic "housing boom" are reverberating across U.S. rental markets with rents suddenly soaring at the fastest rate on record. In the Hoya Capital Single-Family Rental Index, we track the two single-family rental REITs (SFRs) Invitation Homes (INVH) and American Homes 4 Rent (AMH), as well as Canadian-listed Tricon Residential (OTCPK:TCNGF).

Short on Supply, High on Demand. Mirroring the surge in suburban home values amid a historic and lingering housing shortage resulting from a decade of under-building, SFR REITs have reported double-digit rent growth in recent months while occupancy rates continue to set record-highs. During Q1 earnings season, these REITs reported 10.1% rental rate growth on new leases, which accelerated further in April to 13.0% with no signs of slowing, yet. Invitation Homes provided an update this week in which it reported that it achieved new leases rent growth of 14.1% in May - the strongest month on record - and significantly raised its full-year earnings guidance.

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. The intensifying housing shortage has been particularly acute in the faster-growing Sunbelt regions and in suburban markets where home values have been soaring at double-digit annualized rates throughout 2021. Per the Zillow Group (NASDAQ:Z) ZORI Rent Index, nearly all of the major Sunbelt and suburban housing markets are seeing accelerating rent growth with annual increases likely to eclipse double-digits by the end of the summer.

Aided by WWII levels of fiscal stimulus - and policies that have 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 as SFR REITs recorded the strongest same-store NOI ("Net Operating Income") growth of any REIT sector in 2020 at roughly 4%. 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. Collectively, these SFR REITs own nearly 200,000 homes across the United States.

Quieting the critics that questioned their ability to operate efficiently, SFR REITs have been leaders in the Property Technology (PropTech) revolution to reduce costs, increase renter satisfaction, and fuel accretive growth. Honed out of necessity, SFR REITs have effectively leveraged emerging technologies like virtual house tours, Smart Homes, and fully digital relationships between renters and property managers which have proven to be especially critical amid the COVID-19 disruptions. While the fast-growing SFR REITs appear pricey compared to other REIT sectors, valuations remain relatively compelling compared to many other PropTech disruptors in the housing ecosystem.

Rapid 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. These REITs have tapped into the emerging "iBuying" industry to source acquisitions through relationships and direct investments into companies like Opendoor Technologies (NASDAQ:OPEN) and Zillow Group (Z) and leverage data from CoreLogic (CLGX), CoStar Group (CSGP), Black Knight (BKI), Redfin (RDFN), and Offerpad to source accretive acquisition opportunities. Elsewhere, an investment this year from commercial real estate broker Jones Lang LaSalle (JLL) should raise the profile of Roofstock, which manages an online brokerage marketplace for single-family rental investors.

Outside of these iBuyers, soaring rents have renewed institutional interest in the SFR and Property Technology space as well, as two private companies announced capital raising deals last week to purchase single family properties. Invesco is backing property technology firm Mynd Management to spend up to $5 billion to buy 20,000 single-family rental homes in the U.S. over the next three years while non-traded REIT sponsor Fundrise announced that it closed on a $300 million credit facility which will be used to finance nearly half a billion dollars of newly constructed single family rental units. Major SPAC deals this year include Tishman Speyer's merger with smart lock maker Latch and Firth Wall's acquisition of smart home automation company SmartRent.

Performance of SFR REITs

Riding this rental revival, Single-Family Rental REITs are the single-best performing property sector since the end of 2019, gaining another 25.1% this year following these strong earnings results and recent updates. This compares to the 20.7% returns from the broad-based Vanguard Real Estate ETF (VNQ) and the 13.0% returns from the S&P 500 ETF (SPY). Unlike many other interest-rate-sensitive REIT sectors, rising interest rates and mortgage rates have historically benefited these SFR REITs as households on the margins of buying or renting tend to be pushed towards rental markets.

The entirety of these YTD gains has come over the last quarter alone as SFR REITs 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 a bit 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 relatively slower-growing West Coast markets have weighed a bit on performance.

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.

Deeper Dive: SFR Earnings & PropTech

As discussed in REIT Earnings Recap, residential REITs were the positive standouts in Q1 as the red-hot ownership markets have "passed the torch" to rental markets as rents begin to catch-up with soaring home prices. While all segments of the rental markets - apartments, SFRs, and manufactured housing - have seen accelerating rent growth in 2021, SFR REITs began this recent uptrend on a higher trajectory than their multifamily peers after a solid year of growth last year while many REITs were struggling to collect rents.

Diving deeper into Q1 results, both American Homes and Invitation Homes achieved the "trifecta" of guidance increases, boosting their full-year revenue, NOI ("Net Operating Income") and FFO guidance during Q1 earnings season. AMH now sees FFO growth of 9.5% at the midpoint of its range, up from its prior outlook for 7.8% growth. INVH - which raised its guidance in its Q1 results - raised guidance once again this week and now sees FFO growth of 13.0% this year, up from its initial guidance of roughly 5%. Both REITs also reported record-high occupancy rates above 98% in Q1.

Surging home values can be both a tailwind and a headwind for SFR REITs as investment yields compress if rent growth can't keep pace with price appreciation. AMH has led the shift towards internal development and we see the lines between homebuilders 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.

Despite soaring home values, SFR REITs have switched back into "growth mode" and continue to plow ahead with external growth plans through both traditional channels and emerging growth channels ranging from ground-up internal development, partnerships with homebuilders, and through the aforementioned iBuyers. 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.

Meanwhile, AMH reiterated its expectation 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 now 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.

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 20.5% year-over-year. Properties remained on the market for just 17 days in April while the month's supply of available homes stood at just 2.4 months, also near 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 1.6% compared to the REIT sector average of 3.1%. SFR REITs pay out just 42% of their available cash flow, however, and dividend growth has averaged more than 20% per year over the last five years, powered by the combination of robust external growth and organic rent growth.

The SFR sector was immune to 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 - along with Tricon Residential - have again boosted their payouts in early 2021, joining a positive wave of more than 60 equity REITs that have raised their payouts this year. TCN currently has a dividend yield of 2.1% followed by INVH at 1.8% and AMH at 1.0%.

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, but AMH announced last month that it will redeem its Series D (AMH.PD) and Series E (AMH.PE) on June 30th. The five remaining preferreds pay an average yield of 5.6% but trade at an average 7% 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 fifth 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% premium 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% and 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: PropTech Revolution

The positive reverberations from the post-pandemic "housing boom" are now being felt across U.S. rental markets as single-family housing rents are suddenly soaring at the fastest rate on record. Single-Family Rental REITs are the single-best performing property sector since the end of 2019, quieting the critics that questioned their ability to operate efficiently as SFR REITs have emerged as leaders in the PropTech revolution which has reduced costs and fueled accretive growth. Strong earnings results have pushed their YTD gains to nearly 30% and while the fast-growing SFR REITs appear pricey compared to other REIT sectors, valuations remain compelling compared to other PropTech disruptors with yet-to-be-proven business models in the housing ecosystem.

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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.

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.