Inflation-Proof Your Portfolio With These 3 Rental REITs

Jun. 21, 2022 7:00 AM ETAVB, EQR, UMH14 Comments

Summary

  • The residential REIT sector includes apartments, manufactured housing, and single-family rentals.
  • In this article, I’ll provide one pick in each of these three subsectors.
  • Investors can look to these rental REITs for their pricing power advantages – which should enable them to deliver superior earnings growth in 2022 and 2023.
  • Looking for a helping hand in the market? Members of iREIT on Alpha get exclusive ideas and guidance to navigate any climate. Learn More »
Rental income is shown on the photo using the text

Andrii Dodonov/iStock via Getty Images

Let’s talk about the residential side of real estate for a moment. I know it’s not my normal focus, but bear with me, nonetheless.

I’m pretty sure I can make it worth your while.

On June 6, you see, I saw this headline on Yahoo: “The Hot Housing Market Is Bringing Homebuyers to Tears.” I didn’t get to write about it right away (as evidenced by this article’s later date). And when I did a search for it, I came across a similar article dated the day before.

That one was from Fortune with an even more specific title to it: “The Housing Market Is Making Most Millennial Home Shoppers Burst Into Tears, Survey Finds: ‘It’s Deeply Personal and It’s Emotional.’” It begins like this:

“Planning a wedding, being fired, having a child – they’re among life’s most stressful milestones that sometimes require a cathartic cry to cope.

“Add to that list ‘buying a house.’

“Half of new homebuyers said the process ‘left them in tears,’ according to a new Zillow survey released Thursday, with Gen Zers and millennials ‘far more likely to cry at least once during their home-buying journey,’ at more than 65% and 61%, respectively.”

And before those of us from previous generations start poking fun of the “youngsters,” let’s be frank here.

This housing market is insane.

If at First You Don’t Succeed…?

When those of us over 40 were shopping around – “back in our day” – it may or may not have been a seller’s market. And there may or may not have been multiple offers on the houses we wanted.

But I think it’s pretty safe to say that, if we didn’t get the first house we wanted, we got the second. Or at worst, the third.

Not so now.

One of my team members started looking for houses with her fiancé in mid-2020. They put a bid on the first house they saw in a nice suburban neighborhood in Central Pennsylvania.

But they were one of many – 15, I think? – and so they lost out because they were only willing to go $10,000 over asking price.

“Only.”

So they moved on to the next opportunity. Where they failed again.

And the next opportunity. Where they failed again.

And the next opportunity…

More than one property they were interested in sold off before they could even view the place. They were on the market for five days or less.

So this now-married couple gave up altogether and rented for a little over a year before trying again in January. As of today, they’re new homeowners. So it did eventually turn out alright… even if they did end up probably paying more for the house than it will be worth five years down the road.

Maybe even 10.

In short, it’s a stressful situation to be in – wanting or, worse yet, needing a home when:

  • Everybody else seems to want one too.
  • Prices are exceptionally high.
  • There are institutional investors offering all-cash deals on top of higher prices.

Welcome to the roaring ‘20s, where everything seems to want to take a bite out of you.

Make Money on the Housing Market Situation Anyway

As that Fortune article continues:

“It shouldn’t come as a surprise (that people are stressed out over the housing market). With inventory low and demand high, most homes receive multiple offers and around half sell for more than their listing price, according to Zillow’s most recent Consumer Housing Trends Report.

“Meanwhile, that Yahoo Finance interview I originally saw records National Association of Realtors Chief Economist Lawrence Yun as saying:

“‘… when you have a multiple-offer situation, and sometimes it is quite intense – 30 offers. So by definition, you have only one winner and 29 losers who have to retry again. So it is a very high expenditure to begin with. And to go through the process of rejection, re-submitting the contract. It can be quite frustrating.”

Then again, the situation isn’t bad for everyone. It’s intensely profitable for apartment owners and the rent-a-house industry.

Faced with repeated failed attempts, many people – like the iREIT team member I referenced – give up and rent. Others don’t bother with the current housing market at all, knowing the ordeal they’d be in for.

Or they understand they’re priced out of it. In which case, again, why bother?

But everyone needs to live somewhere. And there are only three options outside of buying:

  1. Be homeless.
  2. Crash with someone else.
  3. Rent from someone else.

Most people choose option 3, meaning that demand for rented residential space is enormous. It’s a landlords’ market there, to be sure.

Thanks to real estate investment trusts (REITs) though, it doesn’t matter if you’ve already got a home… you’re searching for one right now… or you’re content/forced to rent. You have the opportunity to make money off this market.

Which will hopefully save you a tear or two.

Getting a Feel for the Residential Rental Game

The residential REIT sector – including apartments, manufactured housing, and single-family rentals – represents around 16.2% of the U.S. equity REIT sector’s total market capitalization.

residential REIT sector

iREIT on Alpha

As you can see below, the apartment REIT sector specifically is down around 17% year-to-date. The manufactured housing sector is down 26%. And the single-family rental sector is down 23.5%.

residential REIT sector returns YTD

iREIT on Alpha

Meanwhile, 2022 analyst growth estimates rank apartments as the fastest-growing category with an average growth of 33%. Manufactured housing, for its part, is expected to grow by 7% in 2022 and single-family rentals by 14%.

residential REIT sector FFO growth

iREIT on Alpha

In terms of valuation, let’s utilize the price to funds from operations (p/FFO) metric. In that case, they all trade at the higher end of the range. However, we’d expect to see that given their pricing power.

residential REIT sector current P/FFO

iREIT on Alpha

All three’s dividend yields, admittedly, are lower than many other REIT subsectors. However, so are their payout ratios, which suggests safe and growing payouts from here.

residential REIT sector dividend and payouts

iREIT on Alpha

Knowing at least some of that, I’ve had many subscribers ask for our top residential pick in each category. So I decided I would provide one top pick for each sector.

#1 Pick: AIR Communities: 4.6% Dividend Yield

Utilizing our iREIT tracker to screen for the best REITs to buy right now led us to AIR Communities (AIRC).

AIR Communities: 4.6% Dividend Yield

(iREIT on Alpha)

We recently published a deep-dive article on it for members, where we explained that:

“AIR owns 78 properties (25,618 units) located in top markets including eight important geographic concentrations: Boston; Philadelphia; Greater Washington, D.C.; Miami; Denver; the San Francisco Bay Area; Los Angeles; and San Diego.”

The company was created on December 2020 when Apartment Investment and Management Company, aka Aimco (AIV) spun off AIRC to become a more simplified, stabilized business. The original REIT combined a stabilized apartment business, development/redevelopment, non-apartment assets, and mezzanine loans.

Now separated, AIRC owns and operates its $9 billion to 10 billion gross asset value portfolio. External growth will come primarily via acquisitions (with no development).

AIRC is costal focused. About 40% of NOI is sourced from the admittedly challenged cities of Boston, Los Angeles, and San Francisco. Another 30% is from the Mid-Atlantic (e.g., D.C., Philadelphia), and about 30% is from Denver, Miami and “other markets.”

AIR Communities Overview

(AIRC Investor Presentation)

AIR Communities Continued…

AIRC’s portfolio includes a mix of quality assets, averaging B+, and is roughly 65% suburban/35% urban. Its closest peers include UDR (UDR) and Equity Residential (EQR). AvalonBay (AVB) too given its more suburban coastal profile, but without its development exposure.

Our featured REIT here has the most variable debt among apartment REITs as of Q1-22, at $1.5 billion. However, this variable rate debt exposure has effectively been de-risked.

That’s thanks to it paying down, scheduling paying down, and/or refinancing about $1.1 billion via $693 million in asset sales and $400 million in new 10-year private placements at 4.1%. The remaining $400 million has been hedged at an all-in cost of 3.99%.

Also, worth noting is this: The impact of higher interest rates will be a net-neutral earnings event for AIRC in 2022.

AIRC targets a dividend payout ratio at about 75% of FFO. And there are benefits for tax-sensitive investors since around 67% of its 2021 dividend is characterized as return of capital. The remainder is capital gain.

We consider shares attractive today for a number of reasons. The REIT’s average spreads are wider than their historical average, for one. And its improving core and earnings growth also are attractive.

AIRC also doesn’t have development risk. Plus, 90% of its CEO compensation is linked to performance – with 100% of LTI based on three-year forward relative TSR performance.

As viewed below, we estimate AIRC could return 30% over the next 12 months. All put together, this REIT is one of our top residential buys.

AIRC total annual rate of return

FAST Graphs

#2 Pick: UMH Properties: Dividend Yield of 4.8%

As shown below, UMH Properties (UMH) is our most attractive manufactured housing REIT. Once again, that’s based on our margin of safety score, higher dividend yield, and cheaper p/FFO valuation.

UMH Properties: Dividend Yield of 4.8%

iREIT on Alpha

UMH owns and operates 130 manufactured home communities with approximately 24,400 developed homesites. These are located in:

  • New Jersey
  • New York
  • Ohio
  • Pennsylvania
  • Tennessee
  • Indiana
  • Maryland
  • Michigan
  • Alabama
  • South Carolina.

UMH also operates a community of 219 homes in Florida, which it owns alongside Nuveen Real Estate. And then there’s its approximate 1,800 acres of land set aside for development purposes.

UMH Properties

(UMH Investor Presentation)

On the Q1-22 earnings call, CEO Sam Landy said,

“The acquisition market remains competitive and cap rates remain very low in a rising-interest-rate environment.” Yet UMH is “on track to meet its goal of acquiring $25 million to $50 million of communities this year.”

Moreover, UMH has “a strong pipeline of potential new development deals” as it seeks:

“… high-quality communities that are more affordable than most housing alternatives in just about any market. Existing acquisitions and strong markets of decent quality are trading above replacement costs.”

UMH has internal and external growth opportunities through 3,400 vacant sites with increased sales and finance profitability. Landy further explained that “the biggest challenge it faces is obtaining rental homes to drive occupancy and revenue gains.”

During Q1-22, UMH bought 52 homes, bringing its total portfolio to 8,800 rental assets. It also had over 1,300 homes on order – 300 of which have been delivered and are in various stages of setup.

The backlogs remain long, but UMH is starting to see some easing in certain markets. Meanwhile, rental occupancy rates remained strong at 95.3%. And monthly rent increased 4.9% to $839.

UMH Properties Continued…

At the end of Q1-22, UMH had approximately $615 million in debt:

  • $474 million in community-level/mortgage debt
  • $42 million in loans payable
  • $99 million from its newly issued 4.72% Series A bonds.

At the end of Q1, UMH had $292 million of cash and cash equivalents to use for:

  1. The upcoming redemption of its $247 million worth of 6.75% Series C preferreds
  2. General corporate purposes,
  3. Expanding existing communities
  4. Paying down variable-rate debt
  5. Acquiring additional properties

UMH still owns around $57 million in REIT securities, which we’d like to see it sell and reinvest in communities. We recognize this is just 3.3% of total assets. However, it makes no logical sense to hold them after Monmouth shares have been liquidated, generating a realized gain of $30.7 million.

It’s also worth noting that UMH has an elevated payout ratio – well over 100% based on adjusted FFO (AFFO) in Q1-22. As viewed below, this ranks UMH extremely poorly in terms of dividend safety.

UMH Properties REIT/BASE D-Score

(REIT Base)

Yet forward-looking growth estimates are extremely strong, the primary reason we included UMH on the list. Analysts forecast 33% AFFO per-share growth in 2023, which puts the payout ratio at 70%, a reasonable margin of safety.

Up until 2021, UMH’s dividend history wasn’t much to talk about. After cutting it from $1.00 to $0.72 in 2009, it maintained the same payout until 2021.

However, we can see this changing as expansion plans unfold.

We maintain a “Spec Buy,” recognizing UMH has some “wood to chop” but compelling growth and value. We’re targeting shares to return 30% over the next 12 months.

UMH total annual rate of return

(FAST Graphs)

#3 Pick: Invitation Homes: Dividend Yield of 2.6%

Finally, Invitation Homes (INVH) is our most attractive single-family rental REIT based on:

  • Our margin of safety score
  • Higher dividend yield
  • Cheaper p/FFO valuation.
Invitation Homes 5.3% yield

(iREIT on Alpha)

INVH owns over 80,000 homes – and counting – that are 95% focused in the western U.S., Sunbelt, and Florida markets. Moreover, its houses are “infill” houses – brand-new homes built in developed neighborhoods – with high barriers to homeownership.

It has more than 5,000 homes per market (on average), with more than 98% of revenue coming from those with 1,800-plus homes. That density drives service efficiency and revenue management intelligence.

Invitation Homes 1Q22 revenue

(INVH Investor Presentation)

INVH had a solid start in Q1-22, with robust internal growth and transaction activity. It also sported a large new unsecured debt raise and a new JV.

The company reported core FFO per share of $0.40. That met consensus and was up 13% year-over-year, supported by same-store net operating income (NOI) of 11.7%. Same-store revenue, for its part, was up 9.4%; and same-store expenses rose 4.5%.

INVH's same-store revenue results were up 9.4%, driven by an 8.3% increase in average rent, a 30 basis-point year-over-year improvement in bad debt, and a 47.1% increase in other income.

On external growth, INVH acquired $341 million worth of properties – $218 million on bills of sale and $123 million via joint ventures – while selling $54 million worth. It also maintained its $1.5 billion FY-21 acquisitions goal versus $2 billion in 2021 with 5% yields.

This implies more activity ahead. So does its liquid balance, still-positive weighted average cost of capital (WACC) spreads versus acquisitions, and its funding “optionality," including three joint ventures.

In Q1-22, retention reached new historic highs, with last-12-month turnover coming in at 22.3%. Compare that to 23.1% as of Q4-21 and 25.3% in Q1-22.

Invitation Homes Continued…

INVH also added 198 homes to its acquisition partnership with Pulte (PHM), bumping it to 1,932 in Q1. And INVH has agreed to purchase a total of 7,500 build-for-rent homes from PHM over the next five years.

Its estimated cost going forward is $676 million, assuming $350,00 each, broken down as follows:

  • 483 homes in the second half of ‘22
  • 271 in 2023
  • 1,178 after 2023.

INVH's balance sheet is much improved. Debt/EBITDA (earnings before interest, taxes, depreciation, and amortization) is now 6x. Plus, it has $1.6 billion of on-hand liquidity and no debt maturities through 2025.

Notably, INVH issued $600 million of 10-year unsecured notes at 4.15% during Q1-22 to repay a portion of secured debt. This REIT is rated BBB- by S&P and has generated super same-store NOI growth in 2017-2021.

Analyst growth estimates are strong too at 13% in 2022 and 2023. And INVH has also increased dividends by an average of 35% in 2017-2022.

Its dividend increase this year was over 29%. Yet the payout ratio is a healthy 67% (based on REIT Base).

INVH REIT/BASE D-Score

(REIT Base)

One risk worth noting is a whistleblower's lawsuit filed in August 2020 and "unsealed" in February 2022. It alleges that INVH renovated thousands of homes across numerous cities in CA over the past several years but didn’t pay millions in permit fees and incremental property taxes to the relevant municipalities.

INVH has since filed a motion to dismiss, calling the lawsuit “a manufactured story… that attempts to pawn off information already in the public domain as its own.”

The hearing on that motion is set for July 25.

Even so, we see no change to INVH’s fundamentals. We’ve increased our Buy Below target to $36.00 and forecast shares to return 30% over the next 12 months.

INVH total annual rate of return

(FAST Graphs)

In Conclusion...

Given the state of inflation, higher cost of capital, and potential for a recession in 2023, we consider these three residential rental REITs to be prime-time picks.

Their powerful pricing power advantages should enable them to deliver superior earnings growth in 2022 and 2023.

As noted, there are risks to consider. But after evaluating each, we believe they offer optimal return characteristics.

While the average dividend yield of 4% is lower than many of the longer-duration lease subsectors – such as net-lease and healthcare – we believe that owning necessity “roof and shelter” REITs is an important piece of the puzzle for creating an intelligent REIT portfolio.

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This article was written by

Brad Thomas profile picture
104.87K Followers
Author of iREIT on Alpha
The #1 Service For Safe and Reliable REIT Income

Brad Thomas is the CEO of Wide Moat Research ("WMR"), a subscription-based publisher of financial information, serving over 6,000 investors around the world. WMR has a team of experienced multi-disciplined analysts covering all dividend categories, including REITs, MLPs, BDCs, and traditional C-Corps.

The WMR brands include: (1) The Intelligent REIT Investor (newsletter), (2) The Intelligent Dividend Investor (newsletter), (3) iREIT on Alpha (Seeking Alpha), and (4) The Dividend Kings (Seeking Alpha). Thomas is also the editor of The Forbes Real Estate Investor and the Property Chronicle North America.

Thomas has also been featured in Forbes Magazine, Kiplinger’s, US News & World Report, Money, NPR, Institutional Investor, GlobeStreet, CNN, Newsmax, and Fox. He is the #1 contributing analyst on Seeking Alpha in 2014, 2015, 2016, 2017, 2018, and 2019 (based on page views) and has over 102,000 followers (on Seeking Alpha). Thomas is also the author of The Intelligent REIT Investor Guide (Wiley). 

Thomas received a Bachelor of Science degree in Business/Economics from Presbyterian College and he is married with 5 wonderful kids. He has over 30 years of real estate investing experience and is one of the most prolific writers on Seeking Alpha (2,800+ articles since 2010). To learn more about Brad visit HERE.

Disclosure: I/we have a beneficial long position in the shares of AVB, EQR, UMH either through stock ownership, options, or other derivatives. 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.

Additional disclosure: Author's Note: Brad Thomas is a Wall Street writer, which means he's not always right with his predictions or recommendations. Since that also applies to his grammar, please excuse any typos you may find. Also, this article is free: written and distributed only to assist in research while providing a forum for second-level thinking.

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