Companies investing in single-family homes for rent are growing fast, and REIT funds are getting in on the action.
There’s a new property type in the REIT world. Single-family housing companies are growing fast and generating big profits for their owners, which include two mutual funds.
Baron Real Estate Income (BRIIX) and Principal Real Estate Securities (PIREX) count Invitation Homes, the largest publicly traded single-family home REIT at around $23bn in market cap, as a top holding. The stock soaks up more than 5% of each fund. Both funds also own the second-largest single-family firm, American Homes 4 Rent, among their top-20 positions.
One might not think of real estate as a particularly innovative industry, but the sector has managed to organize several different types of properties into REITs over the years. In addition to the old standbys of office buildings, apartment buildings and malls, more recently minted REITs are filled with self-storage facilities, farmland, cell towers, and data centers. Single-family homes are the latest innovation.
Real estate investment trusts have to pay out 90% of their net income in exchange for having tax-free status at the corporate level. That can make it seem a disadvantageous way to organize a fast-growing company in need of capital.
But because of depreciation charges, net income isn’t always a good measure of the true cash REITs generate. And in any case, investment capital is now plentiful – especially for a property type generating dividend yield in a yield-starved world.
George Taras, an analyst supporting the Baron fund, noted that there’s no shortage of capital to help Invitation and the sector’s second largest company, American Homes 4 Rent, to grow. Todd Kellenberger, client portfolio manager at Principal, goes so far as to say that ‘the REIT model is the right model’ for single-family housing].
‘Capital broadly flowing into real estate is really starting to pick up,’ according to Kellenberger — and single-family is one of the beneficiaries.
The firms are pipsqueaks for the time being, but investors are banking on that changing over time. ‘It’s still early in the institutionalization of the asset class,’ Taras said as he rattled off the salient statistics. ‘There are 128 million homes currently. Around 62% are owned, while 38% are rented, including vertical apartments. The rentals consist of 30 million apartments and 17 million single-family homes. Less than 2% of single family homes for rent are institutionally owned.’
In addition to buying existing homes, ‘Invitation also has a $1bn joint venture with homebuilder Pulte,’ ponted ot Taras. That equates to 7,500 new homes, and that will ‘help on the political side’ according to Taras, where companies are facing increased scrutiny as more Americans get priced out of home ownership.
Massive new supply doesn’t obviously help the business model, after all. But 7,500 homes isn’t a lot. Various estimates put the single-family housing shortage at 4 million to 5 million as construction declined after the 2008 financial crisis, after which builders slowed down their operations.
More recently lumber shortages, due to the consolidation of the sawmill industry, have hampered new construction as well.
Perhaps most importantly, the stigma of renting has declined after the housing crisis 12 years ago, and American feel less secure in their jobs making them reluctant to take on the burden of a mortgage. Both of those factors contribute to the success of the business model.
Finally, the companies have sufficiently developed operations so as to make repairs and maintenance less onerous. Logistics related to maintenance had kept companies from owning large numbers of homes until recently, but Taras notes that streamlining these logistical problem has contributed to the companies being able to generate net operating income margins of over 60%, rivaling those of apartment REITs.
The high quality of tenants, in addition to supply constraints, have allowed Invitation to raise rents on its existing properties on a year-over-year basis through the pandemic. For each of the past few quarters, same-property rental revenue increased by around 2%. That stands in contrast to the largest multifamily REIT, AvalonBay Communities, which has suffered declines in same-property rents on a year-over-year basis of 6% to 9% for the past few quarters.
Avalon Bay owns apartment buildings in big coastal cities, in addition to one property in Denver, while the single-family landlords own more suburban and exurban homes. The contrast in year-over-year rental changes through the pandemic reflect a migration from cities to the suburbs, especially those in good school districts. The pandemic and its work-from-home protocol only accelerated that trend.
Single-family tenants are stickier, and less apt to move. They are more typically families with children in schools, and more tied to their communities. Their average stay is ‘three to four years,’ according to Taras. The average apartment tenant, by contrast, is there for two years.
Invitation Homes stock is up more than 30% for the year through August 25, and sports a 3-year annualized return of more than 20%.
Yet oddly enough, the Baron and Principal funds are struggling relative to their peers this year. Baron’s 17% return for the year through August 25 lands it near the bottom of Morningstar’s Real Estate fund category, and Principal’s 25% return puts in the middle of the pack.
But that may have more to do with the fact that property types like offices and apartments that were smashed last year have rebounded this year. Avalon Bay, for example, is up 40% this year.
The two funds have delivered the goods over longer periods. Over the past three years, the Baron fund, begun in late 2017, has delivered a 19% annualized return, landing it in the top 3% of the category. The Principal fund’s 13.8% and 9.6% annualized returns over the last three and five years, respectively, have landed it in the top quartile of the category on both time periods.
Invitation Homes doesn’t look particularly cheap on traditional REIT metrics. Its dividend yield is less than 2%. But the growth runway is potentially so long that more REIT investors may nonetheless find it compelling.