House prices have been rising at an unprecedented clip, according to the Federal Housing Finance Agency (FHFA) House Price Index. In July, prices rose 19.2% year over year, which is reminiscent of the bubble years of 2004 to 2006. Unfortunately, investing in rental properties is often a laborious process, and real estate isn’t necessarily the most liquid investment out there.
Investors who want to gain exposure to this sector without buying a property should take a look at Invitation Homes (NASDAQ: INVH), which has the advantage of stock market liquidity and real estate returns.
Single-family rentals are ready for institutional money
Historically, single-family rentals has been a highly fragmented industry, made up primarily of mom-and-pop landlords who own a handful of properties. That changed after the real estate bubble burst in 2008. Institutional investors raised capital to buy distressed foreclosed properties, rehabilitate them, and then rent them out.
Technology enabled institutional investors to handle the property management functions, which have historically made managing a lot of properties difficult. Data analysis also helps companies like Invitation analyze potential acquisitions and deploy capital most effectively.
The current environment is ideal for the single-family rental strategy
Single-family rental real estate investment trusts (REITs) are in the perfect economic environment right now because interest rates are low and home price appreciation is remarkably strong. Low interest rates allow Invitation to borrow money cheaply, and rapid home price appreciation drives rent increases.
At the end of 2020, Invitation had a portfolio of 80,177 single-family rental homes with an average monthly rent of $1,874. Its geographic focus is primarily the West and South. Last year, Invitation generated $711 million in funds from operations (FFO), or $1.24 per share.
REITs generally use FFO per share instead of net income when discussing earnings. This is because depreciation and amortization charges take a massive bite out of net income. Depreciation and amortization are noncash charges -- in other words, nobody writes a check out to “depreciation.” This means that net income tends to understate the actual cash flows of the company.
Real estate appreciation, rental income make for a great combination
It is important to recognize that just because Invitation’s real estate assets are appreciating in value, you won’t necessarily see that taken into account directly in the financials. Companies don’t “write up” real estate assets, so the only time you will see evidence of home price appreciation is when Invitation sells properties. Invitation is getting a rental yield on the property, and when you take into account home price appreciation, the company is generating over a 20% return. Few financial assets can match that.
So, is Invitation Homes a buy? The stock is trading at 31 times 2020 funds from operations per share, which is a hefty multiple. Competitor American Homes 4 Rent (NYSE: AMH) is trading at 32 times, which demonstrates that the entire sector is priced for perfection.
That said, the fundamentals for the sector are quite strong, given a housing shortage, strong price appreciation, and the fact that the sector will probably be consolidated by companies like Invitation. Personally, I wouldn’t reach for it, but it is hard to doubt the fundamental story here.