Goldman Sachs Analysts recently released a report predicting a 2008-style real estate correction in some areas of the United States that have seen excessive home price increases that have not been accompanied by similar wage growth. The investment bank’s report cited San Diego, Phoenix, San Jose and Austin as the four metropolitan areas expected to experience large home price declines.
If the report is accurate, it could spell big trouble for single-family real estate investment trusts (REITs). American Homes 4 Rentals (IMF: 1.14%)?
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American Homes 4 Rent aggregates the single family rental market
American Homes 4 Rent is a REIT that focuses on owning and renting single-family homes (many REITs in its category tend to focus on apartment development). Historically, single-family rental properties were a highly fragmented industry dominated by small “mom-pop” type landlords who owned one or two rental properties. For a long time, the conventional wisdom was that single family rentals were not a scalable business and there were no economies of scale. American Homes 4 Rent has proven that the business model really works.
At the end of September 2022, American Homes 4 Rent had a total of 58,961 single-family properties in 22 states, including 1,057 properties for sale. The company’s largest geographic market is Atlanta, followed by Dallas, Charlotte and Phoenix. Phoenix accounts for 3,399 properties, representing 5.9% of American Homes 4 Rent’s portfolio. American Homes 4 Rent is not exposed to the other markets mentioned in the Goldman Sachs report (San Jose, San Diego and Austin).
The company does have exposure to some top markets like Charlotte, Nashville, Jacksonville, and Tampa. So if home prices in Phoenix collapse, what will happen to American Homes 4 Rent? First, it should have no effect on the book value per share because the company does not “write down” the value of its real estate as prices rise. Most of American Homes 4 Rent’s portfolio was purchased an average of about seven years ago, so there’s a lot of home price growth that doesn’t show up on the balance sheet.
Vacancy rates are still extremely low in Phoenix
As a general rule, rents lag home price increases by about 21 months. This is because rents reset annually at most, and they only reset to market value when the tenant vacates the apartment. Very few landlords will raise a tenant’s rent by 20%, even if housing prices rise by that much. Given that Phoenix only makes up about 6% of American Homes 4 Rent’s portfolio, any potential drop in rental inflation would have only a small impact on earnings. Phoenix’s rental market is still extremely tight, with a rental vacancy rate below 4%, the tightest market in 20 years. We could see house prices fall and rents move very little as landlords have little incentive to lower prices.
American Homes 4 Rent expects 2022 funds from operations (FFO) to come in between $1.52 and $1.56 per share. REITs tend to use FFO to describe earnings instead of earnings per share as reported under generally accepted accounting principles. (GAAP:). That’s because depreciation and amortization is a large expense under GAAP, but not an expense a company would write a check to pay. This means that earnings per share under GAAP tend to understate a company’s cash flow.
American Homes 4 Rent pays an annual dividend of $0.72 per share, meaning its payout ratio (dividend divided by FFO per share) is below 50%. This is extremely low for a REIT and indicates that even if rental appreciation in Phoenix stops, the dividend is well covered and should not be at risk for a dividend cut.
Brent Nyitray, CFA has no positions in any of the stocks listed. The Motley Fool has positions in and recommends Goldman Sachs Group. The Motley Fool has a disclosure policy.
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