Thursday, May 12 2022

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As a dividend growth investor, I am always on the lookout for investment opportunities with attractive valuations. Sometimes an investment that is overvalued in absolute terms can present an opportunity if it is undervalued relative to other investments in my portfolio. I believe such a situation exists with regard to American Homes 4 Rent (New York Stock Exchange: AMH). I gladly sold my holdings in Gladstone Land in order to take advantage of the current investor craze for farmland-related assets and put that money to work in an investment that I believe has much greater potential for increase its payout over time – -AMH.

American Homes 4 Rent is an equity REIT that invests primarily in single-family homes. It started its operations in 2012, and since then it has gained a reputation as one of the leading operators in this field. The company had more than 57,000 single-family homes in 22 states at the end of 2021, with nearly 95% of those properties occupied. AMH’s role in the rental market is to serve as a centralized source of financial capital and management expertise. AMH is positioned to succeed because of the economies of scale it is able to exert across its broad portfolio, experience in the single-family rental space, and technology platform.

AMH has a well-diversified portfolio, with a single market (Atlanta, GA) accounting for nearly 10% of the total rental portfolio. Also noteworthy is the country’s lack of West Coast representation in AMH’s major rental markets. This gives the REIT distinct southern exposure, with Georgia, Texas, Florida and North Carolina making up significant portions of the portfolio. AMH generally targets homes that are relatively new (i.e. built after the year 2000), ideally sized for growing families (at least three beds and 2 bathrooms), and occupy a price tag of $250,000. at $550,000. The company also considers qualitative factors such as property condition and proximity to good school districts that make its investment decision.

Table of properties held by AMH by geographic market

AMH 10-K Report

AMH has three main strategies for developing its portfolio: it can purchase an existing home or a portfolio of homes, it can purchase a new home from a domestic builder, or it can build a new home using its in-house development team. This latter option sets AMH apart from many of its peers, including publicly traded Invitation Homes. In fact, AMH owns 18,000 lots on which it can choose to build additional rental units at some point in the future. This gives the company a unique avenue for possible growth beyond engaging in bidding wars with other buyers during a white-hot housing bull market. In fact, I believe AMH management is showing at least a modicum of discipline in not overpaying for new properties. For example, in Zillow’s recent attempt to liquidate its company-owned real estate inventory, AMH turned out not to be a voracious buyer of company inventory. According to CEO David Singelyn, while they offered extremely low rental yields for the properties, other buyers were willing to offer even lower rental yields – and AMH chose not to chase stratospheric prices for these properties. While the net result of this decision has been fewer acquisitions for AMH, it tells me that management is not willing to pursue growth at any cost, which gives me more confidence in the long-term future. of the trust.

AMH’s growth – along with the current inflationary environment – has resulted in a significant increase in revenue. These increases gave management enough confidence to guide a double-digit increase in the percentage of base funds from operations (FFO). The $1.56 amount shown in the table below compares very favorably to the company’s current annualized dividend payout of $0.72, which reinforces the idea that AMH has ample headroom to continue. to increase its dividend at a competitive rate. However, as interest rates rise, it is possible that the drag on FFO growth caused by financing costs will increase.

Chart showing Core FFO growth

AMH investor presentation

There are a number of favorable macro indicators that suggest growth in the single family rental segment is likely to continue for the foreseeable future. As millennials age into their prime earning years, persistently high housing prices may force them to remain renters longer than they otherwise would be. This situation is expected to persist until the housing undersupply caused by the slowdown in construction activity after the Great Recession is resolved. Finally, while single-family rental growth has been robust since the pandemic, the purchase price of single-family homes has been explosive in comparison, suggesting that the relative economics of renting a single-family versus the buying a single family home may remain tilted in favor of renting for years to come.

Charts showing the macro factors driving single-family rental demand

AMH investor presentation

Dividends

AMH has always offered a tiny dividend yield. However, AMH compensates for this by offering favorable prospects for dividend growth going forward. Last year, AMH began its dividend growth streak by doubling its payout from 5 cents per quarter to 10 cents. This year, AMH has reduced its pace of dividend growth, but still committed to increasing the quarterly payout by 80%. These massive increases likely signal a company looking to share more of its earnings with investors in the form of shareholder distributions. I expect AMH to continue this transition in the years to come, with double-digit percentage increases in dividend payout for years to come. Contrast this meteoric growth with that of Gladstone Land – a slower-growing REIT that, despite its higher starting yield, has seen much lower average growth in its dividend payout in recent years.

American Homes 4 less than Gladstone Land in % change in dividend
Data by YCharts

The case of (relative) value

American Homes 4 Rent is certainly not cheap in absolute terms. Similarly, however, there are also not many stocks that offer similar exposure to inflation-resistant assets. In fact, one can make the argument that AMH has lagged while some other “inflation bets” (like Gladstone Land) have seen their valuations gallop past their historical ranges.

AMH vs. Gladstone in dividend yield
Data by YCharts

I recently assessed my portfolio and came to the conclusion that Gladstone Land, with its now anemic dividend yield and equally paltry record of dividend growth, was likely to be a poor income investment going forward. Enter AMH. Given AMH’s recent record of massive dividend growth and my confidence in its ability to continue to generate the same growth in the future, I have concluded that AMH represents a very attractive destination to redeploy my capital. already profitable bet on agricultural land. As such, I recently closed my position in LAND and reinvested the proceeds into AMH. Income investors looking to exit overvalued positions might consider a similar course of action if they find themselves in a similar situation.

Risks

As with any investment, perform your own due diligence before committing capital to AMH. First and foremost, the company’s runaway valuation should give all investors food for thought, especially with the increasingly hawkish Federal Reserve. If interest rates rise materially, there is always the possibility that retail demand for AMH shares will slow, dragging the stock price down with it. While I expect AMH’s robust new dividend-rising model to keep it from being valued purely as a bond substitute by the market, I wouldn’t be surprised to see concerns about that as interest rates rise. In addition, increased financing costs could make it difficult for the Trust to acquire new properties or service its already significant debt.

Another aspect to keep in mind is the risk of the company acquiring or even building real estate at the very top of an overheated real estate market. Look what happened to Zillow when they overpaid for a bunch of houses recently. The net result was capital losses and, together with other micro- and macro-economic factors, a crash in the company’s share price. Although AMH is not in the same business as a technology company like Zillow, it could still face similar risks if, against all expectations, real estate prices drop significantly. Such a scenario could reduce the value of AMH’s real estate inventory. Additionally, weak housing prices could also translate into a reduced ability for AMH to raise rents, which could limit its ability to increase its dividend going forward.

Final Thoughts

American Homes 4 Rent is one of the few publicly traded investment options that retail investors need to get into the single family rental game, unless they are buying their own rental property. Although the valuation of this name is extremely stretched, so are some other stocks. After evaluating some of my existing holdings against AMH, I decided that AMH had greater potential for dividend growth in the future. It is true that the future evolution of interest rates, house prices and rental yields all present risks for this potential. However, I believe the favorable long-term economic trends, AMH’s decision to pursue a three-pronged approach to building its portfolio, and the disciplined approach to acquisitions shown by management thus far bode well for its future as a dividend income investment. Investors looking to grow fresh capital should be wary of current valuations, but those looking to grow funds from an already successful investment should crush AMH.

Use my work as a starting point for your own due diligence, not a substitute. All investments involve the risk of loss of income as well as principal. Consider consulting an investment advisor before making any investment. I am not a tax specialist or investment advisor. Please consider consulting a tax professional before making any investment. Graphs generated by the author are subject to error due to discrepancies in source data or securities listed on multiple international markets.

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