Demand for Suburban Homes at Affordable Levels Should Drive Growth for Invitation Homes

Senior Equity Analyst

Kevin Brown

Invitation Homes is the largest single-family rental real estate investment trust with a portfolio of over 84,000 homes. The portfolio is geographically diversified across 16 U.S. markets with approximately 37% of its homes in the Western United States, 31% in Florida, and 22% in other Southeastern markets. The cost of renting is lower than homeownership in most of the portfolio's markets, which supports high occupancy and should allow the company to pass along significant rent increases without much pushback. The company's size gives it some economies of scale in terms of controlling costs as it can hire its own maintenance and repair technicians to service its homes, allowing it to maintain higher operating margins than smaller competitors that need to contract out the same services. The company regularly recycles capital by selling noncore assets and using the proceeds on higher-quality acquisitions with better growth prospects.

Invitation Homes focuses on owning newer homes in the starter and move-up segments, which are typically around $350,000 in price and less than 1,800 square feet. These homes typically attract a younger demographic. This coincides with a generation of millennials who have long delayed many adult milestones but started to move to the suburbs during to the pandemic, and this trend will likely continue over the next decade as they age and start families. Given that millennials typically lack the necessary capital for a down payment, many have chosen to rent single-family homes when they move to the suburbs. This increase in demand combined with slowing supply due to high construction prices should promote solid fundamental growth for several years.

However, the long-term outlook for this segment is not as rosy as the next few years may appear. The baby boomers are also aging and will eventually return their housing stock to the market. The increased supply will either lower housing prices to the point that renters can afford to purchase a home or create new rental housing stock that will compete with Invitation Homes' portfolio. Ultimately, we don't think the single-family rental market will support growth above inflationary increases.

Business Strategy & Outlook

We assign a no-moat rating to Invitation Homes. Though the company has desirable properties in high-growth markets and segments, the initial rents and rent increases it achieves on its properties compared with the initial capital investment produce returns that are below its weighted average cost of capital.

To generate high, growing rents, a residential property would have to be located in a market with very strong demographics to support the rent and high barriers to entry. Population growth and household formation growth both directly lead to demand for more housing stock, which support high occupancies for a residential portfolio. Once an apartment building reaches a fully stabilized occupancy level, the apartment manager can increase rent on existing tenants, knowing that the marginal tenant who would move out because of higher rent can be replaced by the excess demand for the units. Job growth also leads to population growth by attracting people from other areas to the market and leads to household formations by providing people currently living with parents or roommates the means to afford their own space. Income growth allows people to afford more-expensive housing, which in turn allows landlords to push higher rents onto residents who can afford those increases. For a rental portfolio, high property prices encourage renting and allow the landlord to set higher initial rents. High property prices also attract housing developers, so there would have to be significant barriers to entry, like high construction costs, zoning restrictions, and access to capital for investment. 

Invitation Homes' portfolio is mostly located in markets that have favorable demographic trends, including population, job, and income growth, and have high homeownership costs. Invitation Homes concentrates on starter homes, a segment of the housing market that should see higher demand. Millennials have delayed their adult milestones like living on their own, getting married, having children, and purchasing homes over the past decade. As this age cohort gets older and checks off more of these milestones, it will increasingly consider living in a single-family home in the suburbs, creating more demand for Invitation Homes’ portfolio. Many of these markets also have very high prices, with the average purchase price for a single-family home in an Invitation Homes market over $400,000. Considering that the millennial generation entered the job market around the Great Recession and so delayed saving while also being burdened with record student loan debt, many millennials lack the money for a down payment on a home and therefore will most likely consider renting over purchasing.

Despite the positive demand drivers in Invitation Homes' markets and portfolio, we don't believe the company would be able to maintain any excess economic returns that it generates. While Invitation Homes has the largest portfolio of single-family homes for rent in the country, its portfolio is just a drop in the bucket of the overall housing market. For example, while Invitation Homes owns over 12,000 homes in the greater Atlanta market, there are nearly 2.3 million homes in the Atlanta metropolitan statistical area. If Invitation Homes does start making economic profits, additional market participants will be encouraged to rent out their single-family homes to attempt to steal the profits. Additionally, the barriers to entry are very low in most markets, and economic profits will attract more developers to build competing properties. The increased competition from single-family homes converting to rental stock and increased development would quickly eliminate any prolonged internal growth that the company generates. Invitation Homes also must compete with all other market participants to purchase homes in these markets. Given the high prices in these markets, forward 12-month acquisition cap rates have been in the mid-5% range. Since the initial rents are low and internal growth is generally limited by competition, we believe that the economic returns generated by the company won't exceed the company's WACC.

We use an adjusted return on invested capital calculation to determine if a company historically has shown or is forecast to have the characteristics of an economic moat. After adjusting the ROIC calculation to use maintenance capital expenditures instead of accounting depreciation, we calculate that over the past few years, Invitation Homes has averaged an adjusted ROIC more than 300 basis points below our 7.1% WACC. While the adjusted ROIC rises over our forecast horizon as the assets stabilize from recent transactions, it does not exceed our WACC estimate, affirming our view that Invitation Homes' portfolio should be assigned a no-moat rating.

None

Economic Moat

Invitation Homes

Invitation Homes, Inc. engages in the acquisition, renovation, leasing and operation of single-family homes as rental properties, including single-family homes in planned unit developments. Its services include property management, selection of homes, maintenance program, and online payment. The company was founded by Marcus Ridgway, Dallas Tanner, and Brad Greiwe in 2012 and is headquartered in Dallas, TX.

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