Single Family Rental: A Major D.R. Horton Asset Sale
We look at the major single family rental transaction by D.R. Horton and the context for rentals and builders.
“It’s good to have options.”
We consider the recent $1.5 bn single family rental transaction by D.R. Horton for the company and in broader industry context.
While various sources frame the supply-demand shortfall of housing units from 4 million to over 6 million, the main point is that building the right homes in the right locations is a good strategy even at 7% mortgage rates.
Some under-the-radar headlines over the past week show D.R. Horton (ticker: DHI) entering into a sale of home rental units. The news did not earn a press release from DHI, but the reported transaction involves a $1.5 bn purchase of homes that DHI has built specifically for its rental segment. There were no comments from the players in the deal, but we saw 4,000 homes in the trade press (HousingWire and the Wall Street Journal cited Bloomberg). The party in the transaction was Pretium Partners, a major alternative investment manager with almost $52 bn under management at year end 2022 with expertise in real estate, mortgage finance, and corporate credit. They also manage single family residential funds.
Pretium published a white paper on the housing supply-demand topic (from 2021) that is consistent with a lot of the industry color you see across the agencies and trade rags. That study was published before the chaos of 2022 in mortgage rates and affordability, but the basic framework still holds true. Employment, demographics, household formation rates, regional economic trends, the relative mix of existing homes for sale, mortgage rates, relative affordability, consumer credit conditions, homebuilder community planning by product segment and by region, and a big basket of variables get rolled up in different ways by different experts. The sum of it all is “shortage.”
D.R. Horton as a major single family rental supplier…
We had looked at DHI in detail in a recent Credit Profile report (see D.R. Horton: Credit Profile 4-4-23), and there are few better microcosms of the US housing market than what the #1 US homebuilder is doing. DHI has created a new business segment as it built out a growing build-to-rent operation that was posting very strong profitability growth. The rental operation had been more biased toward multifamily in prior years and was lumped into “other” as a business segment. It is now part of a consistent plan targeting single family.
The growth rates and impressive margins generated by DHI in the Rental segment are in the report. The pace of buildouts and sales of the rental communities are “lumpy” in terms of when they get booked, but the segment offers an attractive diversification strategy for such a major homebuilder. It will be interesting to see how many other builders follow.
The above chart offers some food for thought. We plot comparative total returns for the trailing three years for DHI vs. Invitation Homes (INVH) vs. the XHB homebuilder ETF. The time series starts in June 2020 as COVID was in full swing, shutdowns were pervasive, and the vaccine would not show up until Nov 2020. INVH is the largest public REIT operating in the single family rental (“SFR”) space with over 80,000 homes and carrying value around $17 bn (1Q23).
A lot of action in SFR asset management has been in private funds, but the mix of underlying assets can vary widely. It comes down to acquisition costs, rental rates, and valuation upside for the houses, but the assumption is that newly minted homes will be attractive in this asset subsector. Being the one who builds new SFR homes –whether leader such as DHI or smaller player such as LGIH – is good business while overall residential construction volumes remain constrained by mortgage rates.
INVH stock lagged the builder equities for a number of reasons including the reality of forward rental rate growth questions and what the rising multifamily supply will mean by region. INVH modestly underperformed the S&P 500 over this period (not shown) across the 2021 tech boom and rally this year. INVH total return was closer to the equal weighted S&P ETF and equal weighted NASDAQ 100 ETF (not shown) than it was to XHB and DHI.
The number of those who don’t believe in the massive supply-demand shortfall analysis of the housing market are a dwindling population, but the more viable debate is whether the economics of the single-family rental market has turned unfavorable with rent growth far less attractive than it had been when the pandemic saw a demand spike.
The Single Family Rental markets fill a supply-demand gap...
The SFR market generally has garnered no shortage of headlines in recent years with the explosive growth of the segment and capital commitments during the pandemic. The sustained growth in the area is easy enough to see with the rise of dedicated funds and a window into the business from public companies such as Invitation Homes.
Like any major consumer/household decision, the choice of residence is about more than just “rent vs. buy”. The opportunity to move into a new single family home without all the cash outlays and attention a new home needs is proving to be very attractive to a growing base of the population. The age of student debt and tight paychecks is consistent with SFR growth across regions outside the metro areas and across the country.
The SFR topic needs more focus in separate pieces, but the DHI strategy seems to be the best of both worlds. SFR has also captured a growing share of LGI Homes operations in the more basic entry level homes they have been very successful in growing. For DHI, they fill that demand with supply that they can deliver at high profit margins. That has been a good strategy, and the business can turn over balance sheet usage efficiently and “play it again” as the economics of the business allow.
In the debates around SFR prospects, the bigger question of forward rental rates gets blurred into the discussion of what the underlying assets will be worth later and how that rolls into longer term valuation of SFR assets. Those are issues for another day, but the supply shortfall lurking around 5 million units (some say 4 million, some say over 6 million) would seem to be favored by newly constructed homes where the local market has been rigorously researched by both the builder (in this case DHI) and expert managers. The buyer and builder/seller in this case comprise two pretty good sources of support for the basic gut check of logic and the intrinsic value of high demand vs. inadequate supply.