American Homes 4 Rent (AMH) Earnings Call Transcript & Summary

Thanks for coming today too. I'm excited to have American Homes with us. If you don't know me, I'm Joshua Dennerlein, the senior analyst covering the residential REITs at BofA. So right next to me, to my left is CFO, Chris Lau; to his left is CEO, David Singelyn; and then to his left is COO, Bryan Smith. So we're going to have a few opening remarks from the company. And then, as was typical yesterday, we'd love to have audience Q&A. I have tons of questions, but this is for you guys. So please jump in any time.

Thanks, Josh. I'm going to have my opening comments around 2 areas. Demand for single-family rentals on the rental demand side. A little bit about our growth programs and where we are in this changing environment. And then I will ask Chris to go through a very brief operating update as well. To begin with, on demand for single-family rentals. Today, demand remains as strong as we've ever seen it, the recurring message that we tend to have. When you look at where we are today, not only is there a housing shortage that this country has today what we have seen, that has changed over the last 6 months, is the new supply of housing, at least from an affordability standpoint, coming out of the homebuilders is been reduced. And that is being filled in part by additional demand for high-quality single-family rentals. And so today, we see demand remaining very strong, and expect that to continue for our product type into 2023 and for -- actually for many years to come, even in light of where the economy is today. Talking about the second point, and that's our growth program. So obviously, a lot has changed in the last 6 months. Our cost of capital has changed. And we look at our growth programs based on the cost -- our cost of capital, with a spread to that cost of capital when we are approving acquisitions and development. And talking about development, we are very blessed and pleased that we have a very strong development program that today in 2022, is going to continue to deliver what we projected at the beginning of the year, and that's 2,200 to 2,300 homes. Just a couple of comments on what we see in the marketplace. First on the acquisition market. This is the acquisition of traditional homes. Price discovery continues. As I said, our yield targets have risen as our cost of capital has risen. The -- we have seen in the last couple of weeks, maybe in the last month, the first hints of some price softening in some of the markets. It's predominantly on the Eastern side of the United States for us, in our markets on the East, excluding Florida, and to a much lesser extent, if any, in the West Coast markets. We are currently underwriting, continue to underwrite each and every month, but our acquisition pace today due to our yield targets being slightly different, we're about 25 to 30 per month. One thing I would say about acquisitions and development in these types of times, if you go back and you look at what happened in the '90s, what happened in 2005 to 2010-'11, those are all markets that were similar, maybe not identical to this market. Those that are well capitalized, have the financial wherewithal, have the operating systems, will benefit. So long as that they are disciplined and patient, those opportunities will show. We just have to allow the price mechanism, price discovery to occur. Going through the other acquisition channels, National Builder and our development program. National Builder Program, this is what many call build-to-rent acquiring homes, that are purposely built for rentals or are brand-new homes that end up in the rental pool. We have not seen many opportunities in this area for quite some time. Recently, that has changed. Today, we are sitting on a list of potential acquisitions that have been provided to us by National homebuilders that are in the tens of thousands. That has all come over the last 5 weeks. Most of it's come in the last week, at least half of it has come in the last week. More than 3/4 of it doesn't hit the markets that we would be buying in, or the locations that we'd be buying, in or the type of asset. Maybe there are 2 bedrooms, not 3 bedrooms, maybe they're townhomes. The other 20% to 25% prices today still haven't reached a point where it makes it feasible for us to buy under our models. Our development program is a little different. Our development program continues to find opportunities even with the elevated expectations of higher yields resulting from cost of capital. We are finding vacant developed lots for the first time in 3 years that are being offered to us. This is lots that we can bring to market in 9 months, 10 months instead of 4 years. It's got all the infrastructure in place, all the roads in place. We haven't closed on any of these. We haven't put it under contract. The price hasn't been there yet. But it's the first time we've seen those opportunities presented to us. Acquisition of land that we had under contract over the last number of months. We have seen discounts in renegotiating of some of those opportunities, typically in the 10% range, sometimes as high as 40% in an instance in Boise. And the other piece is that we have started seeing the supply chain loosen up significantly. The supply chain, as the homebuilders are reducing their activity, is benefiting us, and that's translating also into more favorable pricing. It's not all the way through the supply chain yet. The homebuilders are still very active building homes that they had started, and they are finishing those homes. And so the latter parts of the supply chain still see increased or heightened demand from the homebuilders, but we expect that to reverse as well. With a couple of the favorable investment platforms or opportunities, the favorable pricing to build, the favorable land that we're seeing, we couple that with the increase in revenue that we are seeing in our sector. You see it in the same homes. It translates into our opportunities for growth as well. And we do see opportunities to continue to add homes through our development pipeline, not only in 2022, but all the years in front of us as well, at a level that's heightened from our 2022 delivery pace. With that, just a minute or 2, have Chris go through some operational items. You may have a deck that was posted on our website. If not, you'll get a couple of the highlights.

Yes.

Chris?

It hit our website beginning of this week. For anyone that wants to follow along, it's on Page 5. But really key takeaway. Leasing and demand continues to remain seasonally very strong into the third quarter, and quite frankly, pretty consistent with the guidance expectations that we just increased this last quarter. Same-home average occupied days were 97.2% for the 2 months, which reflects some, I'll call it, modest return of seasonality that, again, we were expecting -- that we'll likely see carry into September as well. But even though we're seeing some seasonality return to the business, which honestly, I would characterize as a good thing, it means that the world is kind of going back to normal. Dave mentioned this at the start, demand overall continues to remain just incredibly strong. Give you a data point on that. If you want to look at showings per available unit for the 2 months of July and August, they were nearly double, showing levels per available unit pre-pandemic. So demand continues to remain really, really strong, which has enabled us to continue pushing on rate growth as well with August quarter-to-date blended leasing spreads of 9.6%. Just for some context, that is 200 basis points of improvement over same period last year, and notably, 30 basis points of sequential acceleration over the second quarter, really supported in part by the strengthening that we've been seeing on the renewal side of the equation. So overall, like I say, a good update today. Leasing environment is strong. Demand is strong into the third quarter. And I'd be happy to open it up to questions.

Yes. Thanks guys. It's an awesome intro there. Maybe -- I jotted down a couple of questions from the opening comments, but maybe, Chris, to expand on that comment you just made about the demand. Is there -- what's driving that doubling of demand from a year ago?

Yes. And actually, best to maybe to hop in on that is Bryan because he got his finger on the pulse on the daily basis.

Yes. So there are a number of positive things on the demand side for us. We've talked about migration patterns from -- California to the Western United States is one of them. I think there's an appreciation -- a better appreciation of our value proposition. And people are realizing that the institutionally managed homes, it's just a different product than what people thought rentals would be, call it, a decade ago. So there's an appreciation for that. There's an understanding that it's a very good alternative to home ownership for those who choose. And then, we benefited too from the migration patterns, but also from some of the changes in the workplace. So better appreciation, migration, really a better offering has all contributed to it, and we just don't see it slowing down right now.

Is there any risk on the migration patterns as some of these companies like kind of force us all back to the office?

Yes, there's always risk. We track where our residents are going and move out. And we haven't seen -- I've said this in the past, we haven't seen any marked difference. We haven't seen any indicators that these migration trends or patterns are reversing. I think it's a little bit different here. We have -- we're offering a product that's larger, that has yards. It's really designed for families. Our typical -- our average age at application is late 30s. The income levels are well into the 6 figures. Are they able to choose where they're going. And I think the moves that we've seen certainly appear permanent in nature. We're talking about the stuff on the West Coast, but it's the same on the East Coast, too, or Eastern United States, migration out of New York and New Jersey into the Carolinas and Florida. And as far as we have seen today, it's very sticky, and we believe it's going to be long-term.

And keep in mind, too, not all of this is pronounced cross-state migration, right? Part of this is the fact that, because people are not -- as they return to the office, as people are not returning on a full 5 days per week basis, they're now freed up to make a different housing choice based on where they want to be oftentimes once they're in the family stage in a suburban, much more family-friendly environment, that they're now unlocked to be able to live in, when they don't have to be so concerned on commuting 5 days a week. So that's part of the dynamic, too. That's not even captured in some of the dramatic cross-state migration trends.

Interesting. And then, David, you mentioned, it sounds like your acquisition yield targets increased recently. Can you quantify that? And then maybe just thinking about across all 3 channels, like how much you've kind of increased them?

Josh, it's actually a really dynamic and changing environment. Where we used to look at what is our cost of capital on a quarterly basis, we're down to a monthly basis, sometimes even more frequently than a monthly basis. And so those numbers are getting reset frequently. You can look at our cost of capital. We're keeping consistent spreads, both on acquisitions and development to where they were previously. And so we've already seen 100 basis points change over where we were at the beginning of the year, and that will -- appears to be continuing. Especially in light of this week's announcement, I would expect that is going to have implications that are going to translate into probably higher interest rates and higher cost of capital even further. And we will adjust accordingly. But that's how we're going through it. And then to put numbers out right now, as it's so dynamic, I don't know if that's that meaningful -- pricing point.

Right. Maybe could you just remind us how you think about when you're investing across the 3 channels, like what you're kind of targeting, given investment spread and...?

Well, I mean, I think, it's the same question. If you go back to the beginning of the year and you can then just -- you can look at our cost of capital, like I can -- We were in the high 4s on acquisitions and the high 5s on development. And all of that, as I indicated, has moved about 100 basis points already this year. And unfortunately, it's going to probably move a little bit more. Fortunately, at least on our development side, with the cost coming down on the investment side, and the fact that we continue to see strong performance, we're growing into those higher required deals. And I would expect on acquisitions, as price discovery continues and those markets find clearing prices for homes to be sold, we will find opportunities there as well.

And then you mentioned the price softening in U.S. East Coast markets. I guess why are those markets softening first and...?

Yes, that's a good question. I think, some of those markets had a little bit more inventory than the West Coast markets that were a little bit hotter. I think, once you get a couple of homes moving down, then others do follow. It's not a significant movement, we're talking in the 5%, 10%, at most 15% range. And if you look at home affordability, for people to want to want to sell their homes, there has to be an acknowledgment at some point. They're going to need to lower their expectations. The market -- the way it normally works in a down market is, you see elongation of listing types, and then you see more homes being added to the list. And at some point, people make the realization, if we want to move our home, we have to lower prices. This just happened there first by chance.

Okay. Interesting. Any kind of sense on how much softening we might see or...

Yes. I think, as time goes on, and it's going to be a gradual process as interest rates continue to go up, and it's putting stress on the affordability. By the way, home affordability today is much more leaning towards rentals than it ever has, or at least has in the 12 years that we have been doing this. As home affordability continues to get more and more stressed by the cost of capital, which is mortgages for homeowners, those prices are going to have to come down, and it's just going to take some time. I think you're going to see this continue while the market resets, and it's going to continue into early next year.

And then you mentioned the National Builder Program. It sounds like a lot more opportunities that are being presented to you. I guess, how attractive are those overall? And are there any kind of bigger potential opportunities down the road, as kind of these builders kind of think about their strategy?

Yes. Well, a couple of points there. One is, we mentioned that about 20%, 25% would be great opportunities for us. What this also has done is -- the way this process has typically worked is, we've had discussions with the division presidents of all the National homebuilders as to what they would like to do with some of their inventory. That process has changed. And now we are actually having meetings. Bryan and I have had some recent meetings with some of the top 5 homebuilders of corporate offices, and they're coming in and they're looking at different programs that they can put in place, not only to sell assets, but maybe to venture -- joint venture with us or look at other opportunities. So it's led to some new discussions that we have not had in the prior couple of years due to the fact homebuilders had a very, very strong retail presence at that time.

Any questions from the field at this point? Maybe could we -- I always think one of the unique aspects of your company is just the development platform. Can you maybe just go over your overall strategy on that front, and also how you plan to kind of grow it in the years ahead?

Well, I think we're continuing what we put in place 5 years ago. We tested this program. That's how we tend to look at new opportunities. We did it slowly. And once we concluded that, our assumptions were validated, or we had tweaked to some of the assumptions that needed to be tweaked, and decided to move forward. We have opened up a number of markets. And today, we have a development presence in about 16 markets. Not all of them are delivering homes yet, but we have a presence in 16 markets. The first aspect is, you have to buy land. And it's a 4-year process, typically. It's going to be 5 years, in some cases, taking vacant land -- unimproved vacant land, going through the infrastructure, the vertical -- or the horizontal building process, bringing it to a point where you can vertically build, and delivering homes. So this is a long-term program. And so some of our markets we're acquiring land. If you look at our delivery pace, the delivery pace has continually increased year-over-year. But you can only deliver where you have land that has been improved upon. Last year, about 1,600 homes, this year, 2,200, 2,300 homes. '23 will be higher than that. But if you go back and look at where we were buying land and volume, it started in about late 2019, 2020. That means 2024 is going to be a breakthrough year in volume.

And then [indiscernible] you made the announcement of the kind of the land bank partnership. Any update on that front? Sounds like it was like -- it could be a big opportunity.

The land banking programs that we started looking at in 2019, have paid exceptional dividends, not in the areas that we expected to, but in additional areas. And we have multiple partners today we are land banking assets with. That is essentially they buy it and give us an option. So it derisks our development program. But these individuals also control a lot of land. And I just talked a minute ago about having the opportunity of buying BDL's land that's already improved horizontally, that we can bring to market much quicker. Those opportunities predominantly are coming out of these relationships that we have with land banking organizations.

And then, maybe move Bryan in the conversation. Just are there any initiatives that you're working on to kind of get further margin expansion across the portfolio?

Yes. I mean that's -- we're focusing on that every day. I think, starting with a key initiative, we still believe that by improving communications and the resident experience, there's room to improve retention. That's going to be super impactful to start. We have some technology improvements that we're working on, that will help with efficiencies on the management side, on maintenance, logistics, inventory control. So we're actively trying to improve the system that way. From really the overarching perspectives though, improved communication internally with our own resources, improved communication with the residents, are a couple of key initiatives that I think translate into longer stays and more efficient administering of the maintenance program.

Obviously, the largest lever to margins is pricing power to the top line, right? These are great initiatives we talk about. Ancillary income and things like that are great on the margin. But really, the most impactful lever is pricing power to the top line, and the ability to outpace expense growth, which -- even though this year, one of the topics is inflationary environment. What that means for expenses and our ability to translate that into incremental growth on top line and expand margins, I think, speaks to the ability to be able to do that.

And that's a great lead-in to just go over kind of the pricing power you're seeing across markets and kind of what your expectation is going forward.

Yes. It all ties back into levels of demand that we talked about earlier, and it's just really a fantastic environment for that. Then the second piece is going in and seeing -- are there any supply changes that we see on the horizon. And for the location of our homes, we're very particular about where we buy, where we invest. We're not seeing any major supply chains coming. So I think the pricing power supported by our loss to lease that we've talked about, supported by improvements in the resident experience on the renewal side. And really no big changes on the supply side and the horizon, gives us a lot of confidence going into next year. And then just to reemphasize a point, there's a graph in our deck that shows the difference between affordability, between buying and renting in our markets. And our business performed really well, and by this particular calculation, it was cheaper to own. And that's since flipped. When we ran this particular graph, a couple of weeks ago, it was 20% cheaper or 20% less expensive to rent in our markets. That's going to bode well for us going into next year as well. So really particular on our locations. It's where people want to live. It's where people are moving, and no supply issues, give us really good position.

Let me add one thing. Bryan mentioned it in his first comments, and that was, the single-family rental value proposition is becoming better well known. What that really is, is this. If you go back 15 years ago, single-family homes had a perception of being a housing option of near last resort. Today, it is deemed to be a high-quality housing option. That has changed over time as a result of the institutions, ourselves, and some of our institutional peers coming in, and really resetting the expectation of what single-family rental homes looks like. Today, we see a significant demand for this product -- this institutional product. We have 17 million homes today that are single-family rentals. 200,000, 300,000 of them fall into this Class A area. That's very, very meaningful when you start talking about recessions and other things like that. These are the assets that people are going to continue to desire through that time. It is also the fact that people today recognize that this is a high-quality and high-value proposition. Those are the reasons that Chris's numbers that you mentioned, where we are seeing 2x the demand through our showings and our applications than we did pre-pandemic times. That's what's causing all of this. And so there is just very, very strong demand in our marketplace today.

Any questions from the field? Shy today. I think they went out last night. Maybe, Chris, on the capital allocation front. Obviously, capital has gotten more challenging. How are you kind of thinking about it as you kind of look ahead to next year, and sources and uses and...?

Yes. And a lot of it ties back to what we've already done this year, which we talked about at the end of the second quarter, where we've made a couple of modifications. We pulled back a little bit on our acquisition expectations for this year. Midpoint of guidance now expects that we're going to be acquiring call plus or minus 1,700 properties between the MLS and our National Builder channel. And then, we made the decision, as I'm sure most of you heard, to not redeem another series of preferred shares that became callable a couple of months ago at this point. And so what that's done is, it's freed up about $300 million to $400 million of what I would call dry powder capital capacity compared to our prior capital plan, to enable us to be incredibly opportunistic and ready to go, when some of these opportunities materialize that Dave has been talking about. And so as we head into next year, and think about those opportunities, I think Dave said this, we'd love to see some of those this year. Realistically, it's feeling like those are probably going to be more '23 type of timing, which means heading into next year that dry powder capital capacity will be rolling over. And as I think about kind of the components of external growth, it's still too early to put hard numbers to it. But the first area that I would point to that has turned into the consistent and predictable backbone of our external growth is the development program. And we know that we will see nice and meaningful increases in the production volume and deliveries from the development program next year. That's piece 1. And then, we can be very nimble and opportunistic on our acquisition channels based on the opportunities and what those look like, both utilizing the dry powder capital capacity already on hand and where the capital markets screen for next year. But obviously, we can be very nimble and opportunistic on those and get too early to put real numbers to it. But we're optimistic at this point that '23 could be a heavier external growth year into '22.

Yes. If you look at history and you go back, and this is going back to my opening comments, and you look at times like those that we're experiencing today, for those that are well prepared and patient and disciplined, those opportunities open up. You can't exactly -- predict exactly the timing to the month or the quarter, but they do open up. We've seen tremendous growth. I've seen tremendous growth in my days at Public Storage when we went through these periods, as long as you remain disciplined and patient. It's not always the easiest thing to do, especially for your acquisition and development departments who -- their whole life is to do transactions and you tell them to slow down a little bit. It's just pretty foreign to them. But we're going to see opportunities. We have the best capital in the industry. If you look, we just got upgraded on our credit rating. We're now BBB flat at S&P. We have a very good multiple. And all the stock prices have come down. Our yields are going up, and we still are going to find opportunities that are accretive to our cost of capital, even though it's adjusted. And that is going to provide those opportunities. So we're going to have -- we can't exactly put numbers around it at this point, how big that opportunity is, but we're going to have some very nice opportunities going into '23.

I'll make one more point that I forgot. I think it's actually a very important one. As we're talking about our channels for growth, and we're talking about capital market uncertainty and cost of capital considerations, all that. One very important thing is we've been very strategic in how we've not just built, but sized the development program. So at the end of the quarter, we owned or controlled via option arrangements, 15,000 lots that will translate into inventory over the next 3 to 4, 3 to 5 years or so. Importantly, as those units work through the development program and pipeline, we've sized it in such a way that in any given year, the ability to build out the development pipeline can be done without the need for equity, right? So it's a combination of retained cash flow, maybe a little bit of recycled capital from dispositions, and then just natural growing leverage capacity of the balance sheet, right? It's very important to size it that way, which again, then means that equity and/or incremental debt turns into opportunistic tools that we can size accordingly based on cost of capital considerations and the opportunity set in a given year.

And I'll add one more thing. I know you want to get to the next question, but 15,000 homes, that's what we own or control through auctions. Those are totally through the acquisition process. We have another 7,000, bringing the total number to over 22,000. Those 7,000 are in the escrow process. Those are the ones that we've got some of our reductions in purchase price on. And those -- some of those will fall out. They always do. But a large percentage of them always end up in closing. They'll close into the land banking, the auction and be available for future development as well.

So that was really interesting on the development side. And so one of the hot topics, we always seem to be fielding over the last few weeks in residential, it's just like the risk of recession, it's like a very macro conversation. It's more, I think, on the apartment side, but what do you see as kind of the pain points and then the opportunities for a recession with your business model?

Yes. I think recession, obviously, it has had a lot of talk. When you think about recession in any real estate sector, whether it's residential or otherwise, you really have to look at how it impacts your Class A, Class B and Class C assets in that group, because it impacts them differently. The first impact is going to be to your Class C and then to Class B. And then obviously, if it's for long, it's going to be Class A. Residential has 2 -- especially single-family rentals. I think we have 2 things that protect us in a way that others don't have. One is it's a required asset for pretty much everybody in this room. We have to have shelter overhead. Some of us will do it through ownership. Many of us do it through rentals. There isn't enough ownership opportunities, at least in affordability today to solve that. So single-family rentals has to play a role in that. We are definitely -- we being the American Homes and the institutional brands, are definitely the Class A in single-family rentals. And you look at our income levels, you look at the desire of people wanting to live into these homes, especially the new communities that are being built with these Class A resort-style amenity centers, the demand is very, very strong. We're going to be the last to be impacted. And when you think about impact, this is a required asset for everybody in the room. So it's going to -- we're not going to see the impacts that we may see in other real estate sectors. When you then move down and you look at our income levels being 5 plus, you get into the multi-family. It's a little bit different asset class. The anchors aren't the same as you have in single-family rentals. You don't have school-aged children in schools that you want to protect, and there's a little bit more mobility. It's why our turnover is lower to start with than multi-family. If you get -- look at multifamily, it's my opinion that you're going to see the first impacts in the Class C and Class B multi-family before you really see it in any of the other sectors of real estate or residential real estate.

We're about out of time. Is there any final question from the field or not? Well, we'll end on that, no, but we do have 3 rapid fire questions that we've been asking all the management teams. They're very difficult. The first one is, which of the following is the greatest macro challenge facing U.S. public REITs today? A, risk of higher rates; B, risk of a recession; or C, the rise of private equity and non-traded REITs.

I think today, the one that we are all dealing with and have to focus on every day is going to be the higher rates. So recession, we just talked about, I think we're -- that's not going to be as big an issue for us.

Which of the following is the greatest sectors-specific risk? 1, labor issues; 2, supply; or 3, capital markets.

Labor has been a problem, although I see it getting a lot better for us, especially in a lot of our disciplines. So -- but labor is always a concern.

Are you seeing any signpost of weakening demand -- yes or no?

No.

Great.

Thank you, Josh.

Thank you.