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

Good morning. I'm Juan Sanabria from BMO. I'm very pleased to have AMH with us. Dave Singelyn, CEO and team are here. I'll hand it over to Dave to say some prepared remarks and introduce the team, and we'll go from there.

Thank you, Juan. Thank you for moderating today. I'm joined today by, to my right -- I guess, your left, Chris Lau, our Chief Financial Officer; and to my left, Bryan Smith, Chief Operating Officer. Just maybe 30 or 60 seconds of opening comments. Operations for AMH or American Homes for the first quarter and second quarter have been very, very strong. Occupancy continues to be strong in the 97-plus percent range. We're seeing some return to seasonality, more akin to what 2019 looked like prepandemic. Although it's not the peaks and valleys are not as steep as we had seen in 2019 and prior. Rental rates continue to be very strong, very strong in the first quarter, blended increases of 7.1%. And in second quarter-to-date, April and May, that number has improved to 7.5%. So very, very strong operationally. On the growth side, we're in a very enviable position to have our development program that allows us to grow in all economic cycles. And so today, we are going to deliver this year approximately 2,300 new homes. So we're right on pace from what our guidance was. We don't see any variability from that. The yields on those homes in the first quarter were in the mid -- low to mid-5s. Those are increasing to 6s. The homes in the beginning of the [indiscernible] year had lumber that we contracted in 2022, the April, May time period. when lumber was $1,300, $1,400 1,000 board feet. Today, it's $400, and that's going to benefit us in the deliveries later this year. Other acquisitions. The acquisition that you would -- we would be looking at from national homebuilders as well as existing homes through the MLS channels, today are pretty much nonexistent. There might be a unicorn here or there. We continue to underwrite many homes. But today, we have the ability to be patient, we have the ability to be disciplined and don't really need to rely on growth through that channel. The yields that we are seeing today are in the 5% range, and I'm not talking in the 5s, I'm talking at 5s. So our development channel, we're leaning into giving us the better product at better yields. And that's kind of where we are at this point in 2023, Juan.

Thanks, Dave. Enough helpful.

Just for the benefit of everyone in the room, I can share just a few more thoughts on the spring update that we posted a couple of days ago in our latest investor deck. I'd summarize it as -- as we were hoping for. As we talked about on our last quarterly call, we've seen really nice and strong spring demand, enabling us to drive further acceleration in leasing spreads. You can see at best on the new lease side, where in March, just to give you a data point, we exited the first quarter with new leases growing at 9.2%. We've built off of that with new leases growing to 9.4% in April, and then May came in at 10%, showing you that nice upward trajectory through the spring season, looking really, really strong. Because of that strength as expected, we were able to reaccelerate on the renewal side with May renewal increases landing just north of 7% at 7.2%. And I think what is really important is we're able to capture that level of rate growth without giving up anything on occupancy. So in both April and May, we were able to hold the line on occupancy at 97.1% on the same-store pool. And then the final point that I would just make is, look, great activity so far in the spring. We're not done yet. Leasing season still continues on for a couple more months. June is very important. July is very important, but also keeping in mind, we're beginning to move into move-out season as well, which is important from a seasonal perspective. And we're moving into move-out season, where we're continuing to push hard on rate and something we're watching closely as we finish out the second quarter. But nonetheless, really strong spring update that I wanted to unpack a little bit more of just to get us going.

Great. And then maybe just as a quick follow-up on that rate update. Any color you could provide on where renewals are being sent out for later in the summer? And when should we expect new lease rates to peak? You talked about maybe a similar seasonal pattern to 2019, but maybe without the peaks and valleys. So just curious if you can elaborate on that?

Bryan, you want to?

Thanks, Juan. The -- I'll start with the renewals. We saw excellent demand and real strength coming into the beginning of the year, and it gave us confidence to mail and kind of increase, you see the improvements that we made on a monthly basis on the renewal side. I would expect that trend to continue for June and July. We're -- again, excellent retention. There's a relative value difference between our cost difference between owning a home and renting a home, the gap right now is as wide as we've seen it before, and it's about 26% overlap markets. So that gives us a lot of confidence on that side. In terms of new lease rate, it's an indication of the strength of demand for our product, the 10% that we posted in May. I would think about that in terms of this is really the sweet spot of the leasing season. And I don't want to call it a peak, but the expectation that we continue 10% for maybe a little bit longer with some tapering due to seasonality in the back half of the year.

And then just curious what you're seeing in terms of the strength of the consumer. Clearly, there's an affordability benefit for single-family, but there's signs of some softening. Any issues with bad debt or churn that we've seen a little bit related to some eviction moratoriums coming off? Just if you could talk a little bit about that piece for us.

Yes. As we talked about in our first quarter call, there is a remaining cohort of residents who are affected by COVID. And there's been some differences in our -- in the really lease administration process, working through the court system and so forth, but it's a small cohort. We've been working through that. If you take a look at the type of applicants and the residents who have moved in, in the past couple of years, the collection profile is very similar to what we saw prepandemic. And importantly, as rents have continued to increase over the last few years, the incomes of that applicant pool have increased at least as quickly. So there's a lot of health and strength in the new residents who are coming through. But there is a little bit of a residual COVID affected effect, I guess, that we're working through. And a lot of it has to do with court processing time. There are some local regulations. There's a little bit of a backlog that we think is temporary, and we expect to continue to work through that this year. But overall, the strength of the resident base continues to impress.

And then maybe just to frame, as Bryan was referring to a small cohort just to kind of put some parameters around that. Historically, just for frame of reference, historically for us, bad debt has run right around 1% of total revenues. At the peak of COVID, bad debt for us, high watermarked to about 2% to 2.5%. Since the high watermark, we've been able to gradually improve that down to -- fourth quarter ran about 1.4%. First quarter ran about 1.4%. And our expectation is that as we work through these remaining households that will gradually return back to normal for us about 1% or so. As we think about -- just as Bryan says, we think about resident profile, credit profile, et cetera, longer term, we don't see any reason why structural bad debt will not return back to its historical 1% level.

Great. And then we've seen maybe switching gears to market performance. We've seen some of the hotter markets kind of return back toward that poster child, in my mind, is Phoenix. And we've heard some softness from others across commercial real estate, maybe a little bit of Las Vegas. Just curious on what you're seeing in terms of which markets are continuing to outperform and do well? And which maybe are a little more softening a bit more?

Yes. I think you're right on the Western markets, Phoenix, Las Vegas were really fantastic for as long as I can remember, the last 3 or 4 years. We saw a rate growth in the 20% range from time to time. Occupancy was fantastic, and that's cooled a little bit. But it's being supported by outstanding performance in Florida. We've seen great, just, economics there across the board with rate and occupancy. More recently, we're seeing outstanding results in some of our Midwestern markets and Houston as an example, which over the past couple of years may have been near the bottom of the pack has shown a lot of life with some excellent growth in April and May.

And let me add one thing to that. When we talk about Phoenix coming down, it's not that we have any markets that are underperforming. If we had underperforming markets, we wouldn't be able to post 97-plus percentage occupancy on a system-wide basis or 10% rental rate growth. If you look at a Phoenix as your example, one, it was kind of in the stratosphere in the last couple of years in the 20% range. And that's not going to be sustainable, but it's come back into a very, very healthy growth range, just not at the 20%. We are, right now, in that very high single digits or maybe even at 10%. And that's very, very respectable. So it's not that we have underperforming markets. I'm very pleased with our footprint, a very well-diversified footprint. So when markets may go through a period that they are a little softer, other markets do pick up. Today, if you look at Houston, we talk about the negative, let's talk about the positives. Houston was a little bit softer in the last couple of quarters. The second quarter, Houston is one of our better performing markets in the marketplace. So all of our markets are performing well, some of them have just come back to a reasonable zone from being very, very high.

Maybe if we could move down the P&L a little bit in terms of -- we talked about the top line demand and the strength of the markets on the expense side. How are you feeling about expectations of some surprise last year for you in one of your peers on the property tax side? So just curious on the latest thoughts and how comfortable you're feeling with particularly your property tax assumptions for '23.

Yes. Property taxes is the right area to be talking about when it comes to expenses, represents about 50% of our overall expenses. Look, the general update on property taxes is that we're still early year in the property tax calendar in terms of receiving information. Latest update at this -- oh, maybe I should take a step back. This year, we are expecting property taxes for anyone that's unfamiliar with what's contemplated in guidance. We're expecting property taxes to grow around 9% at the midpoint. That's largely a reflection of property taxes being backwards looking, and we're still capturing backwards-looking record high and strong home price appreciation driving this year outlook. But in terms of the latest news that we have, at this point, we have initial assessed values back on, call it, a little bit over half of the portfolio. I would say, as expected, we're seeing some pretty strong increases in initial assessed values, just like we were expecting. That then now kicks off appeal season. So to date, we have filed about 14,000 individual property tax appeals that will grow over the course of this year. We will hear back on those over the summer months into the fall. We will receive our remaining initial assessed values. And then the important last piece to property taxes is the [ millage ] rates, which we typically hear back on during the fourth quarter of the year. So still much more information to come so far. I would say we're not seeing or have received anything that is outside of the bounds of what we have contemplated in guidance. And then the last piece that we're watching very closely from a property tax perspective, is the evolving situation in Texas, where some of you may have followed along. Texas is in a unique position where the state is in a large budget surplus position. And the state led by Governor Abbott himself, has called for using a large portion of that surplus for property tax relief. The state has agreed on the need for property tax relief and it has agreed on generally the dollar amount being about $12 billion to $13 billion of surplus funds being used to bring down property taxes. The remaining piece that is still being debated is how exactly they roll that out and implement it. There are 2 proposals on the table, one of which, which is supported by Governor Abbott himself, is you take all of the dollars and use them all to compress property tax rates. That benefits everyone. That benefits homeowners, benefits businesses. It benefits landlords, which then, in effect trickles down to the ability to benefit renters, right? It benefits everyone, that's proposal 1. And then proposal 2 is that the homeowners exemption in the state of Texas is increased. So it benefits homeowners a little bit more. And then the remainder of budget surplus funds are used to compress property tax rate, benefiting everyone, us as well, just a little bit less because more of the benefit goes to homeowners. Still yet to be seen which of those proposals prevails, but nonetheless, I would say, on the margin of positive for property taxes in Texas.

And then just one other question on expenses. Turnover has been low. You've had a very sticky customer base. The length of stay has increased. Curious if you're seeing any change that may be leading to higher turnover, which would have ripple effects through your cost structure given some of the longer length of customers may require a bit more upkeep on the homes as they turn?

Yes. I think there needs to be a little bit of a distinction. Turnover has been improving sequentially for really a long time. Really happy with the retention rates. But we are talking to about this COVID-affected cohort, and there's a little bit of a different dynamic on cost on those turns. Going forward, I think we're -- there's a couple of different things that are happening. Our teams are improving on the execution side. We're managing costs really well on the homes that we're doing self-performance work as an example. So we're getting more efficient in the turn process. At the same time, we've seen a turnover come down. The R&M turn line -- vast majority of that is related to occupied maintenance. We've become very, very efficient on the turn side. So any changes in retention shouldn't have too dramatic of an effect on the cost structure of the homes. So we're really leaning into managing a lot of our own work there and being hyper efficient in that turn.

And then one last question on expenses. Property taxes -- or sorry, insurance. This is the second day of full day of meetings, sorry. So insurance costs, property insurance, a hot button issue across commercial real estate, political now as well, it seems. I know you guys are -- although you're headquartered in California, you don't have homes in California to speak of really. And you've had a couple of insurance companies say, we're not going to ensure homes. How do we, from the outside looking, and think about that for a corporate entity such as yourself, which is homes throughout the country that are exposed to environmental issues, whether it's Florida or California or Texas that kind of seem to be more recurring than not?

Look, I would say, overall, the unfortunate answer is that the insurance market is in bad shape. It is in bad shape. It is a hot button issue. I would say less of a hot button issue for SFR. And the reason for that is over the years, our asset class has performed very different and far better than other forms of commercial real estate. And the reason for that is the concentration of risk, right? You take -- just compare us to apartments as an example. You take x hundred of apartment units, you stack them in one building in -- let's use Florida, just to pick on it. In Florida, that building gets hit by a weather event. You have a large loss on your hands with hundreds of units impacted. You take our portfolio and you take x hundred of units and you spread them over a market in Florida that gets hit by a weather event, we have much more geographic spread over the course of that market. So our loss profiles are very different, which means our loss runs have been different, which means our insurance programs have performed different over the last couple of years. Last couple of years for us, prior to this year, average third-party insurance increase was in the single digits. Apartments on example. I've seen -- we've all seen it in this room, plus 20%, 30%, 40% the last couple of years. This year, we renewed our insurance program towards the end of the first quarter. We saw a 20% -- increase in the 20s, call it. That's what we were contemplating in guidance. That's higher than we've ever seen before. And I would call that a reflection of the broader market, not SFR or our loss, right? It's the fact that the insurance market needs more rate to bring itself back above water, and that's now applying to everyone. And I don't see that changing for the next couple of years. The insurance market is going to need several years, 2, 3, if not more, years of rate increases to get itself back above water. So over the next couple of years, I think you will see more of a move for companies that can, SFR at the top of this list to use captive insurance companies to a larger extent. We formed a captive a couple of years ago, still needs a little bit more time to mature. But over the next couple of years, I think that you'll see that from us helping to manage some of our third-party insurance costs, separate our risk from everyone else. So we're not caught up in the increases that really apply to other forms of commercial real estate, but doing it in a way where it is appropriately sized and backstopped with stop-loss and reinsurance programs so that we do not change the risk complexion of our portfolio or balance sheet at the same time.

Yes. Juan, let me just add one piece here. I just want to contrast insurance for a homeowner versus an organization such as ourselves. There is a lot of press recently out that a number of insurers are pulling out of like a state of California. It's not the only state, Louisiana has some, a little bit on Florida as well with respect to win. So you've got a number of insurers that are not writing insurance on homes in these states for the risk profile, et cetera. The way we insure is not on an individual basis, we insure, on a portfolio basis, but the way we insure is very different. And the insurance market that we go to is very different. So we're not going to the state farms or all states, we're going to the Lloyd's of London and the firemen funds, et cetera, the much larger insurers. And so insurance is still available. Don't worry about the availability of it. It's all about how to manage the cost versus the risk. And that's where the discussion on captives comes in. It's not that you want to take more risk, you just want to figure out if there's a better way to build that mousetrap and structure your insurance programs.

And then switching to -- I know the apple of your eye, the development pipeline and opportunity set. Can you talk about how quickly we can expect some of the -- you mentioned labor -- or sorry, lumber at the start, the cost improvements to start to filter through to where new deliveries will be kind of higher, more accretive yields for you going forward?

Yes. So as I indicated in opening comments, our yields in the first quarter on the deliveries were near 5.5%, near the mid-5s. And that was with lumber we contracted April, May of last year. And so -- and that would been about $1,300 for 1,000 board feet. Today, that's $400. We've also seen other costs coming down, not significantly, but a little bit. On top of that, as we continue to expand our development program, the volume discounts that we are getting are greater than last year. But we also routinely make investments into our company. We've talked on the first quarter about Resident 360. That's in the operations side, but last year and in 2021, we were making investments into the development processes and systems. And those today are paying off in better management of supplies coming in, so less waste in the development process that's bringing our cost down. So we're -- the stuff that we are building today -- and the word build is a very ambiguous term because when we talk about build, we're talking about Phase 3. And that's the vertical build where you have the sticks. So those homes that we will be delivering later this year, we are contracting for today. And that will have a much reduced cost in the -- input cost. So we'll go from 5 -- mid-5s in the first quarter. We're going to be at 6% at the end of the year. It's going to go pretty much linearly up. It's not going to just have a step function going up. But I also -- Juan, everybody to keep in mind that not 100% of the benefit is necessarily baked into even the ones that we deliver at the end of the year. Labor, et cetera, that was necessary to do Phase 2, which is the land infrastructure. We call it horizontal development. That was done in 2022, maybe even 2021 for some of that work. And so a little bit higher cost than what we would be seeing today on some of that land infrastructure work. Not a significant reduction on labor yet, but there's a nominal reduction. So as we go into '24, I expect that we'll even have slightly more accretive structure than we are seeing at the end of this year.

Can I also add, when Dave talks about yields, just to clarify for everyone, when he talks about yields, that is fully loaded, including all of our internal team and infrastructure costs associated with the development program. Over the last day or so we had a couple of questions around how much G&A expense are you carrying because of the development program? And the answer is 0. Zero G&A expense because all of it is captured within -- think of it as a development subsidiary that then gets allocated into every single one of our finished homes, right? We do have people, infrastructure, technology to support the development program. That's part of the secret sauce in terms of how we can do what we do. But all of that is burdened into the homes that we deliver. And when Dave quotes yields, it yields against those fully burdened costs of the homes.

Yes. I'll add just one more to punctuate that. Not only is it all the labor costs, it's all the carry cost, too. It's all the property taxes during that period of time as well as a burden for interest carry. Let me just point out an intangible difference. We get better yields. The reason is we don't have a development profit that we're paying to a national homebuilder. So the input cost for us is probably 80%, 85% of what we would buy that same house from a national homebuilder. They need a development profit, and that just translates into a better yield. But more important than favorable on the economics, we build a better house. And the reason we do it is because we're the owner long term. We're going to own that house for 10 years. So we're going to put higher-end plumbing fixtures in. We're going to build the decking differently. So we don't have the same maintenance load 5, 10 years from now. So higher-end plumbing, you don't have to replace them. If you build decks out of composite wood as opposed to raw wood, you don't have to waterproof at every 2 years, keeping your maintenance cost down. So there's a lot of thought put into how we build. We build differently because we're the owner, and we don't own it or have to warranty it for 1 year, we do it for the life of the asset.

And maybe just with the remaining time, a question, I guess, for Chris, on the balance sheet, have a maturity in '24, you also have some optionality with how sticky and strong home prices have stayed on the disposition front, if you could talk about plans, I guess, on both ends on the sources and uses with the dispositions and then the balance sheet as well?

Yes. Maybe start with the balance sheet first. We have 2 securitizations that mature at the end of 2024, totaling about $1 billion. Both of those securitizations have a 12-month prepayment window without penalty, which means that we can begin to start looking for opportunities and the right point in the market to address those maturities towards the end of this year. So we have a nice wide window to be able to address those. Plan A has been and continues to be to look for opportunities to refinance those into the unsecured bond market. We have those 2 securitizations. And then we have 2 more that are technically 30-year securitizations that don't mature for another 21 years, but we have the ability to repay those in 2025. So my view, assuming a healthy and functioning unsecured bond market, is that the balance sheet is 100% unencumbered by the end of 2025. From a disposition side, you're exactly right. We are seeing great traction in the market on our product for sale. Taking a step back -- I know we're short on time here, but the punch line is that over the years, we have developed a very rigorous asset management process, where we're regularly reviewing every single one of our assets in the portfolio, all the way down to a monthly basis. And when we identify outliers that are underperforming our expectations, we review those as to whether or not that's the appropriate allocation of capital. And sometimes and often times come to the conclusion that we should sell those homes to recycle the capital back into our current growth programs. One of the great parts about our type of asset class, given its granular nature is that we can decision make down to the unit level. You can't do that with an apartment unit. And so when we identify those homes, we move them into our disposition program, which is being able to capitalize on really strong resale value still today. In the first quarter, we sold 600 to 700 units generating close to $200 million of recycled capital proceeds. Those homes moved very quickly in the market. They sold like 98% of list price at an average disposition cap rate in the 3s.

That's nice.

Yes. I agree.

Threes are nice. I think we're out of time at this point. So thank you, everybody, and thank you for letting me moderate.

Thank you, Juan.

Thanks, Juan.