AMH - American Homes 4 Rent

T0rm3nted · Dec 13, 2016

American Homes 4 Rent (AMH) is an internally managed real estate investment trust (REIT) focused on acquiring, renovating, leasing and operating single-family homes as rental properties. The Company's primary objective is to generate attractive risk-adjusted returns for its shareholders through dividends and capital appreciation by acquiring, renovating, leasing and operating single-family homes as rental properties. The Company operates in the segment with activities related to acquiring, renovating, leasing and operating single-family homes as rental properties. It owns approximately 38,780 single-family properties in over 20 states and has over 10 properties in escrow that it seeks to acquire. Approximately 36,400 or 93.9% of its properties are leased. Its integrated operating platform offers property management, acquisitions, construction, marketing, leasing, financial and administrative functions. It is externally managed and advised by American Homes 4 Rent Advisor, LLC (the Advisor).

T0rm3nted · Dec 13, 2016

Getting close to attempting to play a bounce here, target of $22.50ish...

T0rm3nted · Dec 13, 2016

Gave this one a shot today. Entry at $20.20. Currently up 1.39%

DutchLung · Dec 14, 2016

grain of salt of course, but beware. I've had my run ins with companies like this IRL and they are just fly-by night operations that prey on people with poor credit/financial habits.

American Homes 4 Rent : Plenty Of Red Flags

Summary
Macroeconomics of buying versus renting may soon shift unfavorably against the rental industry.

Consumer complaints are everywhere. Particularly concerning are those surrounding false billing and unwillingness to share work invoices.

Margin profile is weak, and cash generation is not strong compared to residential REIT peers.

Use of asset-backed securitizations to raise capital could fall out of favor, forcing the company to raise funds through means with higher costs.

American Homes 4 Rent (NYSE:AMH) has not seen much investor appetite since its IPO in 2013, and shares have generally languished. However, institutional investor ownership remains high, and many retail investors have been drawn in by the company's many series of preferred stock options, which carry much higher yields than American Homes 4 Rent common equity. Many of these retail investors are comforted by the large insider ownership holdings (nearly 13M shares, or over $260M worth of stock) by Tamara Hughes Gustavson, daughter of founder B Wayne Hughes, along with CEO David Singelyn's own massive 9M share stake.

The recent rally to touch all-time highs, however, has tempted me to the short side here. Rampant consumer complaints directed toward American Homes 4 Rent, along with a specious roll-up business model, combine together to make what looks to be an incredibly weak investment by my take. The macroeconomics point to a likely tipping point in renting versus buying, and any macroeconomic weakness could see the company's use of inventive financing (non-recourse debt backed by company assets held in special purpose entities) to fund growth dry up completely.

Macroeonomic Viewpoint: Market Top?

Broadly, many readers are likely familiar with the economics of renting versus buying. Generally, these metrics tend to move in lock-step. If rent costs rise, the breakeven period for buying (expected time in home) decreases, which motivates either prospective tenants to buy outright or for competition in the rental space to emerge. Given entry costs are low, and economies of scale minimal, the single family home rental business has always been competitive. However, there are occasional disconnects.

Recently, there has been a surge in rental activity in the United States, which has driven the cost to own well below the cost to rent in many areas. The usual reasoning given for this disconnect persisting is continued strict credit standards on new mortgage issuance by banks (non-QM and non-prime mortgage issuance is basically non-existent), which has pushed many buyers out of the market, even if they could otherwise afford to purchase. As a result, rental demand is at all-time highs. Per a recent Harvard Study:

The decade-long surge in rental demand is unprecedented. In mid-2015, 43 million families and individuals lived in rental housing, up nearly 9 million from 2005-the largest gain in any 10-year period on record. In addition, the share of all US households that rent rose from 31 percent to 37 percent, its highest level since the mid-1960s.

Those in the industry take the viewpoint that there is a fundamental shift in demographics and consumer preferences - essentially that consumers are willing to pay more in order to maintain flexibility. Sentiment may have changed as well, given that many newly formed households, which came of age during the housing collapse of 2007-2010, simply do not want to bear the risk of ending up like some peers (going underwater on mortgages, facing foreclosure, etc.). This is a debatable topic, and there are points to both sides, but it is important to remember that vacancy rates are almost zero for American Homes 4 Rent. Basically, as soon as they can turn a house over from a previous tenant, it does not take them long to find another. Upside from improving vacancy rates, once a tailwind, is now non-existent.

Complaints Around The Business Model

Prospective investors don't need to go far to find complaints from tenants on treatment, two examples below:

They should be called "Property Mismanagement" Company, as opposed to a "Property Management" Company! We moved into a rental home, July 1st, 2016, and are only at the end of our 5th month of renting through AmericanHomes4Rent, and we have had 5 different "property managers", assigned to our account. Each representative, less helpful, and more disrespectful, than their previous counterparts!!! Water leaks/damage, mold, inexperienced maintenance workers, rude property managers/personnel, and erroneous/false charges for utilities!!!

Source: Review from Customer in Norcross, GA

They just want your money, and [will] charge you for every single fee they could possibly think of. Please be beware if you decided to rent from them read the LEASE VERY CAREFULLY... They want everything under their name: utilities, etc. They charge you 45.00 for a convenience fee every month. You don't even know who's your utility provider are and what the charges are for either. Trust you will regret it once you sign that lease. They don't fix anything but they will charge you for everything. This company is a scam, the property manager does not care and they are rude, they are not to care for your safe living. All they want is your money...

Source: Review from Customer in Agoura Hills, CA

There is a Facebook group dedicated to users who believe they have been unfairly charged incorrect fees by the company. There are 784 Better Business Bureau complaints lodged against the company in its largest market (Houston, TX). As a result, class action lawsuits alleging wrongful charges, like this one in Illinois, are not uncommon. Given the company's short operating history (five years), the volume of complaints are quite sizeable.

The point here is that complaints on slow action times on maintenance issues are not unusual for American Homes 4 Rent, nor are they for most companies active in this market. What I am focused on are accusations of erroneous/false charges related to utilities (third party paid through Conservice), not providing invoices for billed work, charging for unnecessary maintenance, and unfair retention of security deposits when coming off lease. Now, I've invested in my fair share of companies with divisive reputations. Beyond that, having had experience in the rental industry, I know how difficult it can be to make some tenants happy. With average rental rates around $1400/month for American Homes 4 Rent, tenants are going to have high expectations, some of which are not going to be achievable. At the end of the day, however, I can't shake the feeling that some things do seem different here, and it is enough to turn me away completely. Before I get into why, I'll provide the company's side of the story.

American Home 4 Rent's response to these issues was to move its property management call center internally at the end of 2013, after the company began to gain some serious scale and complaints started to build (23,000 homes held). This was supposed to reduce maintenance costs, speed up turn times, and provide enhanced customer service. Having the call center managed internally theoretically gave management more control of the interaction, and it now gives tenants the ability to either call the service center, contact their property manager directly (remember aforementioned complaints on this contact changing often), or simply make a request online. Overall, the company believes its "proactive maintenance" approach, via extensive walkthroughs with tenants prior to occupancy, can help alleviate issues.

Perhaps that all might be true, but there may be some basis to what appears to be accelerating tenant complaints on unfair billing practices. As an overview, American Homes 4 Rent derives its revenue from multiple sources. While rents collected from tenants is the obvious (and largest) source, the company also collects revenue from other avenues; primarily fees and tenant charge-backs. Fees are generated from charges like application fees or convenience fees for paying rent online, while tenant charge-backs recover costs on expenses like utilities (American Homes 4 Rent typically maintains control of utilities in its rental properties), property damage, and maintenance costs above and beyond normal wear-and-tear:

Over the past several years, the percentage of revenue generated from these other sources has grown. During Q3 of 2014, the company had 26,161 properties on lease, and generated $4.3M in revenue from tenant charge-backs, or an average of $164/property during that period. Fast forward two years, and that number has now jumped to $30.8M in revenue on 44,746 properties, or $688/property in Q3 2016. Interestingly to me, American Home 4 Rent's presentations and non-GAAP metrics that revolve around reported "core revenue" exclude these charge-backs as a revenue source:

Source: American Homes 4 Rent November Investor Presentation

Depending on how you view this, this can be interpreted as a bit of a shell game. The company simply includes these charge-backs as an offset to expenses (above, within the "R&M, turnover and in-house maintenance, net" line), rather than as a revenue source as it is within GAAP. The only reason for this is to be able to post better reported "core NOI" margins.

It is hard not to be concerned by these numbers. Tenants somehow getting more destructive in the past two years is unlikely, and should be less common anyway given that the average tenant here has a household income of $70-100K and excellent credit quality. The reality is either American Homes 4 Rent is putting the squeeze on tenants by nickel-and-diming them on charges (best case), or billing fraudulently in the worst case. If the company is billing unscrupulously, as many complaints on the internet maintain, the company could be reducing expenses incorrectly in its key presentations, as those expenses did not exist. American Homes 4 Rent likes to speak on its "in-house maintenance" costs, which is basically maintenance costs, net of charge-backs to tenants. In an ideal world, this statistic would have value, as it would show if the company is reducing expenses within its control (such as turnover costs between tenants). If management is being deceptive, then it could be manipulated. For the company's viewpoint on these trends, via COO Jack Corrigan on the Q2 2016 earnings call. This is in response to a question as to why the company has been so successful on tenant chargebacks, and whether the company feels like tenants are getting frustrated:

No, I think actually we under charge back still. We are very sensitive to the tenants especially on occupied maintenance chargebacks. And a very minimal part of that -- part of the chargebacks is occupied maintenance chargebacks. Most of it occurs on the turn and we try to give them as much opportunity to clean the house and leave it in good condition as we can. We give them names of approved cleaners and coupons for discounts and all that stuff."

I'll leave it up to investors to reconcile that statement versus the wide ranging number of complaints, from news coverage to the thousands of gripes on the internet located on the BBB and elsewhere.

No Economies of Scale?

This leads to another big concern. Anyone with experience in the industry will tell you that you really lose the benefits related to economies of scale quickly in this space. There isn't much value to be had, from an operating leverage perspective, from going from managing 100 properties in a certain area to 1,000. That appears to be the case here, given that GAAP operating margins have been flat for years. From 2014 to 2016, owned property count has nearly doubled (25,505 to 48,153), but margins didn't budge an inch, and fell in fact for a period of time.

A likely retort to the lack of profitability here is that both GAAP and the IRS allow depreciation on residential buildings. American Homes 4 Rent fully depreciates its homes on a straight line basis over thirty years, which means these single family homes would reflect no value on the balance sheet after that period. The reality is obviously much different, even excluding land value. I don't disagree at all, and it is a prime reason that investors should focus on the cash flow side of the business. However, free cash flow isn't particularly strong either; 4.8% likely in 2016, weaker than many other residential REITs in this space.

Capital Markets Access

If investors start seeing the company negatively, there could be a cascade of negative consequences for the stock, which would impact further growth. Unlike many companies in the space, long-term debt is primarily made up of non-recourse asset-backed securitizations. When it comes to this debt, American Homes 4 Rent receives funding, typically on quite favorable terms in regards to interest rates. However, these loans are secured by the underlying cash flows of properties placed within a trust; any funds that American Home 4 Rent receives on assets held within these trusts ends up in a cash management account, which the lender can tap to cover delinquencies at a later date. Worst case, the lender could simply liquidate the homes to cover the debt obligations. As a result, any homes moved from the company's managed portfolio to one of these trusts cannot be sold or otherwise transferred. In total, 21,628 homes, or roughly 44% of American Home 4 Rent's portfolio at the end of Q3 2016, are locked up. This really limits the company's ability to make quick changes in its portfolio, or to move out of certain markets that undergo changes (e.g., regulatory reform, widespread job loss).

Interestingly, remember those excessive fees and charge-backs? On all of these trusts, you'll find this verbiage:

In the absence of an event of default, the Borrower will receive any excess cash after payment of monthly interest, principal and property related expenses.

American Homes 4 Rent does have a compelling motivation to ramp up these types of charges. The company gets access to this cash free and clear, rather than it being tied up in a cash account with restricted access by the company's lenders. Given this is non-recourse debt, American Homes 4 Rent does also lose some incentive to maintain extremely high quality standards from a service standpoint.

The continued availability of this type of debt is key for the company's long term health. If investor appetite dries up for this type of securitization, either from a macroeconomic standpoint or from lender's perception of American Home 4 Rent's business quality, the company will lose an extremely important funding source. These securitizations have historically resulted in interest rates of <4.5% on fixed rates for the company, which is much better than what the company would be able to receive otherwise. This is listed as a risk in the company's 10-K filing:

...the inability to consummate securitizations of our portfolio to finance our investments on a long-term basis could require us to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price, which could adversely affect our performance and our ability to grow our business.

The shift to these securitizations as a means of raising capital allowed American Homes 4 Rent to move away from common stock issuance, which carries a much higher cost of capital.

Takeaway

American Homes 4 Rent is riding a thin line between generating profit and risking alienating consumers. News agencies are already starting to pick up on the story, and the company would make an excellent case for regulators to take to the woodshed. Margins are weak, and cash flow is muted, despite vacancies being at all-time lows. With the common equity at these levels, and interest rates moving north, it is tough to see further upside from here. American Homes 4 Rent is an avoid at its best, and a tempting short otherwise.

Author's note: For deep dive research on asymmetric risk/reward plays in the Industrial and Basic Materials sectors (particularly small and mid-caps), consider trying out the two week free trial within Industrial Insights. This new offering doesn't mean I will be cutting down on quality or my allocated time towards my free offerings on Seeking Alpha. Follow me (by clicking the "Follow" button at the top of this article next to my name) to receive general stock market research and commentary, especially on under-followed small/mid-caps across a wide variety of sectors and industries.

Disclosure: I am/we are short AMH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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T0rm3nted · Dec 16, 2016

Dropped below support, but holding pretty well. More support at the 200MA. Another one I'm watching closely in case I need to exit.

heyimsnuffles · Dec 16, 2016

Just doesn't need to drop the 200 day

T0rm3nted · Dec 19, 2016

Climbed back above support today gaining 1.76%

T0rm3nted · Jan 3, 2017

Looks like upcoming resistance and a descending triangle, going to be closing my position out in this one soon:

T0rm3nted · Jan 3, 2017

Just closed my position at $20.84 for a 3.17% gain. Not quite what I was hoping for, but as my chart above showed, I was finding new resistance and ready to lock in some profits. Plus I'm a little bearish this month/quarter with the volatility in the market that I expect to happen with the Trump presidency becoming "real".

DutchLung · Jan 5, 2017

A win is a win. Cheers!

T0rm3nted · Jan 5, 2017

Looks like I sold this AT LEAST 2 days early, as this is now up to $21.31 and what would have been an extra 2% so far. Not the end of the world, as it was still profitable, but looks like I missed out on a little bit. Looking back on it, after it closed above the 50MA, I'm not quite sure why I was so quick to close the position when I am not IN A HURRY to close for another week or so. It did break through the resistance line that I drew in which is what prompted me to sell early.

T0rm3nted · Mar 13, 2021

BrinaDodon said: ↑

I want to rent out a small house. It is in good condition, but I do not know at all what price it is worth to rent it. There are two floors and a total of 6 rooms. Does anyone know the estimated cost of houses now?
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I would assume Google does?

Syynik · Mar 13, 2021

BrinaDodon said: ↑

I want to rent out a small house. It is in good condition, but I do not know at all what price it is worth to rent it. There are two floors and a total of 6 rooms. Does anyone know the estimated cost of houses now?
Click to expand...

Check Craigslist for average prices.

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