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Morningstar | Initiating Coverage on No-Moat Invitation Homes; Shares Look Slightly Undervalued

We are initiating coverage on single-family rental REIT Invitation Homes at a fair value estimate of $26.50 and a no-moat rating. We think that there are several demand drivers that should benefit Invitation Homes' portfolio over the next few years. Invitation Homes is in many markets with high income and population growth. However, most of those same markets are also experiencing a significant housing shortage, which makes the cost of homeownership significantly higher than renting in those markets. Additionally, the millennial generation that has long delayed many adult milestones will likely move to the suburbs in greater numbers over the next decade as it ages and starts families. Given that millennials typically lack the necessary cash needed for a down payment due to a high student-loan burden, they will likely look to be renters of single-family homes as they move to the suburbs, particularly in the starter homes segment that makes up the Invitation Homes portfolio. Therefore, we think that high demand will allow Invitation Homes to pass along significant annual rent increases.

In addition to significant demand for the single-family rental sector, we think that Invitation Homes can drive higher returns than competitors in the space. Invitation Homes has industry-leading asset management and technology platforms that allow it to manage its portfolio more efficiently than smaller competitors. Given the company's scale, it can employ in-house maintenance and repair technicians at a far cheaper relative cost than the third-party contractors that smaller competitors must use. Finally, the recently renovated portfolio should mean that the company shouldn't have a significant capital expenditures burden in the near term. This should all lead to high organic net operating income growth in the short term. We believe that the company is slightly undervalued given the growth we think the company can achieve in the next few years.

However, we caution that the long-term view is not as rosy for Invitation Homes. Invitation Homes owns less than 1% of the homes in its target markets so it is not able to control the market rents. There are virtually no barriers to entry to this sector, so we believe any well-capitalized firm could create a competing portfolio that is able to achieve the same cost efficiencies. The fact that Invitation Homes was created in 2012 by capital raised and deployed by alternative asset manager Blackstone (and the predecessors for the company Invitation Homes acquired in 2017, Starwood Waypoint Homes, were similarly created this decade by alternative asset managers) shows that large companies can enter the space quickly if the potential economic returns are large enough. The only reason that larger competitors aren't springing up is because housing prices have recovered since 2012, and Invitiation Homes has to pay near full price to acquire new homes in markets where housing prices are very high. We don't think that Invitation Homes can add value through external growth and so believe that it is entirely reliant upon its internal growth story, which is driven more by demographics than factors the company controls.

While current demographics make the internal growth story very promising in the near term, we think that eventually the company will face other demographic shifts that sap much of that growth. The millennials are likely to move to the suburbs in larger numbers over the next few years and currently lack the cash to afford the down payment on a home. However, as the millennials pay off their student loan debts and accumulate the necessary capital to afford homeowership, we think that the homeownership rates among this age cohort approach that of previous generations. Therefore, the increased demand that is currently propelling strong growth may end sooner than the company expects. Additionally, as the baby boomers age they will begin to return housing stock to the market. While these homes will be larger and more expensive than the starter home segment that Invitation Homes invests in, we believe that the whole housing market will feel the impact. Invitation Homes' average resident is 40 years old, so the residents older than that average may be tempted by falling prices of larger homes driven by increasingly available supply to purchase. If the homes don't sell, then they may instead become new competition as they are converted to rental properties. Either through lowered demand or increased supply we think Invitation Homes' portfolio will see fundamental growth decelerating over the next decade.