Tricon Residential - Give Me Shelter

Tricon Residential Inc. (TSX:TCN, Financial) (TCN, Financial) is a fast growing single-family rental (SFR) operator owning over 33,000 homes located primarily in the U.S. sunbelt. Tricon also operates two other smaller and peripheral business lines comprised of multi-family rentals and residential development. The stock is dual listed on the Toronto Stock Exchange and New York Stock Exchange. While the company started out in Canada most of its assets and operations are in the US.

Above-average growth

Tricon’s top markets experienced above-average population and job growth over the past decade. The SFR industry continues to benefit from a favorable supply-demand dynamic. Population growth of the 35 to 44 year old age group, the primary cohort requiring single family rental housing, is projected to grow at twice the rate of broader population growth over the next five years, resulting in strong demand for single-family homes. Tricon’s existing Sun Belt markets present significant growth opportunities with a deep supply of resale homes, new homes and Build-to-Rent developments to support its plan of adding ~8,000 SFR homes per year, up from 6,383 homes in 2021. Tricon plans to own about 50,000 homes by 2025.

At the same time, the production of new single-family homes across the country remains well short of historical levels, resulting in a significant supply deficit. In addition to these tailwinds for the sector, the escalating cost of homeownership has pushed an increasing number of families toward renting. Home ownership of millennials is much lower than previous generations at the same age as homes are less affordable, thus more rental demand. These favorable market dynamics have resulted in strong cash flow growth for Tricon, with the company expecting to achieve same home net operating income growth of over 9% this year.

In addition to being a more affordable product, there are several defensive factors that may mitigate against a decline in the SFR business’ cash flows relative to other real estate sectors. First, it is estimated that the average monthly institutional-quality SFR rents for about $1 per square foot, approximately 36% lower than the average three-bedroom apartment rent. Second, Tricon’s business benefits from the strong demographics of its tenants, serving largely middle-market families usually with one or more children that not only require the space and convenience of a house (vs. an apartment) but also tend to be longer-term renters than other household income segments, resulting in lower turnover and more stable cash flows. Third, with Tricon’s estimated 20% gap between in-place and market rents, market rents would need to decline by a significant amount for there to be a negative impact on rent growth on new leasing and renewals.

Balance sheet

A diagram of Tricon's balance sheet is given below. While Tricon has quite a lot of debt (over $3.9 billion), it is balanced by hard assets (i.e. houses). However, there is no doubt that Tricon is quite highly leveraged. The Altman Z-score is just 0.75, implying a risk of bankruptcy.

While the debt is spread out over the next six years, investors need to be cautious that when it renews, it will be at a significantly higher rate. Thus rents will have to increase significantly to cover the increased financing costs. These concerns are obviously weighing on the stock price and look like they are already priced in with the stock down 47% from its highs.

Also, Tricon has also been issuing a lot of new equity to fund its growth. This is actually a good thing as the debt-to-equity ratio is about 1.5. Price to Operating Cash Flow ratio is about 12.5 and Price to Free Cash Flow is about 15. Dividend Yield is about 2.7%.

Valuation

According to Andrew Moffs, senior vice president and portfolio manager of Vision Capital, Tricon shares are attractively valued as they trade at a mid-30% discount to private market values of its properties. The following table compares Tricon with its two major competitors in the US, SFR market.

Tricon is essentially a levered private equity company focused on single family residential rental housing. It has inherently high risk because it is constantly raising equity and debt. Tricon has demographic tailwinds behind it and is focused on the high growth sunbelt markets as well as the millennial renter population. Another thing going for it is inflation, which in the long run, makes residential properties more valuable.

The big question for Tricon is of course interest rates and debt. There is high risk the company could get into trouble in this regard, and investors should ensure a high margin of safety. I would like to see a price-to-operating-cash-flow ratio of below 11, but right now it's about ~13. Personally, I am putting the stock on my watch list and plan to reconsider it when the Fed stops raising interest rates and we get more clarity at what rate Tricon is refinancing its debt. Right now, the stock is falling due to interest rate hikes and debt fears. On the positive side for companies like Tricon, rents are esclating rapidly. Rent inflation in the U.S. increased to 6.24% in August from 5.70% in July of 2022.

In spite of the interest rate risk, I think the company has great potential. It's operating in a high demand asset class arena and is good operator. If I were to guess on what the end game is going to be for Tricon, I think it could potentially get bought out by a larger private equity player who wants to get into this asset class, hopefully at a good premium.