07/13/22 07:18 AM EDT

SELL INVITATION HOMES | 7.13.22 | (INVH)

Rob Simone, CFA

Takeaway: We checked Glassdoor for some margin math, but couldn't find any. So we ran it ourselves...

Hedgeye Cartoon of the Day: Trouble with the Curve

It is 7.13.22, and Active Short MPW is overvalued by approximately ~$15.81/share. By the way, we are more convinced than ever that, given Steward is literally existential to MPW, they will literally do ANYTHING to keep the scheme going. Also, Prospect Medical is most definitely in even worse shape than Steward, in our opinion, albeit a smaller exposure.

Ticker: INVH

Subsector: Single-Family Rentals (SFR)

Headline: Thinking through the implications of yesterday's WaPo story

Yesterday was obviously an interesting day, with the Washington Post reporting on Active Short Invitation Homes' (INVH) systemic non-permitting issue. No doubt almost everyone reading this has already read the article, so we're not going to recap any of it. Rather, we're going to try to think through the implications going forward:

First and foremost, as we said last week following Riverside and Corona objecting to the case dismissal, in our view the most important implication is that the early narratives are effectively dead. This is not only a credible and significant issue, its GROWING in size and scope. This was not a politically motivated "ambulance chaser" in San Diego trying to make a quick buck, rather what is likely to be only the first volley in a series of complaints across multiple jurisdictions. We expect additional cities of the remaining 16 in CA to object to the MTD before oral arguments on 7/25. We expect discovery to be very problematic for the company. All else the same these recent events increase the probability the case is not dismissed and increase the probability the case heads to discovery. It also increases the probability that additional jurisdictions, both state and federal, look into the matter, given the high profile of the WaPo. Put simply, it cannot be ignored. As clearly as we can state it, THIS IS REALLY BAD. Given these rising probabilities, this translates into a higher probability of an unfavorable outcome, which also translates into a lower stock price as the buyside begins handicapping things differently.
Clearly something is very wrong here, the only question is "what will the financial impact/resolution be?" (more on that below). We think its safe to say the question as to whether this is an actual issue is no longer relevant or debatable.
An independent and highly credible third-party news organization conducted its own research and due diligence, and found enough data and evidence to publish this very high profile and damaging story.
Why hasn't the company responded yet via a press release or other public appearance? Why did they try to deflect blame towards the GCs AGAIN? Do they care about this issue? Are they taking it seriously? We think they should, and we are also highly confident that they cared internally about the lawsuit as early as Fall 2021. We suppose it could be because of an earnings blackout period that there has been no response, and there for sure will be questions asked on the 2Q22 earnings call. But lets be honest, are we really going to fall back on what we will call the "Glassdoor Long" thesis at this point? Is that where we are? If that's the justification for owning the stock, maybe its time to pack it all up. There are plenty of REIT options, including in SFR if investors need to own the subsector; why play here? It makes no sense.
A quick aside - in addition to looking at Glassdoor, we would recommend going through BBB customer review section. Here is a link for the curious. Talk about cherry-picking...
Now thinking through potential financial implications:

In Figure 1 below we present a pro forma margin analysis for a representative home that may need remediation.
We assume 1Q22 in-place rents, as well as a conservative 30-day period during which the house is vacant and being renovated / turned, including having non-permitted work "torn out" and replaced.
We assume ~$582 per home per month in standard turnover costs for the 1-month of downtime, as well as no regular-way expense recoveries for R&M, utilities and other opex billed back to a tenant, as the unit will be vacant.
This one-month of downtime results in a 500-600bp negative impact to NOI margin for the year for a single home.
Importantly, it excludes the impact of any needed maintenance or renovation capex, which on a case-by-case basis could be significant and a real cost to the company.
Thinking through this, theoretically an investor can make an assumption for the % of homes that could be impacted across the entire portfolio (20%, 30%, 50% or higher?), and then apply this margin hit for that % while keeping the balance of the portfolio under the status quo. Just 30% of the ~82k homes impacted would result in a ~100bp NOI margin drag for the ENTIRE company by our math. We are fairly certain no one is underwriting this risk right now, irrespective of what we believe will be a general RoC slowdown for the sector.