In 2012, the market got excited about the potential for corporations to consolidate the fragmented single-family home market.
A company such as Silver Bay Realty Trust (NYSE: SBY ) could buy the houses on the cheap, and in the process, develop a national brand that renters could have confidence in using for rentals in most major metro areas. Not to mention that operating as a REIT would provide investors with substantial dividends from income.
While that theory was great, investors didn't realize that during the formative stage, these stocks would report losses. There were no dividends, and investors began to doubt that model, as mounting losses and the lengthy process of stabilizing houses can take up to six months on older houses that need significant renovations.
After an initial bump in Silver Bay, the stock has had a horrible 2013, now trading close to all-time lows. Recently, a couple of other IPOs in the sector have come to market with weak receptions. Both American Homes 4 Rent (NYSE: AMH ) and American Residential Properties (NYSE: ARPI ) offer different twists to the general thesis of investing in single-family rental properties to take advantage of the weakness in housing prices and the increased demand for rentals.
With housing prices soaring according to Case-Shiller over the last 12 months, is the market overlooking the real benefits to investing in the sector?
Investing in crash markets
Silver Bay has been very aggressive in buying single-family rental properties in the most downbeat housing markets. The company focused heavily on the markets of Phoenix, Atlanta, and Tampa Bay, which averaged declines of 43% during the housing crash, and hence have seen solid rebounds in the last 12 months. With over 50% of the housing investment accounting for these markets, the company is counting a roughly 12% gain in its investment portfolio.
Speaking of those capital appreciation gains, the market is clearly ignoring those gains and focusing solely on the company's operations. While the operations are improving, Silver Bay is still bleeding cash, with only 65% of the portfolio leased and the average stabilization process taking up to six months because of the company's focus on older homes. As an example, the average age of a house in the largest investment market (Phoenix) is over 24 years old.
The recent quarter was the first one where new home acquisitions (985 homes) was lower than leased homes (1,197 homes), leading to strong gains in key occupancy rates of 94% for stabilized homes and 87% for homes owned for at least six months. Over the next two quarters, the overall occupancy rate should jump into the 70%-80% range, finally providing some real insights into whether it can run this business at enough scale to be profitable.
While waiting for those operational improvements, investors can key on the estimated net asset value hitting $18.95. Those housing gains aren't shown on the balance sheet, so investors might want to start buying now with the stock trading just above $15.50. Even without the large capital appreciation, the stock has a NAV of a not-so-shabby $17.30, providing a solid bargain with upside potential.
Looking for huge economies of scale
American Homes 4 Rent went public at the beginning of August to limited demand, as the company had to cut the offering to $760 million from original expectations in June of an offering of around $1.25 billion. The stock has held up well in the market, but the reaction is nothing spectacular considering the original hype about investing in this sector. The company has a home portfolio of around 19,000 homes, which places it second in size only to Blackstone. Only 9,882 homes were leased, or 55% of the owned properties, so again, the REIT is still going through the formative process, making the financials of limited use at this point.
Unlike Silver Bay, American Homes is more focused on metro areas that have had stable housing markets such as Dallas-Ft. Worth, Indianapolis, and Houston. Because of this focus, it also hasn't seen solid capital appreciation. The average house is only 11 years old, again differentiating itself from the homes needing vast renovations. The company operates in over 40 markets and over 21 states, so it does provide the greatest potential in the group for creating a national brand that might provide some benefits in the leasing process.
Focusing on young houses
American Residential is the smallest stock of the group, with a valuation of only $540 million -- that's $70 million smaller than Silver Bay. It completed an IPO in May at $21 and has seen a considerable drop to around $17. However, because of the focus on younger homes and a smaller base, the company is starting to grow faster than the others, with 1,558 homes acquired during Q2, or a 61% growth from the Q1 ending balance.
Interestingly, American Residential has a similar focus on the Phoenix market as Silver Bay, with nearly 20% of the portfolio in that metro area. The company quickly shifts to Houston, Chicago, and Dallas as secondary markets, though. This makes American Residentail nearly a blend of Silver Bay and American Homes with a focus on younger homes in areas such as Phoenix and the Inland Empire in California, which were part of the major crash areas.
The company only generated $8.4 million in revenue for the quarter, so the operations remain small, but according to some complex reduction of non-GAAP charges such as IPO expenses, stock-based compensation, and acquisition expenses, it lists a Core FFO gain of $0.08. A good sign, but most investors will want to see a quarter with a cleaner number to gain confidence in the sector.
Not surprisingly, the stocks of the single-family rental companies have struggled in the market. All three stocks are still very much in the formative process, and today's short-term investors are overlooking the long-term value creation because of current weak income statements. Questions remain about the companies' ability to generate significant returns on the monthly rentals of individual assets that are vastly different. The current situation makes Silver Bay the favorite in the group as it has successfully invested in the beaten-down markets and is now generating solid returns on those assets.
Long-term, though, the group has huge growth potential as the three companies only control around $5 billion in housing inventory in a multitrillion-dollar market. Market share growth from consolidating all of the mom and pop players in the sector could be a multi-decade trend.
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