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Single-family home real estate investment trusts (REITs) are brand-new and still untested. The opportunity to buy into the depressed housing market is exciting, but how much will it cost these companies to operate? For a hint, it's worth looking at the apartment and manufactured home sectors.
Where we call home
Silver Bay Realty Trust (NYSE: SBY ) , one of the new breed of single-family REITS, says that there are around 41 million rental units in the country (about 30% of the housing market). Approximately 25 million are apartment units (60% of the total), nearly 14 million are single-family home rentals (35%), and about two million are mobile homes (5%).
Prior to Silver Bay's IPO, there weren't any publicly traded single-family REITs. And there are still only four, none of which has been public for a year. The only way to get a handle on how much REITs like Silver Bay, giant American Homes 4 Rent (NYSE: AMH ) , and American Residential Properties (UNKNOWN: ARPI.DL ) will need to spend to maintain their portfolios is to look at the other rental markets.
Big up front costs
That's important because the up-front costs in the single-family REIT space are huge. American Residential Properties, for example, paid nearly $10,000 in renovations per empty property in the second quarter. It spent about $140,000 per home on its acquisitions, so renovation costs added up to around 7% of the price tag.
That's not surprising since the foreclosed properties that American Residential and the other players favor are often in disrepair. These one-time costs will remain a big issue until the new REITs shift out of growth mode.
While repairs will get capitalized into the purchase cost, this is an issue to watch because that cash is still going out the door today. For example, Silver Bay's average monthly rent roll in the second quarter was around $1,150 dollars. Assuming $10,000, on average, is a reasonable cost for renovations, that expense eats up about nine months of rent. Property taxes alone could turn the first year into a total loss.
Like single family homes, mobile homes offer a completely separated "home," just within a larger complex. That said, manufactured homes are generally owned by the tenants, not the REIT. That's why Sun Communities (NYSE: SUI ) estimates that capital spending (ongoing maintenance) in the manufactured home sector averages just 3.5% of revenues -- building maintenance isn't a big issue.
That's a major benefit to owning manufactured home communities over apartments. Indeed, Sun estimates that apartment owners spend around 9% of revenues, on average, to maintain their buildings.
Clearly, single-family REITs will be more like apartments on the cost front than manufactured homes. But even 9% might be too low a number. Apartment REITs own the building in which their tenants live, but their units are "connected." For example, giant Equity Residential, with 108,000 units, only owns 400 buildings.
If a roof needs replacing, one cost, large as it might be, could repair a problem at hundreds of units. American Homes 4 Rent, the largest of the single-family home REITs has around 20,000 homes. Although many are in close proximity, they aren't connected and don't share facilities.
Out of the gate, the single-family REITs are at a cost disadvantage. While materials like roofing tiles can be bought in bulk, labor is a whole different ball game. So 9% of revenues is likely to be the low end of the range, with no way to tell what the high end could be.
An expensive niche
In a race to grow while the housing market remains depressed, single-family REITs are burning through cash. That's likely to hamper cash flow for at least a year after they decide to slow their purchases. And, once they lease up their portfolios, they could still be the most expensive housing options to run in the REIT space. That doesn't make single-family REITs bad investments, but it does provide at least some idea of what to expect when the asset class matures.
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