The Surprising Buyers of Those Rundown Neighborhood Homes

Single-family REITs have been growing quickly by buying up distressed properties; that opportunity is slowing down in many areas, but foreclosure auctions still look like a potential growth driver, though perhaps not the only one.

Jan 29, 2014 at 9:18AM

Houses

Imagine buying a propety and being a landlord. Now imagine buying thousands of houses and being a landlord. That's exactly what single-family REITs, like American Homes 4 Rent (NYSE:AMH), American Residential Properties (NYSE:ARPI), and Silver Bay Realty (NYSE:SBY), are doing.

These companies have been focusing on acquisitions as they build their portfolios. That opportunity is slowing down in many areas, but it hasn't ground to a halt. Portfolio growth will be a big issue pretty soon, though.

Getting better
According to RealtyTrac, foreclosure activity was down about 26%, year over year, in 2013, and less than half the level reached at the peak in 2010. So, the housing market is healing. That's good news for homeowners, including single-family REITs, since the value of their homes have a better chance of moving higher if there are fewer distressed properties around.

That said, the million-plus distressed homes it represents is still a lot of inventory for sale. And foreclosure activity actually increased in 10 states. Judicial foreclosure, which usually leads to an auction, was a notable weak spot, with activity up around 13%, reaching a level second only to 2010. That's a favorite venue of American Homes 4 Rent, which noted in its third-quarter earnings call that it has been specifically targeting auctions.

According to Daren Blomquist, vice president at RealtyTrac, "There is unprecedented demand from institutional investors willing to pay with cash to buy at the foreclosure auction, helping to raise the value of properties with a foreclosure filing in 2013 by an average of 10 percent nationwide." That's good for the housing market, but it increases costs for buyers like American Homes.

(NYSE:SBY)

Empty homes
Buying a property is just one step in the process for the single-family REITs, because many of the properties they buy are in disrepair. And once they're fixed up, they still need to be rented out. That alone can take between 30 days (American Homes 4 Rent) and 55 days (American Residential, including the time it takes residents to move in). Pulling back from acquisitions and focusing on filling properties isn't exactly a bad thing, either, since occupancy is an important revenue lever for a REIT.

But an improving housing market and rising prices, even at auctions, brings up the question of long-term growth. Occupancy improvements will do wonders over the next year or so. And rent increases, which are taking a backseat to occupancy right now, will help after portfolios are leased up. That should lead to solid results for two, maybe three, years. But then what?

Longer leads?
Acquisitions will be the main driver at that point. That's why Silver Bay and American Residential, which have both pulled back more on the acquisition front than American Homes 4 Rent, could see growth slow materially. The single-family REIT with the longest property pipeline, interestingly enough, is probably Altisource Residential (NYSE:RESI). This REIT is building its portfolio by purchasing distressed mortgage debt.

Fore

Source: respres.

That makes Altisource more of a mortgage REIT today than a property REIT, but the long-term goal is to foreclose on delinquent mortgage debt and take possession of the homes. That's not without its own set of risks. For example, according to RealtyTrac the average time to complete a foreclosure in 2013 was "...a record-high 564 days."

New York was the slowest state at 1,029 days, with Florida, a favored state among the single-family REITs, not far behind at 944 days. However, the long foreclosure lead times may result in Altisource having the best "acquisition" pipeline.

If you are interested in the single-family REIT space, long-term growth should be a key concern. That isn't to say Silver Bay or American Residential are bad investments, just that they could soon be shifting into a lower gear. And American Homes 4 Rent isn't far behind. The lone standout could be Altisource -- but it is by far the most aggressive option in the sub-sector.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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