Recently, REITs have done well. During a three year period ended July 31, the Dow Jones Equity REIT Index delivered annualized returns of 30%. The index reached a peak in May and has since fallen 10%.
I’ve never been a fan of buying indexes. True, they should be the preferred investment vehicle for many investors. But if you have the time and inclination to develop your stock-picking skills, it can be quite rewarding to try to outperform the indexes.
So lets examine a subset of REITs that specialize in buying distressed single family homes, renovating them if need be, and then renting them out. The thinking is these companies will provide an opportunity for investors to bet on a rebound in the housing market.
This company just went public
American Homes 4 Rent (NYSE:AMH) sold shares for the first time on July 31, 2013. Controlling over 19,000 homes, the company is the second largest landlord of single-family homes in the country. Although investors were less than excited over the IPO, shares fell as much as 3% in their debut.
Investors are dubious of the company’s ability to generate profits. In the first quarter of 2013, the company posted revenue of $6.6 million and a net loss of $7.7 million. Less than encouraging numbers from a company valued around $1 billion.
Doubters also point to low occupancy rates as a reason for skepticism. The company has stated that just 11,000 (of its more than 19,000 homes) are currently leased to tenants, an occupancy rate of 58%. But 97% of the properties it has owned for 90 days or longer have been leased. That’s a signal that finding tenants may not be a serious problem for this company.
The company’s founder has an impressive track record
American Homes 4 Rent (NYSE:AMH) was founded in 2011 by billionaire B. Wayne Hughes. When it comes to running a business, not many men have a more impressive track record than Mr. Hughes.
The man founded Public Storage (NYSE:PSA) in 1972. That company has since grown into the largest self-storage company in the world. It expanded from 1 self-storage unit in 1972, to over 2,000 today.
Mr. Hughes and his partners transformed a $50,000 investment in the early 70’s into a $27.6 billion dollar company. Between August of 1990 and August of 2013, the company’s shares multiplied by a factor of 37.55. That represents compound annual growth of over 17%!
I think it’s safe to say that B. Wayne Hughes is pretty good at running a business. Storage units and single-family homes are two very different types of real estate. It’s uncertain whether Mr. Hughes will be able to replicate his storage unit success in the single family housing arena. That being said, his track record is very encouraging.
Another single family home-rental REIT
American Homes 4 Rent (NYSE:AMH) isn’t the only option if you are looking to invest in a REIT that rents out single family homes. Another potential investment is Silver Bay Reality Trust, a company that had its IPO last December.
The stock rose from $18.20 in December to nearly $22 in early January. But since, shares have been on the decline, dropping 27.3%.
Silver Bay owns over 5,000 homes and is valued at $628.5 million. The company has $92.2 million in cash on its balance sheet compared with only $19.1 million in total liabilities. Excessive debt is a non-issue and should not become a problem in the foreseeable future.
Like American Homes 4 Rent (NYSE:AMH), this company is also struggling to produce profits. In the first quarter of 2013, it generated $7.68 million in revenue and had a net loss of $6.4 million.
Silver Bay shareholders have not fared well. The company has paid them two $0.01 dividends so far. Those won’t help to ease the pain in the stock’s drop.
Although it hasn’t neglected to generously reward Two Harbors Investment Corp, its former parent company. In addition to giving 17.8 million shares of its common stock, Silver Bay also gave Two Harbors 1,000 shares of redeemable preferred warrants with a 10% dividend. The company easily could have borrowed money at a lower rate. Cronyism like that is harmful to shareholders, so be aware!
Foolish final thoughts
REITs that specialize in renting out single-family homes are an interesting play on the rebounding housing market. As acquisition sprees come to an end, profits should manifest. The underlying strategy seems solid. Pick up distressed homes at discount prices, fix them up, and then have rent checks flow in for decades.
Implementing such a strategy takes more than a hint of skill. You don’t want to be investing in a REIT that does not have competent management, or engages in practices that destroy shareholder value. As for Silver Bay’s management team, their actions speak for themselves.
But I see a much better opportunity in this field for American Homes 4 Rent (NYSE:AMH). The company has a high occupancy rate for properties owned longer than 90 days. And the founder of the company played a key role running one of the most successful businesses in history. As far as real-estate investments go, American Homes 4 Rent has the potential to be a winner.
The article This Newly Public REIT Appears Attractive originally appeared on Fool.com and is written by Ryan Palmer.
Fool blogger Ryan Palmer has no position in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Ryan is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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