It isn’t exactly rare for companies to go public before raking in the dough. Dot-coms do it all the time, listing on major exchanges with only a modest revenue stream in place. But it isn’t normal in the REIT space.
Or is it?
Just 8 months ago Silver Bay Realty Trust Corp (NYSE:SBY) launched as a revenue-light, asset-heavy pure-play on single family homes. Now, American Homes 4 Rent (NYSE:AMH) is looking to capitalize on the hunger for exposure to single family properties with its own IPO.
What’s the deal with all these startups?
REITs are decidedly in the “boring” part of the financial spectrum, buying properties to lease to tenants for a predictable revenue stream. Typically, a REIT is seasoned for years as a private entity before it goes public with years and years of history to back up its offering.
Today, the thirst for IPOs is anything but typical, which allows atypical IPOs to happen even in the most conservative of sectors.
American Homes 4 Rent (NYSE:AMH) isn’t the only company actively buying properties while working through a backlog of paid-for homes. Silver Bay Realty Trust Corp (NYSE:SBY), which had its IPO in December 2012, currently owns more than 5,000 homes across the United States. As of the first quarter, only 2,413 homes were leased. We will know much more about its portfolio when it reports earnings next week.
A tough market
Investors are rightfully turning their nose up to single-family REITs until their financials can back their valuations. Silver Bay Realty Trust Corp (NYSE:SBY) has shed 12% of its market value since its 2012 IPO. It plans to repurchase as many as 2.5 million shares to buoy its market valuation.
American Homes 4 Rent will likely find the same difficulty as investors digest its portfolio. The company has more homes in the pipeline than it has leased. It’s currently unprofitable, and one-time renovation and acquisition costs are difficult to separate from the portfolio returns when it matures. That makes valuing the REIT extraordinarily difficult – future cash flows can be especially difficult to project.
What is known, though, is that American Homes 4 Rent (NYSE:AMH) has a substantially better business model and cost structure than Silver Bay Realty Trust Corp (NYSE:SBY), which may lead it to better post-IPO performance.
The mechanics of REITs
Established REITs typically employ an in-house management team to acquire and maintain properties. Since an established REIT will do far more managing than acquisitions, the model requires very few employees.
New REITs, especially those that deal in single-family homes, need a substantially larger workforce to buy, renovate, and lease each new property, so they typically rely on a third-party to do the dirty work. American Homes 4 Rent (NYSE:AMH) and Silver Bay Realty Trust Corp (NYSE:SBY) have a third-party to acquire and renovate new purchases. For this service, the REITs pay the cost plus 5%. This is standard.
However, when it comes to the administration, most REITs keep it close to home. American Homes 4 Rent will eventually internalize all of its management functions by December 2014, which should minimize operational costs and expenses.
Silver Bay operates differently, retaining some connection to Two Harbors, which spun off the company in December. Its relationship will cost shareholders 0.375% of the average daily market cap per quarter, or 1.5% per year in administration fees and expenses.
Using the recent valuations to calculate the run-rate of administrative costs, the company will incur charges of more than $9 million per year to manage 5,000 properties, or $1,800 per door, per year. Traditionally, property management can be hired for one months’ rent or less, on portfolios as small as one single family home.
Given the economics of the business, Silver Bay has a much larger cost structure. If Silver Bay eventually trades for 10 times annual rents, it would pay out some 15% of revenue each year in the form of management expenses. American Homes 4 Rent, assuming a scenario of one months’ rent per property, would spend only 8.3% of revenue to manage its portfolio.
Most problematic is that a rise in home prices would cost Silver Bay investors more money each year. If prices were to rise 50%, and the equity value of the company were to follow, then 50% more revenue would be captured by Two Harbors for administration costs. Silver Bay investors effectively have incentive to root for lower stock prices. American Homes 4 Rent investors don’t have to fear that a rising stock price may cost the firm more money.
If you’re thinking about playing the single-family housing market, wait for American Home 4 Rent’s portfolio to mature and its cost structure to stabilize. It has a huge cost advantage over Silver Bay, which should lead it to outperform, all else being equal.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
The article 1 REIT Penalizing Investors for a Higher Stock Price originally appeared on Fool.com and is written by Jordan Wathen.
Jordan 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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