David N. Miller - President and CEO
Peter Martin - JMP Securities
Silver Bay Realty Trust Corp. (SBY) 2013 JMP Securities Financial Services and Real Estate Conference Call October 1, 2013 1:30 PM ET
Peter Martin - JMP Securities
Okay. We're going to move on to our next presentation this afternoon. We have Silver Bay Realty Trust Corp. We're happy to have David Miller, the CEO, who will go through the business model. We'll have a few quick questions at the end and then we'll move to the breakout down the hall.
So I'll leave it to David.
David N. Miller
Great. Thanks, Peter. Thanks for having us at the conference, and I appreciate all of your interest today. What I'd like to do is spend a couple of minutes telling you about Silver Bay and our investment thesis and why we're as excited today as we were when we went public 10 months ago. And then, we'll give a little bit of an operational update and a few thoughts about where we're going forward.
So, quickly here I’ll show a couple of our homes, which we're very proud of I really got a chance to show these off. Top one's a home at Atlanta we bought in June of last year. It's about 2,200 square feet. We bought it for all-in $170,000, so it's about $150,000 with $20,000 in rehab. It rents for $1,500 a month, so it's about 10.5% gross yield there, very representative properties. Down below, one of our Phoenix properties and all-in $120,000, so it's about $100,000 purchased a year ago and that rents for about $1,000 a month. These are great properties. They're in middle class neighborhoods, and there is high rental demand.
And really that's what I want to talk about. We’ve reformed to take advantage of this generational opportunity to buy high-quality, single-family homes at very discounted prices. We focus on markets with strong demographics and employment growth, we'll get into that. We're in eight states right now, but 75% of our portfolio is in really five markets in Phoenix, Tampa, Atlanta, Northern California, and Las Vegas.
So the Silver Bay story here, what are we trying to do? Ultimately, we were formed to do two things. One on the operating side, which is really to create a best-in-class platform and provide quality housing to tenants. On the investment side, it's to create great total return and I think we're seeing that today. The total return takes really two forms. One is the recapture of the distressed discount, the HPA potential which we think is exceptionally strong, and then the rental yields that we will be generating as we lease up our portfolio.
We think the trends are very supportive of this business growing as well as getting strong rental growth in the future, and I think we're very well positioned, and we'll talk a little more about that as I go forward. We take a very disciplined approach to acquisitions, we've amassed our portfolio very carefully over the past, really three, four years, most of it in the past two years and taken a very disciplined approach. We do not overpay.
We do granular analysis on many thousands of assets and ultimately only buy a few dozen. So, we've taken great pains. I think the markets we're in are the markets you want to be in, in this space. They've got the right blend of cheap housing but strong demographic growth, strong employment trends, and that's ultimately what drives real estate values in these markets higher.
So let me spend a minute or two about the investment opportunity. Quickly here, point is these are really large opportunities that has not surprised the resi asset class (inaudible), but single-family rentals is a small component of it. That being said, a small component of the overall market is still in the trillions of dollars, and so we think there's not only a great deal of opportunity for organic growth, of growth related to the foreclosure crisis, but growth going into the future, both from consolidation as well as continued pickup organically of distressed properties which happen in normal markets.
So just quickly on the slide; this is the market overall. It is surprising to most people who are not familiar with our business, there is already a fairly large market for single-family rentals, over 11 million units. It's been around for a long time. It's just mom and pop, so it's highly fragmented and it's something that really hasn't been institutionalized until really the last couple of years, and we think that is something that proves that the demand side exists, and I think the supply opportunities in the past few years have allowed aggregators, such as ourselves, to really get scale and operate this efficiently going forward.
But again, the institutional ownership that you read about in the papers is still very small, perhaps a 100,000, maybe 150,000 homes have been purchased over the past three, four years, and that's just tiny in comparison to the overall markets. So, we see a great deal of growth opportunity and consolidation going forward.
So, the recovery as you all know has lagged, don't need to get too much into this, but the important point is resi sector, because it's so vast, because it's so liquid, a lot of factors going in related to mortgage availability, the recoveries lag, but if you look at other real estate, the commercial property price indices have really not only recovered but in many cases gotten back to pre-crisis highs whereas the resi sector has lagged, but we think is well poised now for accelerating growth to recover.
Most of our markets were victims of both the boom and the bust, but in many cases – in all cases have overcorrected to the downside, and we see a great deal of opportunity to continue to buy despite it bounces off the bottom properties at attractive prices, and here we're just showing Atlanta, Phoenix, and Tampa versus the National. I mean some of these markets have recovered and are now at prices back in 2002, 2003, which was by no means above also.
We look – our thesis is predicated upon replacement costs that there will be a convergence back with that. We think we're still trading in most of these markets, the homes are priced well below replacement costs and ultimately economic forces will push them back up.
So, investment strategy starts, it's really a combination of acquisition discipline, market determination, and the asset level selection. It starts with the markets. We've done a lot of macro analysis, and then going down from MSA level to zip code, we know where we want to be buyers. We think we know where appreciation and rental demand will be strongest, so it starts with that.
Property selection, very important. We use technology and a lot of data to analyze what properties we want to buy, what prices we're willing to pay for that, and then the last part is acquisition discipline. Lots of folks out there have wanted to buy properties and have done so throwing a lot of money to try and come back with a lot of deeds. I don't think that's an appropriate way to ultimately end up with the best investment portfolio and the best portfolio of assets. So, we've been very, very careful. We don't overbid. We don't have people on the ground that can override an investment opportunity.
So, this is the significance of buying and also shows how we think about buying in these markets. So I don't have a pointer here, but right on the bottom, Silver Bay cost basis per home is $129,000, so that's the sort of grayish bar. We believe replacement cost is about $200,000, and we think in five years with 2.5% inflation that becomes $225,000. So that would represent a 12% CAGR just on the appreciation component, we're not considering the rental cash flow yields.
And so, the point we'd like to make here is if you were to pay 15% more, let's say I just wanted to go out and buy really quickly and I paid 15% or 20% more, well, obviously you're going to destroy the IRR there, and that's something that we're just not willing to do and haven't had to do to grow our portfolio. I think the other point I'd make on this slide is currently the markets largely based on macro concerns have put our stock at a price where we're actually trading below our cost bases, so we can actually – investors out there can actually buy the homes in our portfolio below our cost, actually which represents pretty close to the absolute bottom of the housing market in Phoenix, in Tampa, in Las Vegas, despite the fact that those markets have moved up in many cases 10%, 15%, 25%.
As I was saying before the market selection, very critical, we feel very good about long-term demographics in all these markets. We feel good about our ability to buy cheaply, and what this is showing here is we got 75% of our portfolio in these five markets. They've experienced varying degrees of recovery. The point I'd like to make is we still think they are very – there's quite a bit of room to run before they are even close to the replacement costs. Here we're showing just sort of how far they've come back from peak. Peak in itself is not a good measure. We do much more granular analysis and estimate replacement costs for every asset that we own.
So, very important to our thesis is you could sit there and say, well, that's great. You think in five, six, seven years you're going to have 50% upside to get the replacement costs, 60%, but how am I going to realize that? Well, the thesis is predicated upon rental growth keeping up with the capital appreciation. The cost of housing is all interrelated. If ultimately the housing costs in those areas goes up 50%, mortgage rates go up, the cost of attending to the home goes up, all of that will contribute in a world in which supply/demand tightens into higher rents.
Historically and there's not a lot of great historical data that's in track, but going back to 2007, CoreLogic did some analysis, and there really was a tight correlation with a one-year lag. That's something we expect going forward. But in any case, if we are wrong about that, there will clearly be a market for single-family homes in the most attractive areas, because there's obviously another end user for this which is our occupants.
I want to make a point on the macro environment. Here's a chart that shows a competitor, shows the MSCI REIT Index, Homebuilders, and Mortgage REITs, largely housing and rate sensitive sectors. Really since May, no surprise to you all out there since the talk and chatter about [cheapening] (ph) all of these sectors have been hit pretty hard. Silver Bay was no exception, and I think it's something that we noticed that some of these other areas actually will see a diminishing of value whether it's rising rates or it is mortgage bonds, or some of the homebuilder starts, but we're actually seeing a broad improvement in our business both operationally and the underlying value of real estate.
If you look at just CoreLogic numbers, not for our market, nationwide; since May, since the chart starts here, we've actually seen 6% to 7% increase in the underlying home indices, and it's actually a little bit more in our markets. And so, that's going up, so our net asset value continues to rise and our operational improvement is getting better. Despite that, our stock has traded down significantly and is well below net asset value and below initial cost.
So, I want to spend just a couple of minutes talking about our strategy for those not familiar. Single-family REIT goes through a number of phases, but first we have to acquire. We talked a little about acquiring properties. It is a really critical part of the story. Then you have to renovate homes and that's something that we focus a great deal on. It is very important to renovate effectively, to do it to a high quality standard, to differentiate yourself and ultimately to do it quickly and process your acquisitions.
The property management side, something we've spent over the last two years a great deal of time building up our capabilities and ultimately trying to impact the long-term business by focusing on all kinds of things, but I'd say the two things I would point out are tenant screening absolutely critical to this business. It's very easy to jam tenants in to have some near-term occupancy metrics, but that comes back quite quickly to hurt you. So, we've been very, very careful about screening and making sure we get the right types of tenants in from a credit quality standpoint.
And then, the second point is customer service. I think this business, sales in a big scale before – it's certainly in terms of mom and pop investors providing a poor experience, people rented homes. 11 million people rented homes even though the experience was poor and that shows the demand, it shows that people in various life stages or have various credit issues wanted to rent homes, and despite that the experience from doing a lot of research, it was quite poor.
And I think institutional players such as Silver Bay can change that by not only being there to respond to maintenance request, doing good customer service. It doesn't take that much because it's something that did not exists and it is very old hat [ph] for those who are familiar with the multifamily industry and that's where we're going. All of that will lead to low turnover. Low turnover is critical. It saves cost, reduces vacancy and that's something we're very focused on going forward.
Another area that we see great opportunities and efficiencies both in terms of the operating platform on the ground efficiencies, there's cost saving opportunities while we've taken advantage of some, we've really only scratched the surface and that's something that we see a great deal of opportunity as we go into 2014.
So the second quarter, I guess we finished the third quarter, so it's a little odd talking about the second quarter but in the second quarter we made a lot of progress and really what we've done in the third quarter is continue on that path. Our revenue followed the increase in our occupancy which we increased the rate at which we lease significantly in the second quarter really helping to improve our occupancy which was after the first quarter 53% on a total occupancy basis up to 65%. We've been making similar progress this quarter and should expect to see good improvement there as well.
We also measure our occupancy based on homes we've owned for six months as well as a third occupancy measure for stabilized occupancy, all measure slightly different things. Ultimately the stabilized occupancy is what the business looks like on a run rate basis and that's in the 94% range and that's something we think is reflective of what the business looks like from a leasing perspective although I will say I think that's okay but there's room to improve upon that.
The other highlight from the quarter which is noteworthy is the – we released for the first time an estimated NAV which essentially marking to market the real estate book and giving you that metric. That was $18.95 a share as of June 30. Obviously real estate prices have continued to move up in our markets and that compares to a book value of $17.30.
The NAV metric we think is conservative. We've been very scientific about it. We have our own in-house models. We've compared it to third party providers and I think it's reasonable to both to evaluate portfolios as well as to value the portfolio going forward and I think it is showing that total return, which is the increase in NAV and ultimately our ability to generate meaningful dividend yields.
So I will skip ahead here. Slide 20 and again all these slides are available. The operation side of the business which clearly there are questions about it, hasn't been done on a big scale. This is just highlighting our growth of both our acquisitions and then following the acquisitions the renovations and then once you actually have rent ready product, our leasing progress. So that continues to rise.
And something we talked about in our second quarter call is where we sit today which is about 5,600 homes. We've slowed down our acquisitions temporary in the summer to catch up with our inventory and we feel very comfortable today at the similar pace by the end of the year, we'll be substantially leased up and I think that's something there were a lot of questions about earlier but we're making very good progress.
Okay, here we are. So here are the increases in occupancy and we are gaining across the company operational momentum. I think it'd be nice for me to sit here today and say 10 months after IPO everything is humming as perfectly it ever will be. There is a great deal of opportunity for us to continue improving the company and gaining efficiencies. We've made a great deal of progress and I'm very proud of our team because they did a lot in a short period of time.
Looking ahead occupancy by the end of Q4 as I said if you think about the gains from this lower left side, 53% to 65% along a similar trajectory by the end of the year gets you substantially leased up not all the way but in a good place and I think there's nothing we're seeing today that suggest we can't do that. Cash flow generation; this portfolio can support obviously breakeven and good cash flow generation once we get leased up and that's something we're focused on in the next few quarters and really 2014 will be the time that we've got a good, solid leased portfolio and we'll be focused on increasing our cash flow and distributing that to shareholders.
And then the last is NAV growth. Despite some concern about rates, yes, there's been a little bit of a slowdown in the rate of growth in new markets. We still see very, very strong demand shrinking supply and that will ultimately continue I think the upper trajectory across all of the markets we're in quite strongly into next year which will really contribute to the total return.
So I will stop there. I've got five minutes for any questions you might have.
David N. Miller
Sure. So – and I agree with the first part of that statement. In terms of debt capacity, in May we draw [ph] a $200 million credit facility. As of June 30, we draw about 70 million against it. We continue to draw. That's funding our continued acquisitions. I think broadly speaking what's the right amount of debt capacity, we talked about 30% to 50% debt to cap, so clearly we've got room on our existing asset base and our comfortable with that. So that would be where we would continue drawing from to make acquisitions. We're still seeing a lot of really great opportunities in all four of our Florida markets, Atlanta, Texas, some other markets not as much today. But we're still seeing the ability to play very intelligently. So the question is how quickly do we deploy that? Don't know. It's based on the opportunity set. We certainly feel like we've got capacity over the next couple of quarters. The second part of your question about when do we see it coming through? I think you're going to see it. We're just not going to get to a point where we stop acquiring, wait until everything is leased up so that we can produce a quarter sort of run rate because then we missed the opportunity. But we're going to get closer to that each quarter because the rate of acquisition is clearly going to slow relative to the size of the portfolio and relative to where we're buying before. So I think starting in 2014, it will get easier to see that and there's some areas that clearly from a cost structure perspective are overstated because the process of growing rapidly in acquisitions and stabilization are costs that are not required in the business once you're more steady state.
David N. Miller
So securitization is getting a lot of talk, has been for the last year. I think it is a great long-term opportunity set to raise debt. We'll have to see how it initially comes to market. We are fairly sophisticated and we'll take advantage of all areas of the capital structure where it's cost effective and make sense for the business. We'll let others be the leader. I like to describe it as letting some other groups push the boulder up the hill, get it done and then we'll get to piggyback off all the cost and expense associated with that and we'll look at it. But it hasn't been done yet.
David N. Miller
Yes. So our existing line of credit I'll say was 200 million. So what options exist out there today? Reasonably limited but since we're underlevered, it could be possibly increasing obviously the line of credit. There is opportunity to do some sort of hybrid. I know one of our competitors now with the preferred. Convertible debt market is open and there is a possibility to do other sort of commercial term loan type debt. We're keeping an eye on securitization. It doesn't exist today but over the next quarter or two, people are quite confident that something will occur. So I think that's the range of opportunities today and we're going to be focused on obviously the cost but also what sort of term we can get because a three-year facility is not the right long-term financing for this business but as we get more operational data and history, we think everyone is going to get quite comfortable at the risk profile that is both great on the coverage and asset coverage basis but also cash flow basis, so we're very comfortable that those opportunities to term it out will be there in a couple of years.
David N. Miller
Yes, I think I was referring to a chart where I said since we don't give guidance that the lower left side if you sort of looked at that as a reasonable trajectory and that would give you an idea of where we'd be for the end of the year. But from a cost structure, yes, surely as you lease up, you get operating leverage and are leveraging a lot of the fixed cost in the business. I think I was on a look forward basis there are cost related to the acquisition stabilization that will still be in the next couple of quarters related to doing this that aren't necessarily there long term. The example I give is if you have to lease up 100 properties in a given area in a month, you need more leasing fire power than if it's already steady state, maybe the turnover rate suggests you have to do 20. So you don't need as much on the leasing side and that's just one example. But you are moving towards breakeven cash flow positive and then growth there, it's just not going to be as soon as you hit 90% occupancy suddenly you're at the normalized yield we expect to be at.
Peter Martin - JMP Securities
You've run over. We'll move it down to the breakout room at the end of the hall, it's 12. David, thank you very much.
David N. Miller
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