Silver Bay Realty Trust's CEO Discusses Q3 2013 Results - Earnings Call Transcript

Nov. 7.13 | About: Silver Bay (SBY)

Silver Bay Realty Trust Corp. (NYSE:SBY)

Q3 2013 Earnings Conference Call

November 7, 2013 09:00 ET

Executives

Anh Huynh - Director, Investor Relations

David Miller - President and Chief Executive Officer

Patrick Freydberg - Chief Operating Officer

Christine Battist - Chief Financial Officer

Analysts

Jade Rahmani - KBW

Anthony Paolene - JPM

Dan Oppenheim - Credit Suisse

Dennis McGill - Zelman & Associates

Jana Galan - Bank of America-Merrill Lynch

Operator

Good morning. My name is Betty and I will be your conference facilitator. At this time, I would like to welcome everyone to Silver Bay’s Third Quarter 2013 Financial Results Conference Call. All participants will be on a listen-only mode. After the speakers’ remarks, there will be a question-and-answer period.

I would now like to turn over the call to Anh Huynh, Director of Investor Relations for Silver Bay.

Anh Huynh - Director, Investor Relations

Thank you, Betty and good morning. I’d like to begin by welcoming everyone to Silver Bay’s third quarter 2013 conference call. On the call with us this morning are David N. Miller, President and Chief Executive Officer; Patrick Freydberg, Chief Operating Officer; and Christine Battist, Chief Financial Officer.

For your reference, the press release and financial tables associated with today’s conference call were filed yesterday with the SEC. If you do not have copies of materials, you may find them on our website. This call is also being broadcast live over the Internet and may be accessed on our website at silverbayrealtytrustcorp.com in the Investor Relations section under the Events Calendar page. We encourage you to reference the accompanying presentation to this call, which can also be found on our website on the Presentations page. In addition, we will be filing our 10-Q later today.

Before we begin, please note that today’s discussion may include forward-looking statements. Forward-looking statements reflect our views regarding future events and are typically associated with the use of words such as anticipate, target, expect, estimate, believe, assume, project, and should or similar words. We caution all those listening, including investors, not to rely unduly on forward-looking statements. They imply risks and uncertainties and actual results may differ materially from expectations. We encourage you to carefully consider the risks described in our filings with the SEC, which maybe obtained on the SEC’s website at sec.gov. We do not undertake any obligation to update or correct any forward-looking statements if later events prove them to be inaccurate.

I would now like to turn the call over to David.

David Miller - President and Chief Executive Officer

Thank you, Anh and thank you all for joining us today. It’s hard to believe that as we move towards the end of the year, we are also nearing the one year anniversary of our IPO. Our first year as a public company has been primarily dedicated to building a foundation that is essential to our long-term success.

In the first three quarters of the year, we acquired 2,259 high-quality single-family homes at attractive prices and renovated and leased nearly 3,000 homes. We also enhanced our capital structure by entering into a $200 million credit facility and are well-positioned to add additional debt to continue our growth. As we are now operating with a substantial portfolio of stabilized properties, we expect to continue our trajectory of improved operational efficiency. We look forward to presenting our 2014 strategic priorities on our next quarterly call. Overall, the macroeconomic and demographic trends continue to support the housing recovery in single-family rental industry. And we believe we have assembled an outstanding team to deliver strong results in the years to come.

Turning to the housing market, I would like to direct you to Slide 5. Home prices continued to appreciate with all of our markets exhibiting strength despite the rise in mortgage interest rates. Recent economic reports forecast continued home price appreciation in the coming years sighting decreasing distressed sales, limited housing inventory and positive demographic trends as the primary drivers. Although homebuilder confidence is high, the recent rise in mortgage interest rates moderated housing starts to approximately 600,000 on an annualized basis, representing levels well below the historical average. Foreclosure rates continued to improve. However, distressed inventories are still higher than normalized levels and remain concentrated in select states, including Florida, which is one of the states we are focused on for future acquisitions.

According to CoreLogic, home prices were up 12% year-over-year nationwide marking 18 consecutive months of growth. Our markets have also experienced home price gains reporting strong increases of 3% to 10% over the past three months as of August. We believe our ability to acquire homes in the most compelling markets from a home price appreciation and rental yield perspective has positioned us well to deliver attractive total returns for our stockholders. Although housing appreciation has been strong, most of our markets continued to be 30% to 45% off-peak pricing and remain at significant discounts to replacement costs. This suggests additional upside as our portfolio continues to benefit from the housing recovery. Strong leasing momentum continues to be a central theme for us. For the third quarter, we increased the number of leased properties in the portfolio by more than 900 homes, representing a 25% increase compared to the prior quarter. As a result of this larger base of income producing properties total revenue grew 35% quarter-over-quarter to $14.5 million. Net operating income continued to outpace rental growth increasing 44% on a sequential quarter basis. Christine will provide a more comprehensive review of our financial results later in the call.

On our previous earnings call we shared our objective of leasing the great majority of the 5600 homes in our portfolio by the end of the year. As a result of our strong leasing performance during the quarter we have made significant progress towards achieving this milestone. For the aggregate portfolio occupancy increased 16 percentage points to 81%. Occupancy for properties owned six months or longer improved two percentage points to 89%. Stabilized occupancy increased to 95% for the third quarter. As a reminder it is our objective to achieve an occupancy rate well north of 90% on a stabilized basis. Later on the call Patrick will provide an update on our operations.

Last quarter we started reporting estimated NAV which provides investors insight into the capital appreciation component of our total return profile. As of September 30 estimated NAV increased approximately 3% to $19.50 per share from $18.95 per share as of June 30 reflecting appreciation in the underlying assets of our portfolio and to a lesser extent a reduction in our outstanding share count. It also represents a premium of 14% to our book value and a premium of 11% to our book value adjusted for depreciation. We take pride in acquiring well and believe that over time our NAV will continue to appreciate and be a key driver of total value creation.

In the third quarter we dramatically slowed our acquisition pace and focused on stabilizing the portfolio. As a result, the number of homes in the portfolio has remained relatively unchanged since the second quarter. Today we have approximately 5600 high quality single-family properties in our portfolio in fact previously mentioned we are working towards stabilizing the great majority of these homes by year end. Achieving this will position us to begin generating positive cash flow and to increase our dividend.

On the aggregate portfolio underwritten gross yields remained relatively unchanged compared to the prior quarter at 10%. We continue to see ample opportunities to acquire single-family homes at discounts to replacement cost in select markets and have begun acquiring albeit at a more limited pace compared to our historic acquisition experience. The housing market is dynamic and we intend to selectively acquire in markets that have the most compelling total return profiles. Based on today’s available distressed inventory and pricing, we currently see the most attractive opportunities in Florida and Texas. We will continue to evaluate the capital markets for opportunities to raise debt or equity capital in order to execute our strategic plan. Our philosophy is to raise capital if there is an attractive opportunity to deploy the proceeds and if the transaction creates incremental economic value for our stockholders. To fund future acquisitions, we intend to utilize the remaining capacity on our credit facility. We believe the moderate leverage between 30% to 50% debt to enterprise value is appropriately conservative for the single-family REIT business model.

Given our current portfolio of homes in our existing $200 million credit facility, we are comfortable adding incremental debt to our balance sheet. Our options include increasing our credit facility, possible securitization for other hybrid structures. As we have recently seen with the home securitization, we believe that the financing options in this sector are rapidly improving as banks and the capital markets become increasingly more comfortable with the single-family rental sector as an institutional asset class.

In July, the Board of Directors authorized the share repurchase program, which enabled us to buyback our common stock in the third quarter at levels that we believe represented a significant discount to intrinsic value. We believe repurchases at these levels create long-term economic value for our stockholders. We are committed to being a prudent steward for stockholder capital and as such, we intend to execute additional share repurchases if and when conditions warrant. At the same time, we have recognized that there are inherent benefits to scale in our business model and that size also creates greater liquidity for our shares. This creates the tension between growth and share repurchases. We intend to prudently balance these two objectives always seeking to optimize shareholder value in the long-term. Since the initial talks of Fed tapering began in late May, we have observed downward pricing pressure on credit sensitive and housing related securities. Silver Bay has not been immune to such pressure and our stock price appears highly correlated to the homebuilding and mortgage sectors, despite our differentiated business characteristics or NAV growth and operational gains in the past few quarters. Nevertheless, we remain optimistic in the long-term potential of the single-family sector as an institutional asset class and believe that by continuing to execute our business plan and through efficient capital allocation, our stock price will ultimately reflect our long-term value creation.

I’d now like to turn the call over to Patrick.

Patrick Freydberg - Chief Operating Officer

Thank you, David. From an operations perspective, stabilizing our portfolio has been our primary focus for the back half of 2013. We are pleased to report that we have made excellent headway.

Slide 6 illustrates our progress through the third quarter. Second quarter marked a substantial increase in renovation and leasing velocity and we were successful in maintaining this momentum through the third quarter. Our renovations team completed over 1,000 renovations. We increased the number of leased homes in the portfolio by more than 900 homes or 25% on a sequential quarter basis. Our top five markets experienced 19% growth in the number of leased properties. Since the beginning of this year, we have more than doubled the number of leased properties on our portfolio and have experienced continued improvement on our aggregate and six-month occupancy metrics. Most notably, we achieved 81% occupancy on the aggregate portfolio, representing a 16 percentage point increase on a sequential quarter basis for the third quarter.

Please turn to Slide 7. Earlier in the year, we presented a plan to increase portfolio occupancy. We are happy to report six-month occupancy rates for the Northern California and Las Vegas continue to rise after the second quarter reporting third quarter’s six month occupancy of 95% and 97% respectively. We are continuing to see strong rental demand in both of these markets, particularly in Las Vegas, where there is a shortage of quality single-family rental homes.

On our last earnings call, we established a target of achieving six-month occupancy of 90% for Tampa and Southern California by the end of the third quarter. And we are pleased to report that we successfully achieved that goal. In Tampa, six-month occupancy improved 11 percentage points to 92%. And in Southern California, six-month occupancy improved 23 percentage points to 90% quarter-over-quarter. Having accomplished our goals in the aforementioned markets, we are looking forward to achieving stabilization for our newer markets. We have been applying the techniques that we have refined over the past year in renovation and leasing. In Southeast Florida, we have taken into account a longer eviction and municipal permitting process, both of which are characteristic of this market. We are confident that the experience we gained will translate into faster renovation and leasing of newly acquired homes, especially given that most of our new acquisitions or MLS incentive auction homes.

For the third quarter, as shown on Slide 8, we reported an average monthly rent for the aggregate portfolio of $1,161 compared to $1,148 for the second quarter. The quarterly increase was primarily due to changes in portfolio mix. As we mentioned on our last earnings call, we have been primarily focused on portfolio stabilization and made the strategic decision not to pursue significant increases on lease renewals during this phase. As we are approaching portfolio stabilization in each market, we will begin pursuing more aggressive renewal increases. We anticipate that this strategy shift will lead to higher renewal rent increases towards the end of the fourth quarter.

The number of homes with lease expiration dates during the third quarter was a relatively small subset of our portfolio and may not be representative of our renewal and turnover experience. Our turnover metrics will become increasingly more meaningful starting with the first half of 2014, which is when we project a material step up in schedule leased expirations. In the third quarter, total number of properties with lease expirations was 675, including properties with month-to-month occupancy in that period. Of these properties, 163 properties turned over implying a 24% turnover rate. This number included 38 evictions or lease breaks and 125 end of lease voluntary move outs. The total of 271 properties turned over in the quarter representing 5.7% of our stabilized portfolio of 4,776 properties. We believe that on a stabilized basis, the single-family sector will likely have lower turnover rates than the multi-family sector. Although there is limited industry research on this metric, we are estimating the turnover rate for single-family sector to come in around 33%, which is supported by our early portfolio datum.

With the portfolio approaching stabilization, our top operational priorities are those essential to delivering attractive NOI margins, namely rent growth, high resident retention and cost containment on turnovers and repairs and maintenance expenses. Achieving high resident retention will result in lower turnover activity and turnover costs. Providing high levels of customer service is critical to resident retention. With this in mind, we remain focused on refining operational procedures to deliver best in class customer service that encompasses all aspects of the resident lifecycle including the application in leasing process, responding to service requests, and lease renewals. For example, we recently refined our renewal process to include earlier resident outreach prior to the lease expiration date and greater follow-up with the resident during this period.

With respect to repairs and maintenance, there are two primary components in minimizing expenses. The first is preventative. We complete extensive initial renovations on newly acquired homes in an effort to minimize ongoing repairs and maintenance. We apply a similar mindset in approaching turned homes each of which must pass the same 60 point quality control inspection process we use during the initial renovation. This enables us to address potential issues before a resident moves in. The second component is controlling expenses by negotiating favorable pricing from suppliers and vendors performing service work and eliminating unnecessary service trips. We have established national accounts to reduce the cost of supplies and we also periodically review recurring service arrangements using our scale to ensure we are receiving good pricing and service quality. We apply the same approach to obtain better contractors to execute service calls. In addition, we have been refining our operating procedures to promote greater focus for our local teams on the elimination of unnecessary service trips and cost containment and believe we can attain even greater operational efficiency and expertise by centralizing the processing related to our repairs and maintenance.

I would now like to turn the call over to Christine.

Christine Battist - Chief Financial Officer

Thank you, Patrick. We are pleased with how our continued leasing momentum has positively impacted our results this quarter. For the third quarter, we reported total revenue of $14.5 million, representing a 35% increase on a sequential quarter basis. Note that while we achieved 81% occupancy on the aggregate portfolio, as of quarter ends, not all these properties were generating rental income for the full period. Net operating income increased 44% quarter-over-quarter to $4.5 million. Slide 9 illustrates quarterly growth in both revenue and NOI. Net loss for the quarter was $6.4 million or negative $0.16 per share compared to negative $0.18 per share for the prior quarter.

This morning I would like to review a few key line items in our financial statements, and then spend the balance of our time commenting on key drivers for NOI improvement. For the quarter we reported $4.3 million in property operating and maintenance expenses, which compares to $2.5 million in the prior quarter. The sequential quarter change is attributable to an increase in repairs and maintenance costs and expenses relating to resident turnover and to a lesser extent an increase in market ready expenses. The increase in repair maintenance costs was mainly due to a higher base of leased properties and in certain markets we experienced higher than expected costs related to plumbing and HVAC repair.

In addition we have observed service call requests by residents upon initial move-in to newly stabilized properties to level off after resident acclimates to his or her new home. Once the portfolio stabilizes, we believe that repairs and maintenance service calls supporting new resident move-ins will decline. The number of turned properties increased quarter-over-quarter and we experienced a corresponding increase in expenses relating to resident turnover. Effectively managing lease renewals and turnover is a critical aspect of our business and we anticipate turnover costs will become a larger portion of our total property operating and maintenance expenses as a greater percentage of our leases come up for renewal in future periods. Market ready expenses related to both our newly renovated properties and homes available for lease as a result of turnover. For newly renovated homes we incur an expense market ready cost primarily for utilities and landscape maintenance, in the tenant property as rent ready to the lease effective date.

Return of our properties we incur these same expenses from the time of move out to the new lease effective date. Market ready expenses increased quarter-over-quarter to an increase in utilities and above average landscaping costs for certain homes. Once our portfolio stabilizes, we expect these market ready costs to decrease because there should be a smaller number of properties in this phase. We also expect that the average rent ready period for a turnover will be shorter than for a newly renovated home.

Real estate taxes were $1.8 million, which is a slight increase compared to the prior quarter due to the corresponding increase of homes transitioning from the renovation to the market ready phase. Home owners association fees were also in line with the prior quarter at $286,000, which reflects the number of homes in HOA communities and the portfolio remains steady quarter-over-quarter. We reported $3.7 million in property management expenses for the third quarter compared to $3.1 million for the second quarter.

The sequential quarter increase was due to the following. First, we recorded $310,000 in un-capitalizable acquisition team costs due to our reduced acquisition pace. Second, we experienced $157,000 increase in third party property management fees associated with the corresponding increase in the number of leased homes managed by our third parties. Third, in line with our expectations, we incurred an additional $121,000 in salaries and recruiting expenses associated with the ramp up of our Southeast Florida office. And fourth, we are in process of upgrading to an enhanced property management system and incurred an additional $121,000 in related software implementation costs.

The collective increase of these four buckets was offset by a decline in cost pertaining to contract labor supporting back office property management function. Property management expenses as a percentage of revenue continued to improve on a sequential quarter basis. We believe that property management expenses as a percentage of revenue today are not representative of our steady-state operations. And we anticipate seeing further cost efficiencies in our internally managed markets. The build out of our internally managed Southeast Florida office will continue to be a drag on earnings until we have a higher base of rental revenues to offset infrastructure expenses for that market.

In addition, there are certain costs that will run off when we transition out of our ramp up phase. For example, our operations will require a less extensive leasing infrastructure when we are no longer focused on stabilizing large volumes of newly acquired properties. And one final point on property management, we reported a total of $411,000 in the third quarter for the software implementation costs that I previously mentioned. We plan to complete this implementation by the end of the first quarter of 2014.

Depreciation and amortization increased to $5.7 million, up 15% on a sequential quarter basis. The increase is primarily attributed to more properties being placed into service. Included in this line item is $619,000 for the amortization of in place leases and $250,000 in amortization of deferred lease fees. As a reminder, the Provident in place releases will be fully amortized by the end of this year and deferred lease fees are amortized over the lease term which is generally 12 months.

In line with our expectations G&A was $1.9 million compared to $2 million in the second quarter. Interest expense was approximately $1 million for the third quarter. Prior to entering into the credit facility in late may we had no debt outstanding. Note that interest expense is net of capitalized interest on properties undergoing renovation and we are forecasting increased interest expense as we finished our renovation.

Turning to the balance sheet. As of September 30, we had cash and cash equivalents of $54 million in addition to $23 million in escrow deposits. We had $145 million outstanding in our credit facility, which compared to $79 million as of June 30. Our availability on our credit facility was $55 million at September 30. Periodically, we identify properties that do not meet our requirements and to-date, have contributed these assets to our taxable REIT subsidiary with the intention of selling these assets. Once transferred, these properties are reclassified at assets held-for-sale in the balance sheet.

Ongoing costs associated with these assets are recorded in the other line in the income statement until the asset is sold. To-date, a de minimis percentage of our total commerce, have been designated as assets held-for-sale and there have been no material leasing operations. As David mentioned, the Board of Directors authorized a share repurchase program for up to 2.5 million shares. During the third quarter, we bought back 500,000 shares of our stock in a series of transactions at an average price of $15.58. Our buyback activity for the quarter was accretive to our book value and estimated NAV contributed $0.02 and $0.05 per diluted share respectively.

Now, let me wrap up with some comments on NOI performance. Although we are currently achieving attractive NOI results in some of our fully leased up markets, we do not believe our third quarter financial results are reflective of our company’s long-term profitability. Looking forward, we anticipate driving top line growth through rental increases and improving the bottom line through cost control. We have been successful in achieving revenue growth as a result of our increased occupancy and believe are focused on attaining increases on lease renewals will continue to benefit our top line. We believe there are several key drivers that will enable us to improve our cost structure as our business continues to evolve.

First, increased revenue will leverage our Southeast Florida infrastructure. Second, as I mentioned earlier, market ready costs will be a smaller component of our property, operating and maintenance spend on a stabilized basis. Third, as Patrick mentioned, we are working on centralizing certain operational processes, including service repairs and maintenance request and certain back office corporate functions. Finally, there are certain expenses we believe, it will either runoff or decrease once our portfolio stabilizes and company matures. These expenses include repair and maintenance service calls relating to new resident movements, the optimization of our leasing infrastructure and non-recurring software implementation cost. We are focused on generating value for our stockholders. And we will keep investors apprised of our progress.

Now, I will turn the call back to Betty for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. (Operator Instructions) The first question comes from Jade Rahmani of KBW. Please go ahead.

Jade Rahmani - KBW

Good morning and thank you for taking the question. I just wanted to drill down on this property operating and maintenance line and really understand what drives – what drove the sequential increase? As a percentage of revenues, the ratio totaled 29.5% well above our 19% forecast and up from 23.5% last quarter and we had expected the ratio to improve sequentially driven by more properties generating revenues. So can you please provide any additional clarification? Was this attributable to higher than expected ongoing operating and maintenance costs or was this primarily attributable to preventative maintenance that you cited or was this also due to the provident portfolio not having sufficient initial CapEx and you underwent more maintenance and repairs that you actually would have expected, on a normal run rate?

David Miller

Thanks Jade, it’s David. I will let Christine and Patrick talk to just sort of overall I think it is a mix of a number of things that you talked about although we do not think that that margin rate is reflective of the long-term stabilized run rate of the portfolio. There is certainly a component related to the ramp up nature of our business right now where properties are in that life cycle and we did run a little bit higher in some categories on R&M do some of things you mentioned there in terms of the initial scope and renovation quality, the early properties and some other factors. I will turn over to Christina to give more color.

Christine Battist

Sure. Thanks David. So a couple to get little bit more into the detail there was higher landscaping costs, as you typically see and this is bringing some amount whether that relates primarily to moving yards in market already homes that aren’t yet fully leased up would be one factor. Similarly HVAC costs were a bit higher than we are expecting as well. Once a tenant moves another we do the 60 point inspection once that HVAC starts running some times there is some fine tuning that needs to happen and once these residents that are and as I have mentioned in my prepared comments we think that our R&M would subside. We did have some storms-related damage in the Atlanta market during the quarter, not having material but it did add to the costs there that we had to absorb. And there was some higher turn costs on some finished properties, that weren’t necessarily anything related to Provident that you had touched on. And finally there was casualty loss on a property that will be recovered in the future which were related to insurance proceeds. So, it’s a whole conflict of factors.

Jade Rahmani - KBW

So, if you could break out the non-recurring total of those items, I mean what would you expect that the impact was in the quarter?

Christine Battist

I guess I would say that in terms of pulling out the non-recurring, I mean it’s a little bit of a mix bag that’s probably now meaningful. I guess, I would say that was we are committed to bringing down this trend in the property operating maintenance. And think that it will be normalized with us having a stable portfolio in these markets, we don’t have to drag of these market ready costs, because if you have noticed well even though we had the 81% occupancy for the quarter you’ll have some higher market ready costs because that portfolio was not fully leased up at 81% for the full quarter.

David Miller

Yes, I mean just in context right, as we are leasing up and again working through the last component of the initial stabilization, when we are talking about hundreds and North of a thousand is being recorded of properties that are not yet leased, being renovated. And as those cycle through as far as the cost that do come through that line item those are going away obviously in a steady state where we don’t add units. So those come down quite a bit. And then there are some items that are certainly inside of our control that we need to do better job on. Take turnover for example really short in the time that we turn properties that’s already in process we are going to see substantial reductions in those times, which again during that downtime not only you are using revenue but you are also incurring expenses that we do market ready. So market ready was a big bucket and then the other half of that of the margin changes that you talked about is due do some of these higher costs and there are spread out of costs.

Jade Rahmani - KBW

So do you expect the ratio, I mean this is extremely critical to understand because with respect to forward earnings forecasts it could dramatically reduce things, do you expect the ratio to improved next quarter and in 2014, can you give any sense for whether a normal ratios should be?

David Miller

Yes, I think the numbers you talked about make a lot of sense. We expect it to come down substantially in 2014 along those lines.

Jade Rahmani - KBW

Alright, thanks.

Operator

Our next question comes from the Anthony Paolene of JPM. Go ahead please.

Anthony Paolene - JPM

Upon Jade’s question just and you mentioned kind of in line what he mentioned makes sense, but can you maybe say that again, I don’t recall exactly how he characterized it in terms of what future repair and maintenance would be as either percentage of revenue or just on a per unit basis?

David Miller

Yes, the – it’s David. The overall cost I think for the quarter which we are running as a percentage of revenue in the high-20s that’s going to come down substantially. Obviously there are a lot of different moving parts in that category. As we talked about before there lots of properties that are not generating revenue that have caused that go on the expense, so that comes down over time and I would say half of that of the margin exceeding what we expect the long-term steady state to be is from that market ready category and others are some of the components that both Patrick and Christine talked about in their prepared remarks regarding settling in costs running higher, but we do see those coming down after the initial move-in from that extensive renovation. And so I think the combination of both of those in getting more to leased up and it’s going to come down to the high-teens.

And one of this factor – one other factor that Jade alluded to is the fact that these early turns are really from the predecessor company period and in many cases take longer because we had slightly more work that had to be done to bring them up to Silver Bay current standards that have been maintained since Silver Bay Realty Trust began. And that not only does it take more time to do, which incurs more market ready costs, but the time of the cost to do those in the THPI portfolio was – this expense did not capitalize. So that’s another reason that we don’t expect the turned cost to be anywhere near where they are now going forward.

Anthony Paolene - JPM

Okay, and then, on the same lines on the property management if I take out some of the items that Christine mentioned and bring it down to call it $3 million there abouts and annualize that to $12 million. And I just simplistically take sort of a 10% of your asset base as being sort of stabilized revenue it would still suggest property management up, north of 15% of revenue. So is either A, that sort of the right number or B, is a portfolio just not big enough to kind get that scale yet, to get that down to 10 or less I guess?

David Miller

Yes, on the property management side again another example that’s running too high as a percent of revenue now, we expect to come down dramatically in 2014. There are a number of things going on, obviously we’re not fully leased up, so the revenue side is not – the cost structure is not supporting yet by the revenue, but we are obviously making quite a bit of improvement there. If you look in this quarter and you back out some one-time items that are not insignificant, it’s already there is lack of scale in the Southeast Florida market that will change over time. There is 5% markup fee that’s really part of the advisory fee that’s just put in there, but I think about that more as the advisory fee. And then we have got some overcapacity, which is required to ramp up the business and so that on the steady state comes down. And so I think more in the 12%-13% range is our current viewpoint and that’s consistent with what our expectations are for our current size and given the required asset management of regional overlay that we think is required to run execution of quality business, obviously that can come down over time with more scale, more assets.

Anthony Paolene - JPM

Okay and then just last question. Given the Invitation Homes execution on their securitization deal, you had mentioned a conservative leverage I think you had thrown out the 30% or so number in your comments, does that make you rethink just balance sheet strategy going forward the ability to perhaps tab more leverage bulk up the operation even greater, just how does that execution change or not the way you have been thinking about the balance sheet.

David Miller

Yes, great question. So first of all I would say we are absolutely delighted with the success they have had with that transaction. And it really is a game changer as far as cost of capital, and it’s something we are spending a lot of time looking at. It’s great for the industry. You can look at the math obviously improves ROEs immensely. And I think it will be something that allows the institutional players call half a dozen or so to consolidate the industry. I think it’s required if you look at that structure you need to have an institutional quality infrastructure. You need to be spread out across the country in a number of different markets. You need to have the accounting and finance function capable of bring it all together and the technology to support that. And there aren’t that many people that can do that, so I think it’s quite good in that regard. So it is something we are very excited about. I think it’s great for the industry certainly something we are going to spend a lot of time on.

And I think, depending what is available to us and we will certainly be looking at that, could that change our viewpoint in the near-term on leverage maybe there are certainly ways to do it that keep you the company inside of more conservative leverage targets overall, but can certainly securitize the stabilized part of the assets with higher leverage rates, which is what they did. So again we are going to take a hard look at that 30% to 50% targets has always been a long-term target and something that could change if the economics are there and we feel that the risk return is appropriate for shareholders. But it’s little too early to tell, but again something we are spending – we are going to spend a lot of time on and take a hard look at going forward. It’s a process that as you know takes sometime but we tip our hat to the Invitation Homes. We are spending almost a year working on getting this done and they did a terrific job. So we are happy to them and I think it’s great for the industry.

Anthony Paolene - JPM

Okay, thank you.

Operator

Thank you. Our next question comes from Dan Oppenheim of Credit Suisse. Go ahead please.

Dan Oppenheim - Credit Suisse

Thanks very much. I was wondering I think some of this will depend clearly on the financing and such, but as you think aside from sort of leverage if you think about sort of optimization of the portfolio and maximizing value right now looks as included some sales in California and then adding some homes in Ohio and Florida. As you think about are we likely to see some of that taking place over the upcoming quarters, how much activity should we expect there in terms of just turning of the portfolio.

David Miller

Yes, I mean we are engaged in sales initially based on just individual properties that we don’t think that the business strategies are cleaning up the portfolio if you will. We have moved some properties in one market in California maybe it’s a small number. But approximately 30 that we are looking to sell just because we did not gain scale and we are not active buyers in that market, but it depends, it’s always going to depend on the price the value where we see relative opportunities. So we certainly could do some strategic sales in a higher price markets. California is good example where it’s just the markets both North and South have been pretty much on fire this year.

That being said we have got very good occupancy cash flow coming in for those properties. So we weight that against what the sale prices would be and where we can deploy that. So we will be opportunistic there, it’s certainly not a wholesale big part of the strategy at this point to be selling large parts of the portfolio off. But certainly longer term, I think amongst players there certainly could be some asset swaps. There will be opportunities to sell portfolios or individual properties to refurbish that capital into better markets, it’s just something we would look at we constantly discuss (indiscernible) early days. And we would really like the properties that we have acquired and so we don’t feel compelled to sell them at this point.

Dan Oppenheim - Credit Suisse

Great and then I guess second question I am wondering about it in terms of just the leasing right now as you had many of the homes for a longer time, just how everything is going in terms of just the rental increases as you have renewed leases and overall what you are seeing in terms of just turnover for the coming years based on some of that we can progress?

David Miller

I will give that one to Patrick.

Patrick Freydberg

All of our markets have exhibited very strong leasing dynamics. And our primary focus that I have – as I have mentioned has been on stabilizing our portfolio. So now that we are approaching portfolio stabilization in many of our markets we began pursuing more aggressive renewal increases and anticipate that this strategy shift will probably lead to higher renewal increases towards the end of the fourth quarter. So we expect the progression of maturing of our stabilization process in our markets to lead to higher rents and better resident turnover characteristics and retention as we get into 2014.

David Miller

Yes and I will just add, I mean as Patrick said clearly what we are trying to lease up many hundreds of homes and that was our focus and our intention we were not pushing rents at all. So in the quarter we are talking about maybe 2%, so it was really something that we were actively not focused on. And going forward that’s already starting to come up, we started early in the process so that’s going to be higher. And I think as we get into 2014 that’s obviously a big focal point for us but it also works out well competitively because if you look to where the vast pools of capital have been deployed over the course of this year have been renovated and will be on the market through the end of the year and maybe the first quarter. But all of the large players will be much more substantially leased up which takes excess inventory off the market and allows you to push price more. So I think that’s what we have seen. We have been very vocal about market rents being under-priced or subdued relative to where they will go because of that phenomenon, but these markets aren’t going to tighten up pretty quickly once we get through that first wave of homes on the market, because the demand is very strong and the supply despite there being a near-term increase in supply. We see that moderating very, very quickly and then forcing pricing up.

Dan Oppenheim - Credit Suisse

Great, thank you.

Operator

Our next question comes from Dennis McGill (Zelman & Associates). Please go ahead.

Dennis McGill - Zelman & Associates

Thank you. David, I think everyone appreciates that lease up stage and the fact that a lot of these homes are not rent ready carry costs without revenue and that the margins today aren’t representing the longer term margins, but what can you tell us about stabilized margins in markets where you have scale, where you have had leasing operations for sometime to give us comfort that there is a real margin that we had?

David Miller

Sure. Without going into specifics, we have talked about margins going 50% to 60% on the NOI side. Other competitors have talked about numbers in that range or in some cases higher, I think. We are a little bit conservative. And we are seeing that in some of our markets.

Dennis McGill - Zelman & Associates

Well, 50% to 60% is a pretty wide range?

David Miller

Yes. I mean, again that’s been our disclosure certainly driving it up to 60% has been our goal. And I think we are going to be a little bit conservative until we get there, but there are markets where we are operating obviously high occupancy that don’t have that ramp up feature that are closer to the 60% range and we are comfortable with the overall range. And there are differences within markets, so I think that’s why we are giving you wideband, but obviously I’d be disappointed which was at the low end of that.

Dennis McGill - Zelman & Associates

Well, let’s maybe ask in a different way, let’s take the midpoint of that, it’s 55%. If you stop acquiring today and got all these homes to at least stabilized state, how quickly could you see the entire portfolio get to 55%?

David Miller

I think we can get there reasonably quickly as we talked about the occupancy. I think you have to keep in mind that we are not stopping and we are building an infrastructure or tailoring the infrastructure to run 5,600 homes and that’s it. If that were what we were trying to do, we would obviously make changes to the cost structure, changes to personnel and the overall infrastructure that would allow us to get there and I have total confidence that we could do that pretty quickly, but that’s not our strategy. For a little while, we are going to see as Christine mentioned, Southern Florida, which is a terrific market and we think has great long-term potential has been a little slower in ramping up and that’s a little of a drag. And there are other examples of that throughout the company that will moderate the base to getting there, but there are individual markets, where we are not buying and we don’t have a big infrastructure that are operating at the upper end of that 50% to 60% range today and we expect that to improve. So that gives us a lot of comfort that we are heading in that direction and the strategic plan will keep us from getting there next quarter, because we are growing. And so again, it sort of depends on the trajectory, but we are comfortable that the business model works well.

Dennis McGill - Zelman & Associates

Have you guys acquired homes in October and November?

David Miller

As I mentioned, we started acquiring again after really not acquiring much in the third quarter, obviously on a net basis, we fairly moved, we did acquire a few homes and yes, so we are acquiring again, but we are looking at obviously our capital and we have got lots of things going on there in the work to think about, but expect it to ramp up somewhat in the fourth quarter and then more so in the first quarter.

Dennis McGill - Zelman & Associates

Okay. And then just lastly some of the smaller and newer markets, I guess, Columbus, Jacksonville, Southeast Florida all stood out where six months occupancy rates were under 50% which seems like an extraordinary low number for six months period? Can you just talk about why that is and how you are structured on the management side within those markets?

Patrick Freydberg

Yes, this is Patrick. The experience that we had in those markets is basically parallel to some of the earlier markets that we worked on and was successful getting our occupancy rates up. It basically comes down to the acquisition pace outstripping the rehab, the initial rehab pace when we are establishing these markets. It took some time in each of these markets to get the rehab pace to come up which now has been the case, but there is a lag period of several months as you know until you start to see the occupancy take place once you have the rehab rent ready inventory available. It just took us a little time in those markets. We believe we are there now and we think as I have stated in my prepared remarks that towards the end of the current quarter we will be mostly stabilized in many of those markets.

David Miller

Yes, I mean I would just add there is nothing fundamentally wrong with the markets. And as we have had little hiccups in the past and it’s from the components lots of different types of things. We had short-term issues, initially in Las Vegas, Northern California. Those are some of the highest occupancy markets similar with Tampa, Southern California. So (indiscernible) lots of little things that get in our way that are fixed by blocking and tackling, and just putting our process in place, sometimes its do with the managers, sometimes its do with misunderstanding about how to scope and renovate properties that we have to go back and do that causes a little bit of delay, but we are very confident that we will get those markets up like the rest of the portfolio.

Dennis McGill - Zelman & Associates

Thank you, guys.

Operator

Our next question comes from Jana Galan of Bank of America-Merrill Lynch. Please go ahead.

Jana Galan - Bank of America-Merrill Lynch

Thank you, good morning. Patrick given that the acquisition actually remains muted, do you think that you are rethinking internalizing property management as well, most (indiscernible)?

David Miller

Yes, it’s David. Let me kick that one off. We haven’t changed our view. We have always said we like the flexibility of having some operating partners. If we have an operating partner that’s performing very well and that’s great, there is no necessary need for us to do anything. Certainly in the near-term obviously if we have a partner that’s not performing well and this happened in the past. It’s something where we have to either change the operating partner or internalize if we had scale. So we continued to discuss ways to do that, it’s something over time we do expect to have more internal property management. I am not sure we lose anything by waiting and seeing what our growth strategy is in certain markets. So that is long-term where we will go and the near-term it doesn’t hurt us. In fact it probably helps us because we have that flexibility of not putting a big infrastructure on the ground.

And so we will continue to look at that. The acquisition environment is fluid. We do have capacity as I mentioned on our undrawn revolver some cash. We certainly have couple of hundred million or more of additional debt capacity. We are in active discussions with lenders and capital markets folks on the best way to do that. And that’s going to queue our acquisition strategy going forward. There is plenty of opportunity in the various Florida markets we are in, in Dallas, in Atlanta. There are also a lot more portfolios for sale. And so that’s something that we will be looking at, obviously at the right price. But we do have the capacity to continue growing in the markets we want to grow in and that will ultimately help drive the strategy on the property management side.

Jana Galan - Bank of America-Merrill Lynch

Thank you. And then given the increased leasing in the quarter, I was just curious if any of your customer profile trends have changed in terms of maybe average household income or have you seen any kind of increase on paying rent?

Patrick Freydberg

No, actually, our profiles have remained remarkably stable, during the quarter. We think that this is probably a measure of our very stringent lease qualification in tenant standards and fair housing compliance background checks. So we think that the kinds of applicants that we have for our leases pretty much understand our credit and background requirements. And I think that contributes to a pretty stable tenant profile.

David Miller

Yes, it’s David. I would also add I mean this is a very important point. We would never lower the credit standards of the application process. just to get occupancy up there in a period because it’s a terrible economic decision that comes back pretty quickly to hurt you. And we are focused on driving long-term value making the right decisions both for the properties as well as the lease applicant process. So again it’s something where we have been very stable and we still achieved excellent leasing gains in the quarter even though we probably have some of the strictest underwriting in the markets that we are operating in.

Jana Galan - Bank of America-Merrill Lynch

Thank you.

Operator

There are no more questions in the queue. This concludes the question-and-answer session. I will now turn the call back to David Miller for his closing remarks.

David Miller - President and Chief Executive Officer

Great and thank you all for joining us for the third quarter earnings call. We appreciate your support and interest in Silver Bay and look forward to seeing many of you in December at the Goldman Sachs financial services conference. Have a great morning.

Operator

Ladies and gentlemen, this concludes our conference for today. You may all disconnect and thank you for participating.

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