But Two Harbors is crossing the Rubicon. It is one of the first to be entering the "new" housing frontier; the step from owning the debt to owning the property, from financial asset to hard asset.
The opportunity in buying portfolios of single family homes (and don't forget, I am sure the bigger banks will talk to portfolio investors as well) is interesting and potentially very lucrative. Imagine buying the house, renting it for a spread to cost of funds (maybe rent to own) and then selling it after a holding period and - as my Texan friends say - toting the note (seller financing). You have now combined the mortgage and the hard assets on your balance sheet. I would expect to see REITs singularly focused on this.
Well, there is a company that is in the process of creating a REIT that is focused on this: Beazer Homes (BZH). The writing has been on the wall that there are opportunities in real estate (foreclosed or in process) which will afford astute investors potentially significant upside. Beazer has recognized the potential and has taken steps to take advantage of the current real estate market.
From the Beazer press release:
Beazer Homes USA, Inc. announced the contribution of its pre-owned rental homes business, consisting of nearly 200 single-family homes in Phoenix and Las Vegas, to a newly formed real estate investment trust. The REIT, which will be named Beazer Pre-Owned Rental Homes, Inc. ("BPRH"), was founded by the Company and includes an investor group led and arranged by affiliates of Kohlberg Kravis Roberts & Co. BPRH was organized to acquire, refurbish and lease recently-constructed, previously-owned single-family homes on a large scale in select markets in the United States. BPRH intends to become a leader in the single-family rental homes business and is one of the first REITs focused exclusively on the single-family home rental market. BPRH will be based in Phoenix, Arizona.
From Beazer's recent 10-Q we find the following information on the pre-owned business:
Beazer began its pre-owned homes business for the purpose of acquiring, improving, renting and ultimately reselling, previously owned homes within select communities in markets in which we operate. We purchased our first home in March 2011. As of March 31, 2012, we owned 190 homes in Arizona and Nevada, of which 183 were leased. The cost, net of accumulated depreciation, of the previously owned homes acquired by our pre-owned homes business was $19.0 million and is reported separately and excluded from inventory. These assets are depreciated over the asset's estimated remaining useful life. For the three and six months ended March 31, 2012, our pre-owned homes business generated $524,000 and $909,000 of revenue, respectively and had operating losses of $62,000 and $200,000, respectively.
Keep in mind that Maricopa County, where Phoenix is located, had 6,781 new foreclosure filings in March, according to RealtyTrac. Meanwhile, one in every 255 housing units filed for foreclosure in Clark County, Nevada during March.
There is plenty of inventory in the areas chosen thus far for the new company to build inventory. As well, Fannie Mae's (FNMA.OB) bulk offering properties are located in the Las Vegas and Phoenix areas as well.
And back to the earlier referenced press release:
Patrick R. Whelan, a residential real estate veteran with over 20 years of experience in a number of senior leadership capacities, including six years as Chief Operating Officer at Archstone-Smith Trust, an apartment real estate investment trust, will serve as BPRH's President and Chief Executive Officer.
"Pat brings to BPRH a wealth of experience garnered during his many years in the real estate industry. He is an outstanding leader and is the perfect person to lead this new venture as we look forward to quickly ramping the business and taking advantage of the market opportunities currently available in the single-family home rental category," Mr. Merrill stated.
The addition of Patrick Whelan brings credibility and know-how to this venture. Recall Archstone was one of the larger, and better run, apartment REITs that ended up (and still is) tangled in the Lehman estate.
Single family housing is very affordable right now and continues to represent long-term value for investors (and prospective owners). According to recent data from the National Association of Realtors:
NAR's composite quarterly Housing Affordability Index* rose to a record high of 205.9 in first quarter, based on the relationship between median home price, median family income and average mortgage interest rate. The higher the index, the greater the household purchasing power. This is the first time the quarterly index broke the 200 mark; recordkeeping began in 1970.
NAR President Moe Veissi, broker-owner of Veissi & Associates Inc., in Miami, said market conditions are optimal for home buyers. "For those with good credit, we've never seen better housing affordability conditions or market opportunities than we see at present," he said. "Although home prices are stabilizing and sales are rising, some buyers still have to jump through a lot of hoops to convince a lender that they are creditworthy, even for a mortgage that would be well within their means. This is especially true for self-employed buyers."
The problem with the single family rental model is the ongoing cost per unit, or maintenance costs. An apartment community can have a landscaper come in and maintain the property for a hundred units at one time. The same can be said of building maintenance. Single family residential units (even community developments) take significantly more time by their very nature. This is the primary stumbling block I see in the single family model. Perhaps this is what Warren Buffett meant by Berkshire Hathaway (BRK.B) would buy a couple hundred thousand single family homes if it were practical to do so. The key word is practical.
Bottom Line: I think the single family rental market is very interesting. Properties are still very affordable and the potential long-term returns are attractive. The sticking point is the maintenance cost per unit. This is where single family costs will be much higher than multifamily costs and increase the discount required on properties and/or companies involved in the sector. I continue to keep an eye on Two Harbors and Beazer to see if this is a viable investment on a larger scale.
Additional disclosure: This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.