After a lot of hype about the single-family rental market, the Silver Bay Realty Trust (NYSE:SBY) IPO turned into a major bust. The REIT went public back in December at $18.50 and quickly shot up to over $22, but any investors buying that hype have felt nothing but pain in 2013. In fact, the stock now trades below NAV near all-time lows around $15.50. Could it finally be time to buy the REIT?
Silver Bay focuses on acquiring, leasing, and maintaining a portfolio of single-family homes in select attractive markets in the U.S. It plans to operate under a REIT where substantially all of future income is returned to shareholders.
For investors that follow Stone Fox Capital, a big warning was issued when the REIT started trading due to the expected weak financials and lack of an initial dividend. In the early days, investors were confusing bargain housing prices with operating profits that would take time to generate. Now as the portfolio of properties start to stabilize (rent ready after renovations that last up to six months or more) the financials should improve vastly. Not to mention, the company provided some new financial metrics that should help encourage investors initially turned off by the large operating losses and lack of a significant dividend.
Another good sign for the stock price has been the recent IPOs of competitors in the sector in American Homes 4 Rent (NYSE:AMH) and American Residential Properties (NYSE:ARPI). These stocks provide investors with other investment options thereby eliminating the premium and scarcity value of the Silver Bay stock at the start. New investors get to obtain the stock at much more attractive prices.
Housing Prices Improve
One of the general issues in valuing a real estate investment is determining a correct method for valuing the individual assets. In the case of Silver Bay or American Residential Properties that amounts to over 4,000 properties to price each and every month. After all, a major reason for buying Silver Bay is the potential for great appreciation in properties bought at depressed levels back in 2011 and 2012 in states such as Arizona, California, Florida, and Nevada.
While American Residential didn't provide any quantitative details on the updated price on the properties owned, Silver Bay provided an interesting metric titled Estimated Net Asset Value (ENAV). Whether the market believes it or not, Silver Bay lists the estimated net value of assets at $18.95 per share or more than $3 above the current stock price around $15.50. The amount factors in an estimated $86 million increase in housing prices or roughly a 12% increase above the nearly $720 million gross purchase prices. With a NAV of $17.30, the market shouldn't be surprised that the ENAV is considerably higher especially knowing that a heavily invested market such as Phoenix soared 20% last year. See the calculation from the earnings release below:
Table - Estimated NAV (ENAV)
The company provided a table in the earnings presentation from Corelogic listing the home price appreciation (HPA) in the markets it operates. With 60% of the properties located in Phoenix, Tampa, and Atlanta, the company should be inline for some strong rebounds in prices. Those markets had an average decline of 45% during the crash.
Until investors see houses sold at sizeable profits in line with the numbers being presented by Silver Bay and Corelogic, it might be difficult for the stock price to achieve valuations on par with the ENAV. After all, no verification exists that it has obtained these market gains due to purchasing properties at attractive values.
So while the company covers the recent trends, it doesn't cover the future potential of housing prices. Will the housing market return to a more normal inflation based gain? The Market Oracle has a good chart shown below listing the returns and price momentum since 1987 based on the Case Shiller index.
While this a national average that only partially impacts Silver Bay and the markets it invests, it does provide a great summary of the overall housing market. House prices are now equivalent to the levels at the start of 2004 or nearly 10 years ago. Not shown here is the chart showing the expectations of analyst Nadeem Walayat that US house prices will rise 30% from the start of 2013 to 2016 or some 22% from the current level. This is a good sign for Silver Bay and this sector.
Lackluster Q2 Results
So while the company appears to be doing well with appreciating real estate assets, the ability to generate operating income and cash flows for investors is yet to be proven out. This is the part of the equation that scares investors regarding the ability to scale assets that generally are unique in nature to the individual market and property.
Unfortunately though, the financials have been focused on these operating results that aren't surprisingly negative as the portfolio of single-family properties takes time to stabilize and lease. Not to mention, the relatively young age of the concept of a large-scale investors in single-family properties could take time to reach full-scale efficiencies and best practice operations. Regardless, the company is making good progress in approving occupancy rates.
The highlights of the Q2 results are as follows:
- Total revenue increased 40% quarter-over-quarter to $10.7 million driven primarily by a significant increase in the number of properties leased during the quarter
- Achieved record leasing pace, increasing the number of leased properties by 1,197 or 50% quarter-over-quarter
- Reported, as a new metric, estimated net asset value of $18.95 per fully diluted share
- Occupancy for stabilized properties increased two percentage points to 94% from 92% quarter-over-quarter
- Occupancy for properties owned six months or longer increased six percentage points to 87% from 81% quarter-over-quarter
- Net operating income, reported as a new metric, increased 79% quarter-over-quarter to $3.1 million
- Owned portfolio of 5,571 single-family properties, of which 3,610 properties were leased, resulting in aggregate portfolio occupancy of 65% as of June 30, 2013.
The good news is the increase in occupancy rates both on a stabilized level and six months owned level. Some investors probably have concerns with how the company classifies a house as stabilized, but the six months is a pure number that can't be tinkered to fit the purposes of the ratio. The company ended the quarter with 2,000 properties not leased yet so naturally it greatly impacts net income with that many properties accruing expenses without any income.
Improving Operating Income
Along with ENAV, Silver Bay provided the net operating income metric. While a good metric to judge the efficiency of operating the homes, it still excludes the management and administrative fees. It also removes the interest expense that will become an increasingly important cost as the new $200 million credit facility is fully utilized and further debt is added. The metric does exclude the depreciation and amortization costs that are a necessary accounting charge, but not reflective of the realities in the single-family real estate market.
A good sign is that NOI jumped to over $3 million in Q2 sequentially from $1.7 million in Q1. As the table below shows though, it doesn't cover the required fees and interest costs that will only increase going forward. Efficiency is being gained so progress is being made, but clearly not fast enough for REIT investors that want a sizeable dividend payment.
Table - NOI
Moving Towards Renovations and Leasing
From a standpoint of getting towards a more mature portfolio, the company leased more properties than it bought during the quarter. The 1,197 properties leased far exceeded the 985 properties bought during Q2. Hence, the occupancy rate for the entire portfolio jumped to 65% from 53% in the prior quarter. Another quarter or two of allowing the leases to catch up with the portfolio will provide investors a better insight of the ability to generate cash flow from the operations.
Management made another point about slowing down property acquisitions during June and into Q3 in order to prevent a large amount of houses from coming onto the market during the seasonally weak leasing months of November, December, and January.
As the slide below shows, this quarter was the first to see leases and renovations exceed acquisitions.
While still too early to make much of any analysis in comparing Silver Bay to the two new IPOs, a couple of interesting points can be made.
American Residential has a similar focus on Phoenix as the top market, but it quickly moves into Houston, Dallas and other Middle America metro areas that had a smaller impact from the real estate crash. In fact, the purchases during July were squarely focused primarily on Texas and secondarily on North Carolina. The general house appears to be younger with the typical market having an average age of around 10 years versus around 30 years for Silver Bay.
The company is slightly smaller with only 4,089 single-family properties as of the end of June, but it is growing faster with 1,558 acquired during Q2. The six-month occupancy rate is similar at 88% versus the 87% for Silver Bay. With younger properties on the menus, the company isn't slowing down during Q3 since it doesn't need the four to six months to renovate these properties.
American Homes 4 Rent is taking the complete opposite view of Silver Bay by focusing on the Texas, Chicago and Indianapolis markets instead of the beaten down hot metros of the financial crisis. Now Phoenix and Atlanta do make the top six markets in properties owned, but the company has limited focus on the most beaten down metros. American Homes is a giant in the industry with around 19,000 homes placing it only second to Blackstone (NYSE:BX). Interestingly, it is also making a greater push towards renovations and leases, as the June totals were virtually equal. So far, the peak purchases of 1,931 properties occurred in April with June dropping down to 1,872. Now that total vastly dwarfed the 436 last June so it's a good sign that the company will turn more to operations than pure growth.
Investors concerned about the sudden surge in private equity and now public firm investments in the sector as potentially excessive need to realize the scope of the single-family rental market. REIT expert Brad Thomas recently reviewed the American Homes 4 Rent IPO and provided vast details on the rental market size for investors wanting more details on that subject. The most interesting point is that the combined property purchase values by Blackstone and the three public companies amount to roughly $10 billion in a market worth $17.7 trillion. If anything, these companies have only scratched the surface of a multi-trillion dollar industry begging for a consolidator that lends a brand name to renters.
Insiders Loading Up
On top of the company authorizing a 2.5 million share buyback on July 1, several insiders are buying the stock. The biggest purchase came from Director Irvin Kessler. He purchased 41,500 shares in August to bring his total ownership up to 2,210,295 shares.
While the preference would be for the company to buy as many properties at reduced rates as possible, the best investment as this point in mid-August might be the stock as it trades considerably below a ENAV that might exceed $19 now. At $15.50, the stock trades at an 18% discount to the estimated NAV that could be even higher. The guess is that management would have a difficult time buying properties trading at similar discounts these days.
The chart had been very ugly since going public back in December, but the recent price action suggests a bottom might have formed in the last week. See the chart below:
Investors will be keen to watch the operational results of these stocks in the coming quarters, but anybody interested in Silver Bay ought to focus more on the HPA data. With a focus on the 'hot' markets that crashed, the company hopes to generate gains from capital appreciation as much as operations. The improved operations could be a bonus especially if the company is able to prove all the doubters wrong that the single-family model can be efficiently scaled to generate cash flow.
For investors comfortable with the valuation model created by the company and expecting general housing price appreciation, Silver Bay might finally be a good bargain. The stock wasn't attractive around the IPO, because the results were going to undoubtedly be ugly with the company going through the formative process. Now investors are able to buy it significantly below ENAV though investors might be difficult to find until profits are generated allowing for sizeable dividends. Long-term investors should start nibbling on the stock with plenty of capital on the side to buy if the stock falls even further. The stock is a huge bargain now, but REIT investors only care if it pays dividends that won't likely occur until 2014.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.