Two Harbors - Back To Business

| About: Two Harbors (TWO)
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Two Harbors Investment Corp (NYSE:TWO) altered their investment strategy in 2011 to include single family residences to its portfolio (I wrote about it here). The rationale was simple: single family housing is cheap and there is money to be made in the own to rent market. Other companies such as KKR (NYSE:KKR) and Blackstone (NYSE:BX) have also gotten into the own to rent business seeing the same compelling valuations that Two Harbors saw.

In the course of my article on Two Harbors getting into this market I stated:

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.

I fully expected that there would be single family REITs created to take advantage of the value in real estate. Today, that expectation has become a reality, due to none other than Two Harbors.

Two Harbors announced today that they would be combining their portfolio of single family residences with a portfolio owned by Provident Real Estate Advisors LLC and creating a new single family focused REIT. From the press release:

In exchange for its contribution, Two Harbors would receive shares of common stock of Silver Bay Realty Trust Corp. ("Silver Bay"), a newly organized Maryland corporation focused on the acquisition, renovation, leasing and management of single-family residential properties for rental income and long-term capital appreciation. Silver Bay will be externally managed by PRCM Real Estate Advisers LLC, which is a joint venture between an affiliate of Pine River Capital Management L.P. and Provident Real Estate Advisors LLC ("Provident"). An affiliate of Pine River also serves as the external manager of Two Harbors and provides acquisition and property management services with respect to Two Harbors' portfolio of single-family rental properties.

Subject to the approval of its board of directors and compliance with applicable securities laws, Two Harbors anticipates that it would distribute its shares of common stock in Silver Bay by means of a special dividend after the expiration of a 90-day lock-up period following the completion of Silver Bay's proposed IPO.

From the presentation on the proposed transaction, the rationale for the transaction is:

    • We believe our stockholders will benefit from the creation of a stand-alone, pure-play single-family residential property REIT.

    • We believe that the proposed transaction will enable the single-family rental strategy to achieve a greater level of scale, operational efficiencies and geographic diversification that can best be captured by a substantially larger portfolio.

    • Additionally, the transaction would allow Two Harbors' stockholders to maintain exposure to the new single-family property rental asset class.

From the Silver Bay registration statement we can glean the following:

Silver Bay Realty Trust Corp. is focused on the acquisition, renovation, leasing and management of single-family properties. We generate virtually all of our revenue by leasing our portfolio of single-family properties and, from this revenue, expect to pay the operating costs associated with our business and any distributions to our stockholders. Our principal objective is to generate attractive risk-adjusted returns for our stockholders over the long term, primarily through dividends and secondarily through capital appreciation. We seek to establish a reputation as a good landlord to our tenants and a good neighbor in the communities where we operate. We believe that we can achieve economies of scale and develop a valuable consumer brand and that we are well positioned to be a market-leading firm in the single-family rental industry.

The portfolio will initially consist of the single family residential portfolios of Two Harbors and Provident. The respective portfolios are comprised of the following:

  • Provident, acquired approximately 880 properties in Arizona, Florida, Georgia and Nevada. Provident acquired these properties through five private limited liability companies for which it serves as the managing member. Provident spent $92.4 million on the properties.
  • Two Harbors has purchased approximately 1,370 single-family properties at a total cost of approximately $150.0 million.

Give the cost of the portfolios, I would expect that Two Harbors will end up with approximately 60% of the newly formed Sliver Bay.

The Silver Bay portfolio will have housing exposure in Arizona, Florida, Georgia, Nevada, Phoenix, Tampa, Atlanta, Las Vegas, Tucson, Orlando and Northern and Southern California.

Bottom Line: The proposed contribution of Two Harbors' single family residential portfolio to the new Silver Bay REIT will accomplish three objectives:

  1. Allow Two Harbors to focus on its core business - mortgage investing,
  2. Give shareholders exposure to the single family residential sector, and finally (and importantly)
  3. Remove the lingering concern over the economics of a single family residential own to rent portfolio. In other words, a simpler, cleaner Two Harbors portfolio.

As a newer shareholder in Two Harbors [I wrote about my swap out of the iShares FTSE NAREIT Mortgage Plus Capped Index Fund (BATS:REM) here], I believe that this is the best approach to take for Two Harbors' residential portfolio as it removes the question on the economics of the portfolio and the potential management distraction that the single family portfolio could cause.

Disclosure: I am long TWO. 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: 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.