I originally got interested in single-family rentals with the spinoffs of Silver Bay Realty (SBY) and Altisource Residential (RESI) in the last half year or so. These companies buy single-family homes with the intention of renting them out. Given that mortgage rates (<5%) are less than rental yields (>5%), it is typically cheaper to own than rent. On face, these companies provide a compelling statement - they effectively arbitrage low mortgage rates with the fed with tight credit standards for mortgages and have an implicit put in stabilizing housing prices.
But how much does this translate to company profits? Rental yields are usually < 10% to begin with pre-leverage (RESI presentation, slide 13) and mortgage/upkeep are ongoing while renters may leave and so profits depend on 1) maintaining a steady stream of renters while 2) keeping costs low.
The first might not be so easy, given that nationwide supply has increased by over a third since 2005 (the housing peak). Early players have amassed large holdings, leading to downward rental yield pressures even as new entrants, such as SBY/RESI, try to capitalize on the new trend. The result? Silver Bay Realty, one of the larger (new) public companies, is so far unprofitable with a 81% occupancy rate even on homes owned for 6 months. 81% might not sound so bad, but then why is SBY unprofitable?
This leads to the second point - just how much economies of scale does one get from managing thousands of houses? Does owning two lawns mean you only have to mow one of them? There may be the usual pricing power that comes with size, but such services to have to be applied to each individual house in different locations etc. If these costs are actually too high, how does one monetize/exit gracefully or at least protect downside? How about an IPO/spinoff?
So, given an industry that has low barriers to entry (only need plentiful capital), revenue that is not consistent, and costs that do scale with size, how well can we expect the institutional herd/interest in such companies to do?
Disclosure: no position in SBY/RESI
(Icon source: http://emersonblognews.blogspot.com/2013/05/lawn-mower-injuries-often-c…)
That is a good point regarding the lack of economies of scale. I think that renting single family homes is a game where local entrepreneurs will untimely be the ones who are the most successful.
I would have to agree. I think that there is a definite tipping point.
Its also a huge capital appreciation play, which is the way some of these guys look at it e.g.blackstone. There's still a lot of room there in some markets.
This business depends entirely on mgmt. ARPI is at around 86% leased (higher than SBY). If you can get to 90% and get economies of scale, then there's no reason why this can't be an institutional level success. Key here is managing operations.
My concern, other than managing operations, is the future - are they going to be able to acquire at discounts to replacement costs and lower prices? And will rental yields grow with home price appreciation?
Industry has been around for ages though.
SBY is unprofitable because of large CAPEX... it is currently in a buying frenzy. Not that I am advocating it as a good investment, even if management executes well and they stablize all of their current properties.. that is already priced in so I think the current valuation is a bit rich + simply story based.
Do you mean they are not cash flow positive? Large Capex doesn't necessarily have anything to do with profitability. And large Capex isn't bad either... It all depends on if the projects will return > the hurdle rate. But I see your point if you think they won't surpass their hurdle rates because of real estate development over saturation.... They could end up destroying value.
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