How Does "Storage Wars" Beat "Million Dollar Listing"?

Bill is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

American Homes 4 Rent (NYSE: AMH) recently filed its IPO in the shadow of the lackluster stock performance of two smaller companies who paved the way in the single-family for rent REIT sector, Silver Bay Realty (NYSE: SBY), and American Residential Properties.   American Homes founder B. Wayne Hughes is respected for having successfully built Public Storage (NYSE: PSA) into the third largest REIT in the U.S., comprised of 2,200 storage facilities with a market cap of $27.75 billion. Founded in 1972, based on number of tenants, Public Storage is among the largest landlords in the world.  The self-storage properties, located in densely populated areas, generate some 94% of the company's sales.

American Homes had a lukewarm reception, as 44.1 million shares of AMH common stock were sold at only $16 per share, the low end of the $16 to $18 price range sought by the underwriters.  Initially American Homes had hoped to raise as much as $1.25 billion from its initial public offering, far more than the $770 million which investors were willing to pay.  There seem to be some nagging questions. 

Is this a proven business model?

It has yet to be proven that the single-family for rental business model can be operated profitably.  It is unclear if this is a scalable business model, and if so, what is the ideal size per market.  In other words, how big is big enough for a public company, and how large is too large to manage the portfolio cost effectively.  Market concentration is a boon for management, but it also represents risks for stockholders. 

Don't forget that as homes appreciate in value, the homeowner can be assessed for higher annual real estate taxes.  There is no guarantee that rents can be increased to offset the property tax increases.  This could erode the margins for operating single-family homes for rent.

Another unanswered question is how the market would value a stabilized portfolio of single-family rental homes compared to more traditional REIT asset classes.  In other words, will investors view them as riskier investments and require higher returns?  This could become a drag on future stock price appreciation.  Here are a few reasons why homes might be viewed as less attractive investments.

Renovation and repairs can impact earnings

While this can be an issue budgeted on the "front end," it still causes delays in leasing while racking up substantial added costs per home.  The largest single-family for rent owner, Blackstone Group with over 30,000 homes, estimates spending about 10% of the value of each home on renovations prior to leasing.  Another way this hurts is by taking an additional 90 to 180 days to be able to begin to market a home that needs repairs

The target market for the single-family home for rent business model is generally seen to be larger families with school aged children.  Typically landlords require a security deposit equal to one month's rental.  After a few years of having families as tenants, there certainly would be a need to refurbish on the "back end" as well. This will take both time and money. 

There will be costs involved prior to resale

You can figure on the replacement of carpeting, as well as:  leak repairs, repainting, expenses for sod and landscape, updating of finishes and appliances to compete in the "for sale market," and other miscellaneous repairs and replacements.  Each single-family home has its own roof, plumbing and HVAC systems.  Don't forget these are for the most part "one of a kind," not "cookie cutter" like apartments.  Also there is no rental income during the repairs, marketing, and escrow time frames.  Sellers typically pay some of the closing costs.  Sellers almost always pay the real estate commissions.   Do your own math. 

Show me the money

I have written previously regarding the losses that were racked up for the quarter ending March 31, 2013 by both Silver Bay and American Residential.  Silver Bay has recently reported results for the quarter ending June 30, 2013.  Silver Bay's Generally Accepted Account Principle (GAAP) losses per share increased quarter over quarter from ($0.16) per share to ($0.18) per share.  

This was attributed to "having many homes in the renovation and leasing stage."  Silver Bay now owns 5,571 homes, with "985 additional properties acquired in Q2."  Occupancy rate for the total portfolio has increased to 65%.  Profitable growth appears to be elusive when you start out with a portfolio that is around 50% vacant.  The average home size is 1,673 square feet, with an average acquisition cost of $129,000 per home.  Average rental is $1,148 per home.

Larger numbers but same basic story

American Homes 4 Rent came to the market with an occupancy rate of around 55%.  In other words, as of June 30, 2013 it has 8,000 vacant homes to renovate and lease -- out of a total portfolio of 17,949 homes.  The average home size is 1,979 square feet, with an average acquisition cost of $166,924.  The average monthly rental is $1,357.  These homes are spread across 41 markets located in 21 states.  In addition, American Homes has another 1,152 single-family homes under contract for purchase.  Similar to Silver Bay, American Home also operated at a loss prior to its public offering due to ramping up operations.

Why gamble when you can invest?

In contrast, Public Storage also reported earning for the quarter ending June 30, 2013.  Public Storage is hitting on all cylinders.  Occupancy rose to 94.9%, while rents increased 3.4% to an annualized $13.85 per square foot.  By way of comparison, this portfolio of "mini-garages" rent for higher dollars per square foot than the portfolio of either American Homes or Silver Bay homes -- which coincidently both rent out for an annualized $8.23 per square foot.  It is an "apples and oranges" comparison, but it is a bit of food for thought as well.

Public Storage beat Zacks Research consensus analyst estimates for revenue and funds from operations, FFO.   FFO is a common REIT metric obtained by adding non cash expenses such as depreciation and amortization back to net operating income.  This allows Public Storage to pay a $1.25 annual dividend, currently yielding 3.1%.   

Investor take away

Early investors in single-family REITs are going to be looking at several quarters of losses and an uncertain future.  I do not see a compelling reason to own shares in either American Home or Silver Bay in the near term.  Moving forward, I do think it is worth mentioning that the average age of the American Home portfolio is 11.1 years, compared to 25.8 years for Silver Bay.  Again, you can do your own math.

Public Storage appears to be a good investment now, and for the foreseeable future.  A recent article points out how among its peers, Public Storage is best positioned to benefit from the "New Industrial Revolution" a confluence of technologies led by 3D printing.  These disruptive technologies could become another earnings driver for Public Storage moving forward. 

Bill Stoller has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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