Will Banks Kill The Golden Goose?

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

As if rising interest rates weren't enough of a headwind for home sales, banks are increasingly foreclosing on delinquent mortgages. If enough of this shadow inventory hits the market, prices could fall. That would be bad for the banks, but good for the new single family home real estate investment trusts (REITs).

Improving Market

After the housing bust, mortgage lenders were in a tough spot. They had so many delinquent mortgages that the market couldn't handle the onslaught of sales that mass foreclosures would cause. So, they did nothing. That created a shadow inventory of homes living in a sort of limbo state.

Blackstone swooped in and bought thousands of homes from the banks, quickly building itself into the largest owner of single family homes in the United States, with around 30,000 properties. Other companies jumped in, too, though not on the same scale.

From a big picture perspective, however, institutions quickly bought up a lot of existing property. That cleared out much of the market's overhang. And, as the market stabilized, sales have begun to pick up. New construction, however, has been the big beneficiary since institutions cleared out the old stock.

Now That Things are Better

However, there are still a lot of homes living in limbo on bank balance sheets. Now that the housing market has picked up, banks have again increased their foreclosure activity. After months of declines, April's foreclosure rate moved higher. From the bankers' point of view, it makes sense to sell while the getting is good.

If too many banks do the same thing, however, they will flood the market with properties. That, in turn, will cause prices to stall or, worse, fall. Add in the fact that interest rates are heading higher, making buying a home more expensive, and the opportunistic move by the banks could turn out to be a second buying opportunity for the companies institutionalizing the single family home market.

The Giant

Blackstone is the clear giant in the space. However, the company isn't a pure play. It is a broadly diversified asset manager. It is good at what it does, however, so investors might find the stock of interest. Still, for those seeking direct exposure to single family homes, there are more focused options.

Home Owners

Silver Bay Realty Trust (NYSE: SBY) and American Residential Properties (NYSE: ARPI) both focus on owning single family homes. Neither has a long trading history, since the older of the two only came public late in 2012.

Silver Bay has a portfolio of around 3,500 homes across Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, and Texas. At the start of the year, the occupancy level of the portfolio was just 50%, which means there is plenty of upside for the rent roll as the company fixes up its existing portfolio.

That said, management continues to look for acquisitions in select markets. The recently announced dividend of $0.01 a share, little more than a token, suggests that growth is going to be the bigger focus in the near term.

American Residential Properties owns more than 2,500 homes in Arizona, California, Florida, Georgia, Illinois, Indiana, Nevada, North Carolina, South Carolina, and Texas, and manages over 600 properties for others.

At the end of the first quarter, its portfolio was 86% leased. That gives it a much more established business right now. However, it means that growth from within the portfolio won't be as meaningful, making acquisitions more important.

The company hasn't announced a dividend policy yet so it's hard to get a feel for management's long-term views. That said, additional acquisitions are a must if it plans to grow its business.

Taking on Some Debt

Altisource Residential (NYSE: RESI) buys “sub-performing and non-performing mortgages.” The REIT then forecloses on the homes and takes over the properties to build its portfolio. That is usually a long and complicated process. However, if banks start to depress prices, they might be more willing to let go of a few more mortgages. That would give Altisource a larger pool to select from.

Note, however, that when a home finally makes it through the foreclosure process, it usually needs material repairs before it can be rented out. At the end of the first quarter Altisource had just $434,000 worth of real estate owned and about $87.7 million in debt owned.

It could be a long and expensive process growing the real estate owned category. That said, this REIT probably has the highest, though most uncertain, growth prospects of the trio.

Another Chance

These REITs are in a new and completely untested category. That makes them fairly high risk. While Altisource is easily the riskiest option, it has the most to gain if banks kill the goose that laid the golden egg by flooding the housing market. Silver Bay, meanwhile, has the most potential for organic top line gains regardless of the housing market's direction.

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Reuben Brewer 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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