Silver Bay: another investment option to play the U.S. housing recovery

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At long last, it seems 2013 will be a year of unadulterated good news for the U.S. housing market, as the year just past displayed the "green shoots" of growth that had been so long in coming.

A way to invest in the trend? U.S. home builders, to be sure, but you won't be getting in on the ground floor: Eight home builder stocks doubled in 2012, and four more increased between 50 per cent and 100 per cent.

Alternately, here's an under-the-radar suggestion for a different way to play the recovery: Silver Bay Realty Trust, the first public REIT to own single-family residential properties.

The Minnesota company debuted quietly on the New York Stock Exchange in mid-December. It combines the portfolios of two private asset managers, one of which is Pine River Capital Management LP, which previously launched Two Harbors, a publicly traded mortgage REIT.

Silver Bay owns 3,100 homes in some of the most-troubled Sunbelt markets. Nearly two-thirds of the company's portfolio is in Arizona and Florida, with the rest in Atlanta, California, Las Vegas and its newest markets of Charlotte, N.C., and Dallas.

Since 2009, Silver Bay's predecessor companies have been scooping up homes through foreclosure and other distressed sales. It's what many investors, eyeing the scores of vacant properties in their hometowns, would have liked to do, but couldn't because of the lack of time or money.

Silver Bay's plan is to make money – and distribute it to shareholders – through rental income, not through quick sales flips of the properties. As Silver Bay notes in its prospectus, "the large-scale single-family residential rental industry is relatively new in the United States," as the country's housing crash turned plenty of previous homeowners into renters.

And yet it's also worth considering the potential for long-term appreciation in Silver Bay's homes. Silver Bay provided statistics on the 2,548 homes in its portfolio as of Sept. 30 (it bought another 500 or more in the fourth quarter, prior to its offering). The company paid $306.7-million (U.S.) for the houses, or just over $120,000 apiece.

What are you paying for them if you buy Silver Bay's shares? Pleasingly, the markup is modest.

The company's market capitalization is just under $700-million, and it's holding about $220-million in cash that it raised last month. That means its portfolio of homes is valued, by my estimation, at about $150,000 apiece — somewhere between 20 per cent to 25 per cent higher than Silver Bay's costs, depending on the assumptions you make about the prices of its recent home purchases. (The median U.S. home price was $180,000 in November.)

The company's price-to-book ratio is just above 1, also a pleasing number; its earnings ratios, however, are incalculable, because it's still losing buckets of money. Specifically, its pro forma results for the first nine months of 2012 show it taking in $8.2-million in revenue and spending $24.6-million, including $7.5-million in "advisory management fees."

A bad sign? Not really. Since it takes time to rehab and rent properties, fewer than half the homes Silver Bay owns (1,186) are rented. The occupancy rate for properties it's owned six months or more averages 91 per cent across all markets.

Silver Bay says its average monthly rent is $1,152 per property. With that, I did a little math: Even minus a 5 per cent property management fee that Silver Bay pays to an affiliated company, that rent represents a yield of nearly 11 per cent on the $120,000 average acquisition price, or 8.5 per cent on the $150,000 or so average value the market currently places on the portfolio. (This is not an earnings yield, as it doesn't include taxes or maintenance costs.)

The downside? There's not a lot of history for either this company or this concept. Plus, time is running out to make low-priced buys in the U.S. housing market. And as Americans' incomes and credit histories recover even as interest rates remain low, it's possible the market will shift away from rentals and back to ownership.

In which case, well, home prices should rise, and the value of Silver Bay's assets should grow. You probably didn't have the chance to buy U.S. real estate at the trough like Silver Bay's founding firms did. They're letting you get on board reasonably early, at a reasonable price, though.