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
These are all really good questions. I work at an REPE shop so I have somewhat of a vested interest in how this play turns out. In my mind however the real issue is, what's the exit strategy? If you entered this trade over a year ago and are betting on home price appreciation, depending on the market you can make a strong return (in Atlanta, Phoenix, and Vegas home prices are up 18-20 percent year over year). The problem is when they're underwriting a certain amount of home price appreciation and then they go to exit the trade and thousands of units come on the market, prices will crater. The exit is the real key.
ReplyDeleteIn terms of economies of scale I think it's more you can hire experienced property managers and you can reduce your costs that way. I do think you're right though that it's not really a scalable industry.
Agreed - the exit, especially with this herding behavior, may be difficult. That 18-20 pct may be harder to obtain given the negative carrying costs of maintenance. Renting should more than offset to make this positive carry, but these late entrants can't seem to be make it work yet
ReplyDeleteThat's just with the home price appreciation which clearly won't last. Assume another 8-10% yield on rent (obviously adjusted for vacancy allowance) and if you got in early it looks like it could be a home run.
ReplyDeleteThe carry costs are significant, Jon Gray was on CNBC yesterday saying they put up to 10% of the purchase price into renovations.