Unconventional Play on Rental Properties

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Source: ishane.

Numerous companies are attempting to take advantage of the previously weak housing prices and the surging demand for rental properties. So far, all of the models are unproven as the complexity of managing houses with individual characteristics at a corporate level faces many hurdles to reach an efficient scale. The traditional model has been to purchase distressed properties in housing markets hit by the financial crisis and turn the houses into rental properties.

Altisource Residential purchases distressed mortgage loan portfolios with a strategy to work with borrowers to modify and refinance loans to either keep them in their homes or convert the unmodified loans into renovated rental properties.

Instead of competing in one-off auctions, the traditional method of acquiring homes and the one preferred by Silver Bay Realty Trust  and American Homes 4 Rent , the company is obtaining non-performing loans in pools that include thousands of loans. The ultimate outcome of these different models is unknown, but the market has so far supported Altisource Residential.

Acquisition strategy
The company has a stated goal of acquiring loans that will lead to 5,000 rental properties in the first year. Back in the second-quarter earnings report, the company listed NPL acquisitions that will total approximately 4,100 loans representing $820 million in unpaid principal balance, or UPB, and $625 million in underlying property value. In most cases, the company is paying an amount that is less than the property values -- providing huge potential value assuming the property can be quickly turned into a productive asset.

The latest SEC filing noted the company agreed to acquire a portfolio of 2,966 mortgage loans with approximately $922 million of UPB and around $790 million of market value for a purchase price of only $537 million. In essence, the company paid an incredible 68% of the property values and only 58% of the UPB.

Lower costs
Altisource lists the current home acquisition costs at 17% lower than the typical REO deal due to a higher NPL discount rate and lowers costs like brokerage commissions and closing costs. If accurate, the company will be a huge winner in the rental property sector assuming it can rent the properties at attractive rates. Using those discounts, the company suggests its book value is $20.70, or $4.20 above the reported value of $16.50.

The one concern with this rental property acquisition method will be a lack of economies of scale as Altisource has home loans throughout the U.S., with every state in the lower 48 other than Wyoming listed as including a NPL.Will Altisource be able to manage rental properties in vastly different markets and locations compared to the other models, where the properties are lumped into a small group of markets providing expected economies of scale?

Unproven models
In the end, both models of acquiring rental homes are unproven. Altisource has done a better job of attracting investors, with the stock gaining since the December IPO. Silver Bay and others have struggled since the process to acquire and renovate rental properties has disappointed the investor community that expects immediate results.

Silver Bay is focusing on older homes in the beaten-down markets of Phoenix, Atlanta, and Tampa Bay. The company had 65% of the 5,571 acquired properties leased at the end of second quarter. A major hurdle to profits continues to be the average stabilization process taking up to six months to complete and lease the home.

American Homes has acquired 19,000 properties, but only 9,882 homes were leased by the end of the  second quarter. The company is more focused on younger houses in the more stable housing markets of Dallas, Ft. Worth, Indianapolis, and Houston. With only 55% of the owned homes leased, the long-term financials are difficult to model and will likely remain that way until possibly 2014.

Bottom line
Altisource provides an unconventional way for investors to invest in the domestic rental market. The theory, though, isn't proven, with the initial NPL purchase only occurring during February. Not to mention the original deals only accounted for $177 million of UPB, which doesn't come close to matching the amounts during the last couple of months.

Good signs exist that the process of obtaining rental homes upfront is preferred compared to obtaining the houses at auctions, but both methods are unproven, and investors need to keep a close eye. Still, all the stocks trade at or below apparent market values, providing investors a level of safety.

More recovery investment opportunities
With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


The article Unconventional Play on Rental Properties originally appeared on Fool.com.

Mark Holder is a Fool contributor and portfolio manager at Stone Fox Capital Advisors, LLC. He nor his firm have any positions 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.

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