American Residential Properties Represents a Rare Investment Opportunity (ARPI, SBY, AMH, BLK)

Single Family Home (SFH) REITs are still relatively new, with the first appearing on the scene in late 2012. For those investors not familiar with these securities, they are publicly traded companies with a business model of purchasing single family homes (hopefully at a discount to fair value), renovating them, and ultimately renting the properties. This has been a common and profitable model for small investors/landlords for a very long time but this has never has been done before with mass scale.

After the 2008/2009 housing crash a glut of pre-foreclosure and foreclosed homes were put on the market at deep discounts. Smaller investors began to purchase these homes, renovate them, and then rent out to those who no longer could afford or desired to actually own a home. This trend continued, and even accelerated from 2010 to 2012, with investor groups or small companies being formed to manage increasingly large portfolios of investment properties.

Finally at the tail end of 2012 the first publicly traded real estate investment trusts that solely own and rent single family homes were formed. Our firm believes these securities represent an interesting, efficient, and profitable way to invest in the US residential single family home market. Three of the most well-known SFH REITs are Silver Bay Realty Trust SBY, American Homes 4 Rent AMH, and American Residential Properties ARPI. Although Blackstone BLK is the largest SFH owner in the country, controlling more than $3B in homes as of mid 2013, it is not by any means a pure play in the area.

This article will focus on one of the pure SFH REITs, American Residential Properties (ARPI). Our firm has been invested in the company since last summer, has spoken to management, and is very familiar with the financial metrics and progress the company continues to make. We also feel out of all the pure play SFH REITs, ARPI represents the most compelling value.

ARPI became public in May 2013 at $21/share and within 2 months settled into a trading range of between $17.3/share and $18.3/share (where it trades to this day). Currently the company owns about 7,000 homes for a total cost of about $1B; located mainly in the southeast, southwest, and mid-western states. If you can purchase these shares somewhere within this range our firm thinks over time good returns will be had.
Our bullish thesis comprises three main areas:

• Market Discount to ‘True Book Value': All SFH REITs are required to write down the assets (rental homes) on their books for depreciation (rental homes are usually depreciated over 27 years). This helps as far as taxes are concerned, as it decreases taxable income but has no other effect on actual cash flow. What this means is, if you look at their financial reports or on any financial reporting websites their book value per share will show up at about $18.4 or so. In reality however, the true book value (or market value) of the homes they own is significantly higher than that figure. Although the company does not comment on this value directly; from the geographic distribution of their homes, home price increases in those areas over the past 1-2 years, and the timing of purchases, a fairly accurate estimate can be made. As a firm, we believe the true book value of ARPI is around $19.5/share -$19.9/share. From the current price of around $18.2/share this represents an immediate discount of 7.0%-7.5%. Whenever you can buy $1.00 for $0.93 (especially in this market) we believe you take that deal! ARPI's Chairmen and CEO, Steve Schmitz, commented on this as well in the latest earnings call saying “because we are in a new sector that the market does not understand our stock is trading far below the fair market value of the homes we own…There in ladies and gentlemen lies a tremendous investment opportunity.”

• Net Rental Yield and Growth: ARPI generates a net rental return on their homes (after all expenses are counted including renovations/capital expenditures) of around 5.5%-6.0% per year. This net rental yield plus 2%-3% rental rate growth per year and another 0.5% - 1% in cash generation from their SFH mortgage portfolio should be able to generate a total free cash flow (FCF) yield of around 8%-9% per year over the long term. Currently all FCF is being reinvested back into the business to purchase new homes and this will continue as long as discount homes can be found in good rental markets. This 8%-9% total FCF yield on an undervalued asset base is very compelling to us.

• Future Dividends: Although currently this is one of the few REITs that does not pay a dividend, we do think ARPI will commence a dividend payment sometime within the next 12 months. Most of the other SFH REITs already have begun paying small dividends (around 1% yields), but even that is quite low compared to the REIT index which pays around 3.7% currently. We think this lack of yield on the sector has prevented many REIT investors from purchasing the security, but this has created opportunity. With very high bottom and top line growth and the prospect of a growing dividend in the near future this could provide a nice catalyst for price appreciation.

Overall, our investment firm, Traphagen Financial Group (www.tfgllc.com) sees ARPI as a rare opportunity to own a rapidly growing and good free cash flow generating home rental company at a bargain price. In addition it also provides good diversification and lower correlations to the rest of a real estate portfolio.