Stocks to Watch in Residential REITs: SilverBay Realty Trust

By Markets Fool.com

SilverBay Realty Trust was formed in 2012, and is a unique residential REIT for one reason: It was the first publicly traded REIT focused on single-family rental housing. While most residential REITs focus on apartment properties, SilverBay believes it has a tremendous competitive advantage in its chosen market for several reasons. And, while it's still too early to say whether SilverBay will be as successful as some of its apartment-focused peers, this is definitely one residential REIT to watch.

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SilverBay's strategy and competitive advantage
SilverBay's goal is to create an institutional presence in an asset class that really doesn't have one yet. In fact, the company estimates that just 2-3% of the single-family rental sector is composed of institutional investors.

The strategy is pretty straightforward: acquire properties at a substantial discount to their replacement cost, create value through light rehab and renovations as well as property appreciation, and then take advantage of growing rental demand to generate income.

SilverBay focuses on markets with strong economic indicators, such as areas where demand for rental housing is growing faster than supply, and markets where there are still a large number of distressed properties selling for significant discounts to their potential value.

SilverBay currently has more than 9,200 single family properties, all of which are located in its 14 "core" markets. Most of these markets have not recovered as much as the rest of the U.S. following the housing crisis, and SilverBay aims to take advantage of this to create value for its shareholders over time. For example, SIlverBay's two largest markets are Phoenix, Arizona and Atlanta, Georgia, whose home prices are still 29% and 31% below their precrisis peaks, respectively.

So far things are looking good
There is a limited history here since SilverBay is still so new, but the results are thus far promising. The REIT just produced its seventh consecutive quarter of revenue growth, NOI growth, and core FFO (funds from operations) growth. The portfolio has a stabilized occupancy rate of 96%, the highest level since the REIT was established.

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Source: SilverBay Q1 2015 Earnings

And while some of this growth can be attributed to acquisitions, a lot of it has to do with increases in the rent generated by existing properties. SilverBay achieved an average rental increase of 3.5% on leases that were renewed during the first quarter, and also had excellent resident retention with turnover below 30%.

Furthermore, SilverBay has done an excellent job of creating value for shareholders through property appreciation -- thanks to a combination of improving market fundamentals as well as strategic rehab and renovations to newly acquired properties.

SilverBay has an average cost basis of $140,000 in each of its properties, and the average market value is $159,000 -- a gain of 13.6% just from improving property values. In fact, over the past year alone, SilverBay's properties have appreciated by an average of 6%. Furthermore, the estimated replacement cost for each of SilverBay's properties is $207,000, which reflects the depressed nature of the company's core markets. In other words, SilverBay paid $67,000 less for each of its properties than they would have cost to build.

Source: SilverBay investor presentation

What could be improved?
As SilverBay grows and acquires more properties, the company's goal is to increase the efficiency of its operations by taking advantage of economies of scale.

One big area for potential improvement I see is that SilverBay's property management expense was equal to 10% of its revenue during the first quarter. This is not as efficient as I would expect from such a large REIT -- after all, I could buy an investment property and find a property manager who will charge me 10% of the rent, or even less.

If SilverBay could trim its property management expense to even say, 8% of revenue, it could make a tremendous difference. During the first quarter, this would have meant an increase of nearly 10% in core FFO.

This is just one example of how SilverBay could grow and evolve into a market-leading and efficient REIT. There is potential to improve efficiency in the way properties are maintained, bought, and sold as well, so we'll see how things progress over the coming years.

One to watch
So, while the concept of a single-family rental REIT is still a relatively new one, SilverBay seems to be off to a promising start. The company is growing at an impressive pace, both in terms of acquisitions and property values, and there is strong potential to deliver returns for shareholders if rental prices continue to rise and SilverBay maximizes the efficiency of its operations.

Plus, the economic and demographic fundamentals look quite favorable for rental properties. Job growth has been strong in SilverBay's core markets, and credit standards for buying a home remain historically tight, particularly in markets that haven't fully recovered from the crash. And homeownership is at its lowest level in decades, which in turn has produced a low rental vacancy rate.

Source: SilverBay Investor Presentation (Q4 2014)

And, for investors who may be jittery about the fact that SilverBay is still so new, bear in mind that it trades for a 23% discount to its net asset value (NAV) of $20.11 per share. While getting in on the ground floor of a new type of REIT isn't for everyone, SilverBay is definitely one to watch over the next few years.

The article Stocks to Watch in Residential REITs: SilverBay Realty Trust originally appeared on Fool.com.

Matthew Frankel owns shares of Silver Bay Realty Trust.. 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.