October 20, 2013 - 6:34pm EST by
2013 2014
Price: 17.40 EPS $0.00 $0.00
Shares Out. (in M): 33 P/E 0.0x 0.0x
Market Cap (in $M): 578 P/FCF 0.0x 0.0x
Net Debt (in $M): -59 EBIT 0 0
TEV (in $M): 519 TEV/EBIT 0.0x 0.0x

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  • Single-tenant REIT
  • Potential Acquisition Target



I am recommending a long position in American Residential Properties, Inc. (ticker ARPI).  ARPI is operating in the nascent, but yet unproven, single-family rental REIT business. 


ARPI’s IPO was in May 2013 at $21.00 per share.  Prior to that, ARPI raised equity in two private offerings -- in May 2012 at $20.00 per share and December 2012 at $20.50 per share.  To state the obvious, ARPI’s limited public existence has not been particularly pretty so far – it would need to rise nearly 21% simply to return to the IPO price.


ARPI is internally managed, which means that as / if it scales its asset base, it should leverage its fixed G&A.  It has no sponsor or external manager with the incentive to dilutively issue equity and grow the asset base (read: fee stream) for its own benefit at the expense of shareholders.


Silver Bay (ticker SBY) is a single-family rental REIT that went public in December 2012 and is also trading below the issuance price.  However, SBY is externally managed, giving its sponsors / external manager an incentive to issue equity even at dilutive prices in order to both grow the manager’s fee stream and to partially “leverage” its excessive current G&A burden (thanks to that fee stream).  Nevertheless, SBY is trading at a smaller discount to IPO price than ARPI.


ARPI is trading at 94% of GAAP BV today and 97% of GAAP BV on a fully diluted basis (including vested and unvested RSUs, OP units, and LTIP units).  The fair market value of its portfolio has increased beyond historical cost as home prices have appreciated.  However, as increased competition bid up acquisition prices for distressed homes and pushed down acquisition yields, investor sentiment around the space has soured.


The “holy grail” of the opportunity for the publicly traded single-family REIT business model was supposed to be the ability to arbitrage the valuation difference in single family homes between publicly traded SF REIT shares (or OP units) and privately owned portfolios that mom and pops and smaller aggregators would be looking to monetize over time.  The public currency was supposed to trade at a premium, enabling the REIT to make accretive acquisitions with its public currency, while at the same time affording the seller the benefits of deferred taxation (by issuing OP units instead of shares to the seller) along with liquidity when desired (as OP units can be converted into common shares).  In theory, there is the possibility that with the passage of time ARPI’s stock price will increase to the point where such an arbitrage would be possible.  In that case, current shareholders should do fine as their shares appreciate.  Moreover, returns to shareholders over time significantly in excess of the underlying returns of the business would be possible given the accretive nature of the acquisitions (similar to Realty Income over the years, as just a single example among many) and vast existing asset base of small private owners of single family rental homes.


While this is possible, it is far from obvious today that it will happen given how week the SF REIT sector has traded thus far in its public life.  What I think makes ARPI interesting and potentially asymmetric is its combined internal management structure and currently subscale platform.  Because of this, I think ARPI has a reasonable likelihood of itself being acquired instead of being the acquirer. 


Over time, it would make sense for a publicly traded scale player or two to trade at a better valuation than ARPI given better cost leverage and greater trading liquidity.  ARPI could thus be an accretive portfolio acquisition for such a player.


Even if another publicly traded scale player trading at a better valuation never materializes, I believe that ARPI could become an acquisition target for a private scale player (such as Blackstone’s Invitation Homes, or Colony’s Colony American Homes).   Blackstone in particular remains extremely bullish on the single family rental opportunity.  Just read Steve Schwarzman’s and Tony James’ comments in the transcript of Blackstone’s Q3 earnings call last week.  Or Jon Gray (Blackstone’s Real Esate head) commenting at a BAML conference on Sept 12 to the effect that: they’re still buying homes 40-45% below peak values and ~30% below replacement cost; land developers need new home prices to increase for development to make sense, which first will require existing home prices to increase; new home prices today average ~36% above existing home prices vs ~13% long term average premium; their homes that have been renovated for 60 days are 96% occupied; they believe the public markets will feel better about the asset class after the platforms have been stabilized and reached scale.  If it would be cheaper to buy ARPI’s cash flowing portfolio in place than to replicate it piecemeal, I think we could see this happen. 


One of the biggest unknowns in the single family rental business model in my mind is to what extent rents will grow over time.  There is a lot of skepticism around this point, especially of late as large portfolios go from distressed acquisition and rehab (not leased) to lease up in short order.  Over time, strong arguments can be made for an institutionalized and professionalized cohort of the single family rental asset class to enjoy higher rents than its mom and pop competition.


However, to the extent that never materializes, there is another option.  As we all saw not even a decade ago, home prices escalated far above levels justified by rents.  Throughout history and across countries and geographies, home prices have often reached irrationally exuberant levels.  The beauty of the single family rental asset class in contrast to the rest of commercial real estate is that not only are there “cap rate driven” investor buyers, but there are also end user homeowner buyers and speculators (subject to animal spirits) who can bid prices up to levels far in excess of what traditional commercial real estate buyers would be willing to pay for.  And single family homes are an extremely liquid asset class relative to more traditional commercial real estate, with millions of individual transactions annually.


So if rent growth doesn’t materialize the way that it should, homes can simply be liquidated into the for-sale home market piecemeal to maximize value.  While there are some complications with liquidating the business in a REIT structure (though none which the SF REIT management teams believe cannot be structured around), such an exit strategy in future years would presumably be even easier for a non-REIT scale buyer like Blackstone.  While it remains unclear if Invitation Homes plans to ultimately stay in the rental business over time, sell their portfolio in bulk in the future, or liquidate the portfolio in future years into the for-sale home market piecemeal, ARPI’s portfolio could certainly make sense for such a private player to acquire in the interim while home prices remain far below those exuberant levels.


In the interim, while ARPI languishes below BV and should not be issuing equity at such prices to grow, the silver lining is that the company can now let the portfolio season, focus on optimizing rental rate growth, and prove out the business model and cash flows.  In the short term, ARPI will continue acquiring for a time as it draws down its revolver and potentially issues term or securitization debt.  But it will have to limit its leverage levels under the current equity REIT structure and under its current debt covenants.  So soon enough, the acquisitions should stop if the stock price doesn’t jump.  I would also think that as acquisitions slow/stop and the portfolio seasons, the improved rental rates and cash flows could provide greater comfort / visibility to shareholders and lead to a higher valuation.


Assuming no more growth, I believe a stabilized portfolio at ARPI could look something like this.


Simple Stabilization Model - No More Growth    
Core Equity                   595             595
Debt                  486.6          594.7
  Book Capital             1,081.3       1,189.4
    Assumed Debt % of Total Book Cap 45.0% 50.0%
Core Rental Biz          
Core rental assets % of Total     77.0% 77.0%
  Core Rental Assets              832.6          915.8
Gross Rental Yield     9.5% 9.8%
  Implied Gross Rents                79.1            89.8
Stabilized NOI Margin     62.0% 64.5%
  Implied Core NOI                49.0            57.9
    Implied Cap at Book Capital   5.9% 6.3%
Preferred Operator Biz        
Preferred Operator assets % of Total   15.0% 15.0%
  Preferred Operator assets              162.2          178.4
Net Rental Yield (Triple Net)     7.7% 7.7%
  Implied Net Rents / NOI                12.5            13.7
Private Mortgage Biz        
Private Mortgage Loans assets % of Total   8.0% 8.0%
  Private Mortgage Loans assets              86.5            95.2
Gross Yield on Loans     12.0% 12.0%
  Implied Interest Income                10.4            11.4
Summary / Corporate        
Core Rental Biz NOI                49.0            57.9
Plus: Preferred Ooperator Biz NOI              12.5            13.7
Plus: Private Mortgage Biz Interest Income            10.4            11.4
Less: G&A                 (12.0)           (12.0)
Less: Interest Expense               (17.0)           (22.3)
  Implied FFO                  42.9            48.7
FD Shares                  33.2            33.2
  Implied FFO / Sh     $1.29 $1.47
Capex Reserve % of Gross Rents   6.0% 5.5%
  Capex Reserve                    4.7              4.9
Implied AFFO                  38.1            43.8
FD Shares                  33.2            33.2
  Implied AFFO / Sh     $1.15 $1.32
    Implied Px / AFFO     15.1x 13.2x
AFFO Valuation          
Assumed Multiple of AFFO     18.0x 18.0x
  Implied Stock Price     $20.67 $23.75
Current Share Price     $17.40 $17.40
  Implied Upside before Dividends   18.8% 36.5%
Cap Rate Valuation        
Stabilized NOI                  61.5            71.6
Assumed Cap Rate     5.75% 5.75%
  Implied Asset Value           1,070.0       1,245.7
Plus: Private Mortgage Loan Assets              86.5            95.2
Less: Debt               (486.6)         (594.7)
  Implied Equity Value at Market            670.0          746.1
FD Shares                  33.2            33.2
  Implied Share Price     $20.18 $22.47
    Implied Upside before divvy   16.0% 29.2%
Dividend Valuation        
AFFO / Share       $1.15 $1.32
Assumed AFFO Payout Ratio     95.0% 100.0%
  Implied Dividend / Share     $1.09 $1.32
Assumed Dividend Yield     5.5% 5.0%
  Implied Share Price     $19.84 $26.39
Current Share Price     $17.40 $17.40
  Implied Upside before Dividends   14.0% 51.7%


Given ARPI’s current valuation at a discount to replacement cost, its size (large enough to matter but not too big to be acquired by a larger scale player), I think that the ultimate downside from today’s stock price is limited.  The greater risk, in my mind, is that ARPI turns out to be a value trap – if the stock stagnates while no buyers come along.


One other potential outcome, to the extent that the public market valuation continues to disappoint, might be for ARPI to change its business model over time to something more akin to a mortgage REIT, with potentially much higher leverage levels than traditional equity REITs, but with double digit leveraged dividend yields.  While the financing markets are not there today, I suspect that that will become a possibility in the coming years as the debt markets, rating agencies, etc get more comfortable with single family rental assets and their cash flows, and as the securitization market for them develops.  Moreover, the President and COO of ARPI was a Salomon Brothers mortgage banker decades ago.


One could potentially structure the trade as long ARPI, short SBY – given SBY’s sponsors have the incentive to issue equity at a discount to BV; worse assets; dramatically worse cost structure due to external management and heavy load of fees; and SBY’s lower likelihood of being acquired.  That said, given my view of limited downside for ARPI and of the main risk being stagnation / value trap, I think it makes more sense to simply own ARPI outright and not tie up additional capital by shorting SBY.



Portfolio seasons and public markets get more comfortable with business model, driving up valuation and enabling accretive acquisitions.


Valuation stagnates and ARPI gets bought by a scale player.

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.


Portfolio seasons and public markets get more comfortable with business model, driving up valuation and enabling accretive acquisitions.


Valuation stagnates and ARPI gets bought by a scale player.

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