The Grey Lady Voices Some Skepticism About IPO of Single Family Rental Player Silver Lake

This site refrains from talking about individual stocks, since we don’t give investment advice. However, a potential sea-change is underway, as a large portion of the inventory of foreclosed homes is being converted to rentals. Private equity firms are pursuing this opportunity eagerly, as the combination of low financing costs and tight rental markets in the US means that, at least on paper, investor believe they can earn attractive income, with potential for appreciation, either by eventually selling the houses to individuals or by taking the company public.

Given all the excitement over this conversion (it was voted the best opportunity over the next 12 months at a real estate conference I attended in the fall), it was interesting to detect a fair bit in the way of reservations in an article in the New York Times on the first IPO in this space, Silver Lake. Once it completes an acquisition, this REIT will own a bit over 3000 homes and plans to focus on Arizona, California, Florida, Georgia, North Carolina and Nevada.

I’ll confess to not having read the S-1 (I expect I will when I get caught up). I don’t consider this to be much of a loss since these homes were all acquired too recently to have reached stabilized yields, which is a function of not just rental levels relative to acquisition costs, but fix up and maintenance, normal turnover, and delinquencies/evictions. Historical financial data is not going to be a predictor of the future. What I find more interesting is how the Times piece, which hews to the journalistic convention of telling both sides of the story, winds up being less than convincing about Silver Bay and features more informed criticism than you’d expect for a piece of this sort.

Some of this admittedly relates to Silver Bay. It’s chief is the 35 or 36 year old David Miller, former Goldman investment banker, then as the Chief Investment Officer of the TARP. Given Neil Barofsky’s pointed criticism of Treasury’s lack of interest in fraud, and Elizabeth’s Warren’s finding that the TARP was buying back warrants too cheaply (which led Treasury to pay more after this unflattering finding), it’s hardly clear that he did as great a job there as his glowing press clips suggest (unless you consider his job to be serving Timothy Geithner in his capacity as bailouter in chief). And it’s not at all clear how doing “special situations” and valuing mortgage securities qualifies someone to run an operating business (my general experience with bankers is they think the ability to oversee a small number of highly paid and motivated lawyers, associates, and secretaries means they know how to manage complex operations).

One of the longer-established players stressed the need for hands-on management and local expertise:

Colony, for example, recently sent 50 people to bid on foreclosed properties at auctions in eight counties in the Atlanta area to ensure that the homes were carefully assessed, recalls Justin Chang, acting chief executive of Colony American Homes, a division of Colony Capital. “You can’t sit in your office underwriting on your computer — you can’t dial it in,” he says. “You need local men and women who really know those markets.”

This is the premise:

Industry experts say the potential profits are enormous. They compare the current home market to the commercial real estate market after the savings and loan bust of the late 1980s and early 1990s. Back then, early investors realized double-digit — and in some cases triple-digit — returns. Still, some question how long — and how far — these big investors can ride the market this time.

The big difference is that the S&L crisis led the FDIC to wind up with an enormous portfolio in its hands which it proceeded to liquidate in bulk sales. The earliest sales produced tremendous profits, partly due to the lack of price parameters, partly due to the fact that the Resolution Trust Corporation knew it had to allow the initial deals to be steals to entice buyers into the pool. By contrast, the Fannie/Freddie bulk sales program has been slow to launch and has become unnecessary; PE investors are so eager than servicers are selling homes individually. Local investors are even assembling small portfolios of homes that meet PE buying criteria and are flipping them. Some even think the market is sufficiently bid up that the remaining opportunity is short-lived in investment terms:

Some real estate experts question Silver Bay’s long-term prospects. And they wonder if the moment to plow into the housing market has already passed. The hedge fund manager Och-Ziff Capital, for example, is already starting to sell the single-family homes it bought since the recession began.

“This will be a workable business as a REIT for at least three to five years,” says Jay Leupp, a managing director at Lazard Asset Management. If the economy perks up and renters start buying, he said, “it may make more sense to liquidate the portfolio and transition into another business or simply return the cash to shareholders.”

Not mentioned in the article was that the use of a REIT may prove problematic; virtually all of the PE firms and other investors pursuing rental strategies who spoke at the conference mentioned earlier were cool on it; they thought a straight-up operating company IPO was preferable. The attraction of a REIT is that dividends paid to investors are tax deductible, but REITs must dividend 90% of their taxable income. For other REITs, this has not infrequently led to scrimping on capital investment and improvements.

And this is before we get to what most observers consider to be the fly in the ointment: single family homes have never been managed by large-scale, absentee landlords before. The PE mavens claim to have this solved, that they’ll concentrate their buying in a small number of locations, that they’ve hired reputable contractors for maintenance and emergencies, and (at least some) say they do careful, in person assessment of prospective tenants. They also contend that technology will help them lower the cost of managing (I’ve never heard this explained in any detail, BTW).

My own big doubt revolves around pricing power. The reason the rental market is so tight is precisely because the homeowners have left their properties much faster than the homes have been sold to new buyers and fitted up for rental. The high rentals are directly related to scarcity. As more PE firms put rentals onto the market, it has to alleviate the supply. At a minimum it will increase the time a home sits vacant before it is leased up again; it has the potential to lower rents from their current levels.

I’m not saying there won’t be a lot of money made. But I suspect just as the best play in the gold rush was supplying the prosepctors, here it is the various intermediaries who will clearly do fine. Focused, disciplined investors likely will as well, but at this stage, you can’t readily tell the poseurs from the real deal. And institutional investors (at least the ones I met) were skeptical of the promoters’ claims. For instance, most of the projections they’ve seen assume 5% annual rent increases. That simply does not map onto an economy where labor has no bargaining power and 2/3 of the jobs being created are low wage.

The Silver Lake IPO could still be a good short term play. It has the potential to trade at a premium to whatever one thinks its fundamental value is by being the only pure play in a hot new space. Personally, I’d rather play the ponies.

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  1. Julia Versau

    First the banksters crash the housing market, and kick out the homeowners. Now they buy up the housing stock on the cheap so they can rent the homes back to us … “at 5% annual rent increases” (or so they hope). Does anyone else see what’s going on here? My despair grows by the day.

    1. John B. Egan

      Julia has hit the nail on the head. I’ve been saying for about a year now. The whole foreclosure mess is a dirty business which in essence transfers individual family wealth to the big players. While our tax dollars were shifted to provide bonuses to bankers, they’ve been kicking families into the streets. People lost everything they worked their lives for and now they get to rent their own homes back from teh banks? In Sacramento, a once $250,000 private with a 7% loan on it can be bought now for $75,000 with a 3% loan on it. Unfortunately, people don;t qualify for the loans, but property flippers and landlords do. So you can now rent your home back for $1500 per month (your original payment) while the landlord pays $500 per month total and pockets the other $1000 profit each month…And gets depreciation to offset his income…Sweet!

  2. Wallyz

    I was in this market working for a contractor, managing subs and scheduling jobs both for bank REO sales and bulk buyer rental ready services. It’s a ridiculous mess, with arbitrary pricing from the banks and Buying groups that end up driving legitimate contractors out of the market, leaving people who do shoddy work and never bring major issues to the attention of the owners. This will eventually degrade much of this housing stock, the large chunk of which is crappy leftovers from both the building boom and older stock that was neglected while owned by people underwater, and while in foreclosure. The back end losses on all these houses will be ridiculously bad.

    Also, many local authorities will crack down on rental stock in nicer parts of town in terms of code compliance, and many places where I am, (Western WA) , the high end suburbs are working to make it harder for companies to have multiple rentals withint their jurisdiction.

  3. Myshkin

    Oddly I just read the story in the NYT before checking in at NC. What struck me about the article, other than an urge to review Two Harbors’chart over the last five years and it’s dividends, was that lurking behind the Times’ assesment of the business soundness of Silver Lake and Two Harbors was the innuendo of an insalubrious nature to Mr. Miller and his little business.

    In fact the opening paragraph sights Miller’s talk at Columbia while he was the chief investment officer at TARP, in which he says, “History has demonstrated that the financial system over all — not every piece of it, but over all — is a force for good, even if it goes off track from time to time. As we’ve experienced, sometimes this system breaks down.” And in the next paragraph the Times reports that, “But, it turns out, sometimes when the system breaks down, there is money to be made.”

    That and the revolving door illustration accompanying the article are a none too subtle comment that something stinks on Wall Street and Treasury. Of course this is not news to anybody reading NC but a little surprising to see the hint of distaste laced through an article in the business section of the Times.

    What’s being described is the next act in turning the entire country into the kind of country the kleptocrats have been pining for, much resembling a company town where the populous works low wage jobs in the mines all day and at the end of the month after the rent comes out of their paycheck and the interest on the credit card and grocery bills applied against their earnings, they sink ever deeper in debt to the company.

    The article goes on to talk about how hard Mr. Miller worked at TARP, taking late calls from lawyers and drinking coffee at the Treasury cafeteria but also says, “Mr. Miller helped oversee the federal bailouts of banks whose risky mortgage businesses helped send the economy and housing market into a tailspin. Now, as Silver Bay’s chief executive, he is trying to pick up family homes on the cheap.”

    1. psychohistorian

      I suspect we can rest assured that Mr Miller will never get caught in a loss. He will have fobbed it off on some unsuspecting fool before the bottom drops out.

  4. shirley

    they tried this crap in the 90s it failed then it will fail now – they forget the labour and costs required to upkeep rentals – this eats up most of your retun unless you do it your self- then there is thr manegment team costs- HEY if you can sell it to joe sixpack and take every thing in fees and wages it beats having to get a job, untill it goes broke.

    1. Mike G

      The way most corporations work, I foresee these being terrible places to rent — neglect of maintenance, routinely ignoring tenant issues, never being able to even contact someone due to skeleton staffing, etc. in an effort to “hit the numbers” that were unrealistic to start with.

      The landlord-tenant relationship can be difficult even when dealing with an individual landlord. Imagine trying to get a response from a corporate bureaucracy. Think health insurance bureaucracy, or trying to get someone in a call center in India to send a plumber when his bonus depends on “keeping costs down” by ignoring your request.

  5. Aaron

    Another Goldman alum doing “God’s work”. I suppose Miller has himself convinced that he needs to be an integral part of that “force for good”, looking out for his fellow man and such.

  6. John

    The article in the NYT ( 12/9/12) Business section missed out another key player that was called in to assist with TARP.

    It was Ken Wilson who is co chairman at the Blackstone Group. Mr. Wilson also left Goldman Sachs along with Mr. Miller to help out President Bush by invitation of Paulson.

    You will find that Blackstone Group has taken the homes of 6,500 foreclosed homes in this deal.

    Is this why Mr. Wilson accepted the pay of only $1.00 to help out the country.

    I am discussed.

  7. Happy Renter

    5% annual raises? Now, this all finally makes sense. Well,on paper. But, of course, that will never happen. Well, at first, maybe, for a few years, but, of course, if that’s the lifeblood of this whole scheme, along with fairly rapid capital appreciation, then somebody is going to very disappointed if they’re still holding these REITs in 2020.
    I’ve been renting most of my life, and, to beat my own drum, I hardly ever get rent increases for the basic reason that I am a no issue tenant who always pays on the first of the month. It’s that simple. Most landlords are terrified of the nightmare renter who starts a meth lab and suddenly stops the cash flow in it’s tracks. The margins are so thin, just one event could put them underwater for months to years.
    Then there’s that whole matter of a major component of the present and future rental market, the “retiring” Boomers, who have no money to speak of, and will have only their meager SS checks to pay rent with. Try getting 5% more annual blood out of that stone.

  8. diptherio

    “This site refrains from talking about individual stocks, since we don’t give investment advice.”–Yves

    Funny, I’d never even thought of looking here for gambling tips…

    ” Personally, I’d rather play the ponies.”–Yves

    My brother-in-law’s cousin’s roommate is a jockey and assures me that Safe As Houses is a sure bet to win in the ninth. The odds are a little long, but trust me on this one…it’s a sure thing…

    1. Yves Smith Post author

      With horses, at least it’s clear you’re gambling. Although there is a moral problem with the way horses in stakes races are often abused…able to race only by virtue of taking performing enhancing drug, too often being doped up to run even though injured, which leads to catastrophic breakdowns (the horse is killed as a result, and sometimes the jockey is killed or badly injured).

      But what is being done to workers in the name of corporate profits is criminal too….

    2. hidflect

      I was in a casino playing alongside a lady who had some involvement in horse racing. She had lost a LOT of money and we were both down to our last few hundred bucks. Well, we fell in together and bet our heads. Two shoes later we’d gotten it all back and she was so relieved, as she got up to go she gave me a parting gift. “Bet everything you have on XX horse in YY race tomorrow!” Predictably I was in the casino the next night and remembered her tip. I stuck $10 on it and won $270. I never bet on horses again.

  9. Jim A.

    I agree. Detatched single family homes just don’t SCALE, it costs almost 20 times as much to maintin 20 houses as it does one. Much of the bubble-induced oversupply is now vacant, and not on the market. As that is brought on line rents are likely to decline. That said for potential small time investor who is good with his hands (for maintenance) and a good judge of tenants, this probably IS a very good time to buy.

  10. Jim A.

    Look at it this way, If you have access to capital and you’re convinced that SFHs as rentals are a good investment, you can either buy a bunch of properties and manage them, OR you can lend the money to buy to small time landlords. If you don’t think that you can judge people’s ability and inclination to pay back loans, what makes you think that you’re going to do a good job of judging their inclination and ability to pay their rent? Because it doesn’t take many bad tenants who get in arrears on their rent and trash the proprty to destroy the thin profit margin in the landlord business. The upside to owning the properties yourself is future appreciation. And while I certainly think that in many markets this is a good time to secure a low cost for rental properties, I think that it’s likely to be more than a decade before we see real appreciation in RE.

  11. Esohbe

    I have been a landlord for over 25 years. I think it will be a good time to buy houses following the carnage brought on by a bunch of people staring at monitors. You can make any deal look good on a spread sheet, but these scenarios collapse when applied in the real world. Wait five years and buy the wreckage.

  12. Jim A.

    Another point. This whole thing still smacks of Wall Street “Deal-ism.” From the guy behind the whole thing to the attention being paid to structuring this as a REIT, it looks like waaaay too much attention is being paid to getting the money in the door and structuring a “deal” and way to little to how you would actually manage all this property. Because getting investment money and acquiring property relatively cheaply is the EASY part here. Actually managing 1,000s of individual properties, keeping them maintained and filled with paying tenants is the hard part, and all we’ve heard on that score sounds suspiciously like the sort of hand-waving “we’ll leverage the efficiencies of doing it online” that we heard from dozens of CEOs during the dot-com bubble.
    And as other here have said 5% annual increase in rent? When payrolls are running far less? With an oversupply of bubble-built housing? Anybody who expresses that much ignorance of the basics of supply and demand is not somebody who I’d give my money to.

    1. fledermaus

      Bingo. I currently rent and in the 7 years I’ve lived there rent has increased by maybe 8% total. I can say that 5% annual increases in rent will just drive the best (i.e. long-term, always pays on time) renters away. Who would put up with that for more than one or two years?

    2. Happy Renter

      “Because getting investment money and acquiring property relatively cheaply is the EASY part here. Actually managing 1,000s of individual properties, keeping them maintained and filled with paying tenants is the hard part”

      This is pretty much what Buffet has said. He’d love to get into this game, but, knows the obvious problems. So, he stands on the side, investing in suppliers and other related businesses, like the gold rush town pick axe salesman.

  13. rob

    this is just the logical step in what would be lumped in the term “asset stripping”. money is talking, and I bet the fools who propose things like this will make a ton of money in the first days after the IPO, just because the “fix is in” and the brokers and those who can, buy up the lots. and with their PR kin get greedy fools to take these overpriced messes off their hands,… and they can walk away with enough money for most people to live the rest of their lives.. to these people ,it is just until their next IPO swindle or salaried/bonus job where they can live in their echochambers where they ARE the masters of the universe…. but the reality of this situation, as it stands in 2012 in north carolina…is that these buffoons who live in NYC, where property accrues no matter what the economy, have no idea what they are doing.These things are real.
    I agree with wallyz…. from what I have noticed here lately is alot of out of town, no touch companies are vying to get contractors to work for nothing,half the going rates for stuff, which you can find when times are tight.. but reality sets in when time tells the truth as to what cheap work does to a real asset… it destroys it…houses get worse, when the people “looking after” them, are underpaid, overworked, not keeping up themselves… they will be defrauding these absentee landlords, they will be doing shoddy work, the tenents will get pissed, they will start treating the property as they feel they are being treated…the life of home finishes depends largely on the care of the occupant….and with a lot of rentals out there, they will destroy the house, and move on. the whole thing will be a mess…not to mention the legal terms of the eviction process.the renter has the benefit of time.they can stop paying rents and it takes months for a sherriff to get them out. by then the house will surely be a mess.
    now, if these wall st types were real businessmen, they would take care of the market,the tradesmen,the renters,and even not fight to reduce wages in a area,so people could afford the rentals,….and they would make money and have well preserved assets…but these people these days are really just vultures….they might as well sell the pipes for scrap and start meth labs of their own…

  14. Javagold

    If we are left no choice but to rent from these criminals I suggest everyone rents 2 houses. One to live in and one to destroy.

  15. Hypothetical_Taxpayer

    “Industry experts say the potential profits are enormous.”


    So houses are going to be somebody’s growth company again?

    They should do a remake of that old movie “The Money Pit”.

    Rents around here go up 2% a year (have been for many years), decent houses are selling at about 2003 levels (not that cheap if you want to ignore the bubble prices) and they are 10 years older, which is really not a good thing.

    Been eyeballing property taxes and I see jumps of 10%-15% this year on individual properties, and taxes didn’t go down when house prices did.

    We also have a mini boom in apartment construction going on nationwide per the building data. Even in my low rent state they just completed a new, sort of upscale, apartment building nearby, so the economics still must have looked favorable for new multifamily units.

  16. Susan the other

    A glossy prospectus, complete with REIT tax benefits, to entice private equity. So I sense a big push by the Fed, Treasury and the FHA? And what better way to pawn off this devastation than wiping clean the ambiguous titles at the same time? It is accomplishing several goals: 1. A deal to PE to help out the housing crisis and stabilize the market, 2. An obfuscation of the lost notes and trashed titles and illegal foreclosures all in one swoop, 3. Saving the TBTF’s own balance sheets, 3. Tax windfalls for everyone! somehow we don’t need to protect taxpayers from this, just from writing down principal, 4. Enough rent money to limp along without losses, 4. Flipping houses for a good profit as opportunity arises… After all the “renters” will be closely screened. And most of them will be set up to rent to own I bet.

    1. Hypothetical_Taxpayer

      I’m sure they won’t want to rent to anyone with a foreclosure or bankruptcy on their record.

  17. Brooklin Bridge

    5% increases? They are going to need a government mandate for more than just forcing us to purchase health insurance from profligate behemoths to get people to pay 5% increases every year on their rent in this economy. What are these people smoking? They need lobbyists to get the government to give them ownership of tax payer supplied debtor’s prisons that the renters and their kids are thrown into when, prostrate, they can no longer pay the mandated 5% increases each year. That way the owners can keep the juice flowing on the back end by taking any SS or gold fillings, or Timmy’s bicycle, etc.

    As to managing the properties, no way. Private contractors of any repute are absolutely crushed by the amount of code and regulations they have to comply with now-a-days and it is simply exploding (no doubt in an effort to eliminate the small contractor). Just keeping abreast of changes in state and local building codes can require full time resources.

    Also, many of those homes are ticking time bombs no matter how experienced the buyers; lead paint, asbestos, and all manner of hidden problems with mold, exposed pipes, hazardous electrical wiring such as knob and tube, and on and on and on. Add all sorts of other costs, particularly materials and living-wage labor, it’s outrageously expensive.

    With single family homes you are either a devoted land lord, a shake down slum lord or a devotee of get out quick. Otherwise: Profits = Poof!

    And that’s just contractors; getting and keeping good tenants is a science/art unto itself.

    There is no way, zero, that this can be a long term viable strategy for an investment firm.

    1. Brooklin Bridge

      Even if they focus only on new houses, they are going to be blind sighted by all sorts of hidden shoddy construction and resultant expensive issues they will have to deal with. Given the numbers necessary to make the investment work in the first place, construction lemons are a certainty and will drag profits down like a rock.

    2. tech98

      Having thoroughly looted and left ruin major sections of corporate America, the “Romneys” of vulture capitalism want to bring their heads-I-win-tails-you-lose asset stripping cronyism to the residential housing market.
      As always, a few insiders structuring the deals and extracting “management fees” will make out like bandits while leaving ruined deferred-maintenance housing and cheap-labor laid-off employees in their wake.
      This can only turn out well.

  18. PeonInChief

    In fact, these are probably good short-term investments. The strategy appears to be: buy housing at 40% off in neighborhoods with a lot of foreclosures, do a basic fix-up, rent to people who are willing to pay what appears to be about a 15% higher rent than surrounding properties (although I’m competent in only a couple of small markets, and only as a renter), get people to sign two-to-four year leases with a rent increase in each year or give the tenants an option to buy, and rent to people who may be somewhat credit-challenged and don’t have other options.

    The only real danger I can see is that an economic downturn could push some of the tenants into insolvency.

    1. Yves Smith Post author

      1. Leases are not two to four year, one is the norm, some landlords offer two years. But the claim is most tenants are there 2 years, less turnover than in multifamily.

      2. I heard of no one giving an option to buy (why would you give someone an option? an option has economic value, and this is currently a landlords’ market). I did hear of one landlord giving credits towards purchase for tenants who always paid on time and always passed monthly inspections of property condition. And those could be turned into actual cash (at a really big discount to purchase value) at the end of the tenancy.

  19. Brooklin Bridge

    Whew! All our problems are solved. Another neo liberal ready for the gate, and a new dynasty to boot. The glass from the ceiling will be the last remains of SS and Medicare as they are whittled away in prep for privatization…

    I wonder why they even still bother with elections. I guess it’s like hanging the stockings when the youngest has known about “Santa” for the last 20 years.

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