How to get an 18% Yield from the Real Estate Recovery

By StreetAuthority | January 22, 2013 AAA

I am a huge proponent of discovering macroeconomic trends and drilling down to find actionable investment ideas.  After identifying a trend, my next step is to look for confirmation with the big-money players. Are hedge funds and other institutional money backing this trend with their bullish bets? I have found that when the big money confirms the start of a macro trend, then there is explosive profit potential if I follow along.

And one of the most powerful macro trends of 2013 is well underway.

Hedge funds have seized upon this trend to the point of it becoming a major story in the financial media. This trend is the confluence of the recovering housing market and the steady change from a society based on homeownership to a "rentership" society.

And this is not just theory. The numbers are proving this trend is already in progress. For example, research firm Zelman & Associates has reported a 67% increase in single-family home rentals in Florida, Arizona and Nevada between 2005 and 2011. This includes a corresponding homeownership rate decrease to about 50% in Nevada. While these numbers are extreme, they reflect what is happening across our nation to differing degrees. 

As the United States begins the shift into a "Renter Nation," home prices are rapidly rising in many regions of the country. San Francisco and Phoenix have seen home prices jump 22% from their lows, Las Vegas is up 11% and many cities in Florida has seen gains of 8% to 10% during the past several years. Overall, U.S. housing prices have climbed more than 5% since the bottom in October 2011. 

These rising prices, although fantastic for existing homeowners who were able to weather the financial crisis, act as a deterrent to aspiring homeowners as prices spiral out of their economic grasp. This is what's fuelling the changeover to a "Renter Nation." 

Carla Pasternak, Chief Strategist of High-Yield Investing, has been telling her readers for months now that the housing recovery is one of the "most dramatic turnarounds in U.S. history." And I am not the only one who wholeheartedly agrees with her.

The big money is jumping on board, too.

Hedge funds have been purchasing single-family homes in large block transactions and renting them out. Once the province of individual investors and small companies, large funds are now getting into the landlord business. In fact, my colleague Michael Vodka recently wrote about a little-known company that bought 16,000 homes.

Clearly, this trend is creating opportunities for investors of all sizes. And instead of investing directly into single-family homes, which can become a difficult and time-consuming task, investors should look into real estate investment trusts (REITs). These types of companies provide investors with a steady income stream from a diverse portfolio of properties they own and manage. So in effect, investors act like landlords, but with the advantage of not having to put large amounts of money or spend too much time on maintenance and administration.

Here are two REITs that are capitalizing on this trend.

1. Two Harbors Investments (NYSE: TWO)
This REIT owns agency and non-agency mortgage-backed securities, as well as a strong portfolio of single-family homes. The company boasts a market cap of nearly $3.6 billion, a price-to-earnings (P/E) ratio of 14 and an astounding dividend yield of close to 18%. Although a yield this high can be an ominous sign of a rough road to come, I don't think that's the case with Two Harbors. 

Cash flow has ramped up from -$11 million in 2009 to more than $150 million expected in 2013. With a cash flow this high, the dividend can be well supported. In addition, the quarterly dividend was just increased, further cementing the investment value. 

Along with the powerful yield, I really like the fact that Two Harbors initiated a share buyback program in November, with repurchasing up to 25 million shares. This indicates the management's firm belief in the REIT's future. 

Technically, the company has been uptrending since mid-November. The stock price has rocketed from around $9 a share to its current price of just more than $12 in the past two months. Although the relative-strength index (RSI) of 80 indicates the stock is severely overbought, I think there is much more upside to go. Remember, stocks can remain overbought for a long time during powerful uptrends. My 12-month target for this REIT is $18.



2. Silver Bay Realty Trust (NYSE: SBY)
Two Harbors recently spun-off its single-family home portfolio in December 2012 into Silver Bay Realty Trust. Two Harbors contributed more than 2,200 single-family houses and $50 million in cash in exchange for nearly 18 million shares of Silver Bay. It's important to note there is a 90-day lock up on the shares. This means after 90 days, Two Harbors must decide to hold, sell or even distribute the shares as a special dividend. Time will tell, but I think the decision will be beneficial to shareholders of both companies. [For more on Silver Bay: "The Easiest Way to Become a Landlord in 2013"]



Risks to Consider: Not all hedge funds are buying single-family homes. In fact, the $31 billion hedge fund Och-Ziff Capital Management Group is looking to sell its portfolio of around 300 single-family homes. The fund was one of the first to see the opportunity last year and is sitting on hefty profits from the investment. I think this is simply a strategic decision triggered by unknown factors within the fund, rather than a change in the macro picture. In addition, there is the potential of rising real estate prices reversing, thus causing losses for investors.

Action to Take --> I like Two Harbors Investment and Silver Bay at present prices. Two Harbors should be entered now with a target of $18 a share and stops at $11. Silver Bay has recently pulled into the value "buy" zone and I have a $31, 12-month target with a $20 initial stop level.

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