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Single-Family REIT IPOs Are Risky Bet

Already two big players have exited the market. Last year, hedge fund Och Ziff (OZ), one of the early entrants into the business, called it quits. And now it appears Carrington Holding is also pulling out of the business, according to Bloomberg News.

Chief Executive Bruce Rose, who raised $450 million for the business from Oaktree Capital (OAK - Get Report) last year told Bloomberg that returns were not adequate to continue investing. "There's a lot of -- bluntly -- stupid money that jumped into the trade without any infrastructure, without any real capabilities and a kind of build-it-as-you-go mentality that we think is somewhat irresponsible," the report quoted him saying.

Indeed, the early entrants to this business face enormous challenges.

Good Yield Is So Hard To Find

Institutional investors are already finding it hard to acquire properties at good prices. Most players are chasing the same properties in the same cities, creating bidding wars that automatically lower potential yield.

Properties can be purchased in bulk only in places where there is abundant supply of foreclosed homes, so almost all players in the business are actively bidding in cities such as Phoenix, Las Vegas, Atlanta, Tampa and parts of California, which is why we are seeing a strong rebound in home prices in these markets.

Most players need to limit their buying to a few cities simply for operational reasons. Managing a widely-dispersed group of single-family homes is an operational nightmare.

In the case of multi-family homes, a number of units are clustered into a single building, lowering the cost of maintenance. But imagine having to handle, say, the plumbing issues of a thousand homes spread all across Atlanta.

"You need a management infrastructure that is much more diffused[in the case of single-family homes]," said Aronson. The attorney believes operational difficulties will ultimately trip up bulk investors who lack experience in property management. "People who rent don't take anywhere near the care of a house compared to those who own."

Many big investors are working with property management companies, but that means they are likely giving up some of the yield to management fees. Others are building their own management infrastructure, but that is going to take time to scale up.
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