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Single-Family REIT IPOs Are Risky Bet

Stocks in this article: CLNY SBY OAK ARPI BX

Meanwhile, they are aggressively ramping up property purchases in an "arms race" fashion, hoping to build a large portfolio of homes before prices rise even higher.

But it takes time to refurbish homes and rent them out, which means occupancy levels in the initial years will be lower. That means lower cash flows and it means that investors buying these REITs will have to wait a couple of years before yields start firming up.

In some cities, the conversion of single-family homes into rentals has created more supply than there is demand for rental homes. KBW analysts factor in a 4% annual inflation in rent but it is not clear that all areas can pull off such significant rent increases.

A report from online company Trulia in April suggests single-family rents are already flattening in many markets. "Nearly 4 million more single-family homes have been added to the rental market since 2005. This new supply has fully caught up with the increased rental demand during the housing crisis - causing single-family home rents to flatten nationwide," the report noted.

Are REIT IPOs Worth The Risk?

Buying into a single-family REIT IPO is likely to be a high-risk bet at the moment, given that the business model is unproven and we don't have players with a well-established track record.

Investors who choose to buy into this need to be strong believers of the long-term story, says Scott Crowe, who heads a newly-formed real estate securities unit at Resource Real Estate. "Do you buy into the macro picture? -- Housing will recover, there will be a high propensity to rent and REITs will be able to penetrate this market."

Crowe believes REITs will be able to professionalize the single-family rental business -- historically the mainstay of mom-and-pop investors - in much the same way REITs have stormed the self-storage business that was once dominated by individual investors.

But even he is a little wary of the current crop of REITs hitting the IPO market.

For one, they are externally managed, which involves paying a fee to an outside company. Most externally managed REITs tend to trade at discounts because of concerns that manager and shareholder interests aren't aligned.

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