) -- An ability to scale up rapidly will be a key differentiator that will separate winners from the losers in the single-family rental business, according to FBR Capital analyst Steve Stelmach.

"Low cost of capital and scale -- not the transitory effects of regional rental yields,acquisition types, or maintenance expenses -- will be the differentiators for the space as this sector develops," he wrote in a report Monday.

The business of buying up single-family homes at distressed prices, fixing them up and converting them into rentals has attracted institutional investors in droves over the past year.

Now a number of them are lining up to raise money from the public. While

Silver Bay


and recently listed

American Residential Properties


are the only public companies, others including

Colony Capital's

(CLNY) - Get Report

single-family arm and Oakland, California-based

Waypoint Homes

have filed to go public.

But the institutionalization of single-family rental business -- traditionally operated locally by mom-and-pop real estate investors -- is still in its infancy and remains an unproven business model.

Also see: Single Family REIT IPOs Are Risky Bet >>

While not everyone can be winners, larger REITs will have an advantage, according to a report published Monday by FBR.

"At the end of the day, we believe this sector will ultimately have only a handful of large competitors, as returns will compress as home prices grow, thus creating a much higher barrier to entry for hopeful entrants in just a few years," Stelmach wrote.

Right now, opportunity is ripe for acquisition of properties as "shadow inventory" -- loans in some stage of foreclosure process or seriously delinquent -- should provide a steady supply of homes over the next one to two years.

Core Logic

estimates shadow inventory at 2.2 million.

However, shadow inventory will "eventually dwindle" and the opportunity to buy homes at deep discounts will shrink. At that point, the industry will go through a consolidation and larger REITs with low cost of capital will likely benefit.

"The dwindling supply will, we believe, lead large REITs to look toward smaller competitors that are either finding it difficult to manage their current portfolios or looking to monetize the price gains they will have likely realized. We believe the larger REITs will be able to acquire these portfolios at an advantageous cost of capital and at prices that are still economically beneficial to shareholders, while also limiting the competition within the space," Stelmach wrote.

Moreover, having scale is important as it keeps fixed expenses low, improving yield. REITs in acquisition mode will face a bloated expense structure in the initial years until properties stabilize and start contributing to rental income. So the goal should be to "grow quickly" to minimize the drag from general and administrative expenses.

The analyst initiated coverage Monday on American Residential with an outperform rating. He cited the management team's long experience in the real estate industry as an advantage. American Residential Properties' portfolio totaled 2,531 homes as of March 31, 2013, up from as low as 70 homes in June 2012. The company has homes in 10 states, with its largest footprint in Arizona. Nearly 86% are leased, with an additional 10% roughly ready for lease.

-- Written by Shanthi Bharatwaj New York.

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