This Stock Could Offer Both Share Price Upside and Passive Income Potential

If you’ve been watching late night television, you’ve surely come across many infomercials that tout the promise of real estate riches.

Six-figure incomes are promised — on just one single-family home — with the use of massive amounts of leverage.

To hear the pitchmen, you can simply have the renters pay off the mortgage.

[ad#Google Adsense 336×280-IA]It’s a persuasive argument, but one that falls apart in action.

My own experience buying single-family (SFR) houses started in 2002, and by 2006 I owned as many as six homes.

I still own a few rentals after selling most just before the housing bubble burst, but in my experience, I found that real estate is far from passive income.

Calls come in at all hours for repairs and the bookkeeping can be a part-time job itself.

I now prefer a simpler way to invest in real estate: real estate investment trusts (REITs). Until just a few years ago, REITs exclusively focused on commercial property. In 2013, new REITs were launched that focused on single-family properties. I’ve found one REIT in particular could be a perfect substitute for managing your own portfolio of houses.

A Great Time To Get Your Start In This Popular Investment

Ever since Will Rogers said in the 1930’s that “Real estate is the best investment in the world because it is the only thing they’re not making anymore,” real estate has been one of the most popular ways to build wealth.

Despite the hurdles to managing a SFR portfolio, the segment still offers strong return potential. The bursting of the housing bubble left some deep obstructions in the market, many of which have yet to be worked out. Builders have been loath to build homes as rapidly as they had done in the past. Meanwhile, new household formation has outpaced new housing supply since 2007, creating a gap that is driving demand and higher housing prices.

To be sure, demand is not back at peak levels. Ballooning student debt is constraining the purchasing power for millions of people, and home ownership rates have declined for all age groups since 2004. This all underpins a very healthy environment for SFR investing and are factors that could take decades to resolve.

While Yale economist Robert Shiller found that the national average home price only increased about 0.2% a year above inflation over the long-term, the effect of leverage and the tax advantages through depreciation mean that SFR investments can offer stable double-digit returns when rent is included. For large-scale investors that can buy bulk portfolios at a discount, the returns could be even higher.

The majority of the 14.9 million single-family rental homes in the United States are held by individual investors, most of whom have high management costs and limited diversification. Institutional ownership is less than 1% of the market but a huge opportunity — larger players can realize better margins and diversification from scale.

And one company is the runaway leader in establishing an institutional-size portfolio of SFR real estate.

The Easiest Way To Become A Landlord

American Homes 4 Rent (NYSE: AMH) is a SFR REIT with 37,300 properties in 41 markets across the United States. Nearly all (90%) of the company’s properties are leased with a high renewal rate of 78% (for the quarter ended May 2015). AMH is the largest public company in the SFR space, larger than all other public companies combined. The company operates 18 property management offices and two property management headquarters, routing listing and tenant calls through a national call center for maximum efficiency.

Scale efficiencies have allowed the company to consistently book core net operating income (NOI) in the 63% range, on a quarterly revenue base of around $120 million. NOI of $76.5 million in the most recent the quarter was a 60% increase over the same period last year. The company reported core funds from operations (FFO) of $0.57 per share in 2014 and could be on track to post $0.76 per share this year.

The $0.05 quarterly dividend represents only a 1.25% annual yield, but that could jump when the company reaches its scale goals. Analysts expect rental revenue to jump by 16% next year to $706 million and a dividend increase could be required, to comply with federal REIT distribution rules.

Company founder Wayne Hughes recently disclosed on August 26 that he bought four million shares for just over $62 million. In the past 18 months, Hughes has accumulated six million shares (or nearly 3%) of the company for an average price of $15.86. Hughes became a billionaire by developing Public Storage (NYSE: PSA) and knows REITs inside and out. He founded American Homes 4 Rent in 2011 before taking the company public in August 2013.

Shares could be worth $19 each on a multiple of 25 times expected 2015 FFO, which would provide for a 21% total return on the current trade. Over the next couple of years, I expect cash distributions to start accounting for a larger portion of returns as the company matures.

Risks to Consider: The SFR market is difficult to manage and AMH could face setbacks during an economic recession and higher tenant delinquency. Understand that the investment is a longer-term one to allow the company time to mature.

Action to Take: Take advantage of huge scale in single-family residence management with shares of American Homes 4 Rent (NYSE: AMH) to benefit from share price upside and true passive income potential.

— Joseph Hogue

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Source: Street Authority