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Wednesday, February 12, 2014 - 08:30

How To Profit Like Buffett Only Wishes He Could

Wednesday, February 12, 2014 - 8:30am

Among the broader bull market of 2013, one sector enjoyed a boom so substantial that it increased investors' holdings by $2.2 trillion. And I'd bet that most readers are already participating in this explosive trend.

I'm talking about the housing market -- but unbelievably, many financial pundits and self-proclaimed gurus are warning of the coming dangers in this market while overlooking the facts.

While it's easy to have your investment decision swayed by a well-expressed opinion, the only way to drill down into financial reality is to tune out the noise and study the actual numbers. In this case, the numbers tell a far more bullish story than the fearmongers and perma-bears would have you believe.

According to a recent study by research firm CoreLogic, nearly 4 million U.S. homes shifted from negative equity to positive last year. The Federal Reserve has reported that homeowners' net equity holdings surged by $2.2 trillion between the third quarter of last year and the same period in 2012.

This tremendous increase in equity provides consumers confidence, which boosts spending across the board and lifts the entire economy. Additionally, greater access to more capital means more investment, further fueling the economic rebound.

CNBC
Warren Buffett said in a 2012 CNBC interview, "I'd buy up a couple hundred thousand single-family homes if I could."

I am not concerned about another housing bubble because unlike during the financial crisis, banks and lending institutions have much tougher regulatory and internal underwriting oversight. It is much more difficult today to qualify for a loan than it was in 2007. This means smarter loans are being made, with strong odds of being repaid.

There's also the fact that housing inventories are finally declining. There is currently just over five months of inventory on the market, compared with a normal level of six and a half months of inventory.

Famously, Warren Buffett said in a 2012 CNBC interview, "I'd buy up a couple hundred thousand single-family homes if I could."

Now there are REITs following this suggestion that I think will make a fantastic investment over the next several years.

How Can I Profit From The Housing Trend?
Obviously, owning residential property is the most direct way to capture profits from rising equity levels. I wholeheartedly recommend buying rental properties as one way to benefit from this sea change, but this approach isn't suitable for many investors. Although the profits can be staggeringly high, it's far from an easy business and often requires substantial hands-on work.

Thankfully, there is another way to benefit from this explosive growth: purchasing REITs that invest in single-family homes. These specialized REITs purchase, rehabilitate and rent out single-family homes on a much larger scale than an individual investor could possibly accomplish. REITs are required by law to return at least 90% of taxable profits to investors, which makes them an ideal investment under the right economic situation.

Here's a closer look at two of these specialized REITs:

American Homes 4 Rent (NYSE: AMH)
This Maryland-based REIT owns more than 21,000 single-family homes across 22 states. The REIT is part of both the Russell 1000 and the Russell 3000 indices. It boasts a market cap of $3.1 billion and just over $77.4 million in revenue. However, the company just went public in July and has not yet been profitable enough to pay a dividend. Shares have pushed to a high near $17.

Silver Bay Realty Trust (NYSE: SBY)
Silver Bay specializes in single-family homes and has a market cap of just under $642 million, revenue of $35.7 million and $53.7 million in cash. Its portfolio consists of nearly 6,000 single-family homes with an occupancy rate of 95% on stabilized properties. During the third quarter, revenue increased by 35%, net operating income climbed 44% and net asset appreciation rose 3%. Just like American Homes 4 Rent, Silver Bay is not yet profitable, but it does pay a dividend yield of 0.2%. SBY's price pattern is similar to AMH's, with price stalling out in the $17 range after pushing higher.

Risks to Consider: Single-family REITs are a relatively new product on the market, so unexpected risks may exist. In addition, the expanding real estate market is tightly tied to the economic recovery. Should the recovery take a step backwards, real estate will be among the first sectors to suffer. Always use stop-loss orders and diversify when investing.

Action to Take --> Both Silver Bay and American Homes 4 Rent are still in the investing stage, so there has not been enough time to earn profits. As the real estate market continues to improve, inventories drop, and banks tighten their lending standards, profits will likely increase for single-family REITs. I look at these as a longer-term investment and expect to see shares in the $26 range within 24 months. Combined with the expected dividend yields, both REITs will make solid investments.

Wait for a breakout close above $16.40 on Silver Bay and $16.80 on American Homes 4 Rent before entering to confirm the upward momentum has returned.

P.S. My colleague Nathan Slaughter has been pounding the table for months, telling readers of his High-Yield Investing advisory about the enormous opportunity in real estate right now. To learn more about Nathan's absolute favorite picks in real estate, which help regular investors unlock an income stream previously reserved only for America's privileged elite, read his special report by clicking here.

David Goodboy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.