Fabrice Taylor, CFA, publishes the President's Club investment letter. His letter and The Globe and Mail have a distribution agreement.
If you're following the U.S. housing recovery you probably wish, as I do, that you'd bought some properties a few years back, when they could be had for next to nothing. House prices have recovered sharply, and with the leverage that comes from a mortgage, you'd have made a very attractive return, especially if you'd bought in markets such as Florida, where the bounce is even more pronounced.
Fortunately, there may be a way to go back in time, so to speak, and buy houses today at prices that prevailed a couple of years ago.
Delavaco Residential Properties Corp. is a Canadian-listed owner of houses and multifamily properties in the United States, notably in Florida, New Jersey, Georgia and Texas.
The company owns about 900 houses and more than 600 apartment suites, all of which were purchased at distressed prices beginning in 2011.
Delavaco has decided to sell its houses and reinvest the substantial profit in multifamily buildings, specifically mini-multis, or apartment buildings that are bigger than those individual investors buy but smaller than the bigger buildings real estate investment trusts target with their low cost of capital. It's a sweet spot for a company like Delavaco.
Here's why I think you can buy U.S. homes cheaply by investing in Delavaco, as I have done. The company very recently listed a block of its Florida houses. Including renovations, Delavaco paid an average of $74,000 (U.S.) for the homes, which it has been renting out since purchase.
The company has already received written offers for a majority of the homes with average prices of about 60 per cent more than it paid. However, the return to Delavaco shareholders should be even higher because of the debt employed for these purchases.
The shares, meanwhile, trade at a discount to the net market value of the properties. So investors who buy today are getting the properties for a discount to their market value, which continues to rise.
The value of the company's multifamily properties also appears understated on the balance sheet. Earlier this year Delavaco bought six apartment buildings (it's worth noting that the seller took payment in Delavaco shares valued at $1 when the stock was quoted at 88 cents, another testament to the discount.)
Delavaco paid $65,000 a unit for the buildings, one of which was later destroyed by fire. The insurance reimbursement was required to be at replacement cost, which ended up being almost twice as much as the purchase price. Fire also destroyed two of its Florida homes, and again the insurance repayment was about twice the purchase price.
I could go on but hopefully the evidence is convincing: It appears that if the company were to sell all its properties and pay all its debt, it could give shareholders back at least 25 per cent more than the stock is trading for, and possibly more.
But that's not the plan. As mentioned, the company is going to raise money by selling its houses and focus on mid-level multifamily, meaning smaller apartment buildings. The sale of the homes will also allow the company to pay off a 7.5-per-cent debenture, which will then be replaced with 4-per-cent debt, boosting the profit margin and making the company more competitive in the hunt for properties.
The multifamily market looks very attractive at the moment. Rents are rising rapidly. The New York Times recently reported on the drastic rise in eviction notices in the United States. While sad for those receiving them, the reason behind this phenomenon, says the Times, is likely "a severe shortage of rental housing caused by a lack of new construction during the recession. The tight supply of apartments means landlords can now afford to be more exacting in their standards, if not outright aggressive in replacing renters with those who can pay more."
Because of the high fixed costs and high debt loads in real estate, even a small increase in rents can lead to a big increase in cash flow.
Delavaco's board is unusually strong for a smaller company. It includes a who's who of both Canadian businessmen and real estate entrepreneurs, including Marc Muzzo, Romeo De Gasperis, Kelly Hanczyk (former CEO of Transglobe Apartment REIT and current head of Edgefront Realty Corp.) and renowned investor Michael Seruya.
These directors are not accustomed to failure and investors can invest alongside them – on better terms – as insiders paid $1 for their shares.
Delavaco plans to initiate a dividend in the first quarter of next year, which it hopes to increase as cash flow improves. And while it trades in Canada, it does so in U.S. dollars (and will pay dividends in that currency), providing a nice hedge to a falling loonie.
The risks with Delavaco are, first, that it's small and therefore brittle. Also, an unexpected downward turn in the real estate market or employment would be bad news. And execution risk is always present.
However, barring these, it's hard to go wrong when you buy dimes for a nickel so I think investors with an appetite for small caps would do well on this name.