10-K 1 a14-2977_110k.htm 10-K

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

(Mark One)

 

x

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2013

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to            

 

Commission file number 001- 35760

 

SILVER BAY REALTY TRUST CORP.

(Exact name of registrant as specified in its charter)

 

Maryland

 

90-0867250

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

601 Carlson Parkway, Suite 250

 

 

Minnetonka, Minnesota

 

55305

(Address of principal executive offices)

 

(Zip Code)

 

(952) 358 4400

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $0.01 par value

 

New York Stock Exchange

 

Securities registered pursuant to section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o  No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

Non-accelerated filer o

 

Smaller reporting company o

 

 

 

 

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

As of June 30, 2013, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $612 million based on the closing sale price as reported on the NYSE on June 28, 2013.

 

As of February 28, 38,591,263 shares of Common Stock, par value $0.01 per share, of Silver Bay Realty Trust Corp. were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Part III of this Annual Report on Form 10-K incorporates by reference certain information from the definitive proxy statement to be filed for the registrant’s 2014 Annual Meeting of Stockholders. The registrant intends to file the proxy statement with the Securities and Exchange Commission within 120 days of December 31, 2013.

 

 

 



Table of Contents

 

Table of Contents

 

 

 

Page

PART I

 

 

Item 1.

Business

5

 

Executive Officers

10

Item 1A.

Risk Factors

11

Item 1B.

Unresolved Staff Comments

32

Item 2.

Properties

33

Item 3.

Legal Proceedings

34

Item 4.

Mine Safety Disclosures

34

 

 

 

PART II

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

35

Item 6.

Selected Financial Data

38

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

40

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

54

Item 8.

Financial Statements and Supplementary Data

55

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

79

Item 9A.

Controls and Procedures

79

Item 9B.

Other Information

79

 

 

 

PART III

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

79

Item 11.

Executive Compensation

79

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

85

Item 13.

Certain Relationships and Related Transactions, and Director Independence

85

Item 14.

Principal Accounting Fees and Services

85

 

 

 

PART IV

 

 

Item 15.

Exhibits, Financial Statement Schedules

86

 

Signatures

89

 



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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Annual Report on Form 10-K and its exhibits contain forward-looking statements within the meaning of the federal securities laws. Forward-looking statements relate to expectations, beliefs, projections, future plans and strategies, anticipated events or trends and similar expressions concerning matters that are not historical facts. In some cases, you can identify forward-looking statements by the use of forward-looking terminology such as “may,” “will,” “should,” “expects,” “intends,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” or “potential” or the negative of these words and phrases or similar words or phrases which are predictions of or indicate future events or trends and which do not relate solely to historical matters. You can also identify forward-looking statements by discussions of strategy, plans or intentions. Forward-looking statements may include statements about our projected operating results, our stabilization and renovation rates, the number of properties we purchase by auction, our ability to successfully lease and operate acquired properties, including turnover rates, projected operating costs, estimates relating to our ability to make distributions to our stockholders in the future, market trends in our industry, real estate values and prices, and the general economy.

 

The forward-looking statements contained in this report reflect our current views about future events and are subject to numerous known and unknown risks, uncertainties, assumptions and changes in circumstances that may cause our actual results to differ significantly from those expressed or implied in any forward-looking statement. We are not able to predict all of the factors that may affect future results.  For a discussion of these and other factors that could cause our actual results to differ materially from any forward-looking statements, see the discussion on risk factors in Item 1A, “Risk Factors,” and in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in this Annual Report on Form 10-K and other risks and uncertainties detailed in this and our other reports and filings with the Securities and Exchange Commission, or SEC.  These risks, contingencies, and uncertainties include:

 

·      Our ability to successfully employ a new and untested business model in a new industry with no proven track record;

 

·      The availability of additional properties that meet our criteria and our ability to purchase such properties on favorable terms;

 

·      Real estate appreciation or depreciation in our target markets and the supply of single-family homes in our target markets;

 

·      General economic conditions in our target markets, such as changes in employment and household earnings and expenses or the reversal of population, employment, or homeownership trends in our target markets that could affect the demand for rental housing;

 

·      Competition from other investors in identifying and acquiring single-family properties that meet our underwriting criteria and leasing such properties to qualified residents;

 

·      Our ability to maintain high occupancy rates and to attract and retain qualified residents in light of increased competition in the leasing market for quality residents and the relatively short duration of our leases;

 

·     Our ability to maintain rents at levels that are sufficient to keep pace with rising costs of operations;

 

·      Lease defaults by our residents;

 

·      Our ability to contain renovation, maintenance, marketing, and other operating costs for our properties;

 

·     Our Manager’s ability to continue to build its operational expertise and to establish its platform and processes related to residential management;

 

·      The management agreement with our Manager was not negotiated on an arms-length basis and may not be as favorable to us as if it had been negotiated with an unaffiliated third party and may be costly and difficult to terminate;

 

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·  Our dependence on key personnel to carry our business and investment strategies and our ability to hire and retain skilled managerial, investment, financial, and operational personnel, and the performance of third-party vendors and service providers other than our Manager, including third-party acquisition and management professionals, maintenance providers, leasing agents, and property management;

 

·  Our ability to obtain additional capital or debt financing to expand our portfolio of single-family properties and our ability to repay our debt, including borrowings under our revolving credit facility and to meet our other obligations under our revolving credit facility;

 

·  The accuracy of assumptions in determining whether a particular property meets our investment criteria, including assumptions related to estimated time of possession and estimated renovation costs and time frames, annual operating costs, market rental rates and potential rent amounts, time from purchase to leasing, and resident default rates;

 

·      Our ability to accurately estimate the time and expense required to possess, renovate, repair, upgrade, and rent properties and to keep them maintained in rentable condition, unforeseen defects and problems that require extensive renovation and capital expenditures;

 

·  The concentration on our investments in single family properties which subject us to risks inherent in investments in a single type of property and seasonal fluctuations in rental demand;

 

·  The concentration of our properties in our target markets, which increases the risk of adverse changes in our operating results if there were adverse developments in local economic conditions or the demand for single-family rental homes or natural disasters in these target markets; and

 

·  Failure to qualify as a REIT or to remain qualified as a REIT, which will subject us to federal income tax as a regular corporation and could subject us to a substantial tax liability and compliance with the REIT distribution requirements.

 

The forward-looking statements in this Annual Report on Form 10-K represent our views as of the date of this Annual Report on Form 10-K.  We anticipate that subsequent events and developments will cause our views to change. However, while we may elect to update these forward-looking statements at some point in the future, we have no current intention of doing so except to the extent required by applicable laws.  You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Annual Report on Form 10-K.

 

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PART I

 

Item 1.    Business.

 

Silver Bay Realty Trust Corp. is an externally-managed Maryland corporation focused on the acquisition, renovation, leasing, and management of single-family properties in select markets in the United States. Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation. We generate virtually all of our revenue by leasing our portfolio of single-family properties. As of December 31, 2013, we owned 5,642 single-family properties in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, and Texas, excluding properties held for sale.

 

Silver Bay Realty Trust Corp. was incorporated in Maryland in June 2012. We completed our initial public offering and a series of contribution and merger transactions, or the Formation Transactions, on December 19, 2012 in which we received net proceeds of approximately $263.0 million (including the closing of the underwriters’ overallotment option on January 7, 2013 by which we received net proceeds of approximately $34.5 million) and acquired an initial portfolio of more than 3,300 single-family properties.  Prior to that time, we had no substantive operations though, as described below under the heading “Business — Formation Transactions,” we are considered a continuation of our Predecessor’s business operations. We are externally managed by PRCM Real Estate Advisers LLC, or our Manager.

 

We have elected to be treated as a real estate investment trust, or REIT, for U.S. federal tax purposes, commencing with, and in connection with the filing of our federal tax return for, the taxable year ended December 31, 2012. As a REIT, we generally are not subject to federal income tax on the taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to some federal, state and local taxes on our income or property.  In addition, the income of any taxable REIT subsidiary, or TRS, that we own will be subject to taxation at regular corporate rates.

 

Silver Bay Realty Trust Corp. conducts its business and owns all of its properties through Silver Bay Operating Partnership L.P., or the Operating Partnership, a Delaware limited partnership. As of December 31, 2013, Silver Bay Realty Trust Corp. owned, through a combination of direct and indirect interests, 100.0% of the partnership interests in the Operating Partnership.  Silver Bay Realty Trust Corp. has no material assets or liabilities other than its investment in the Operating Partnership.  Silver Bay Realty Trust Corp.’s wholly owned subsidiary, Silver Bay Management LLC, or the General Partner, is the sole general partner of the Operating Partnership. Except as otherwise required by the context, references to the “Company,” “Silver Bay,” “we,” “us” and “our” refer collectively to Silver Bay Realty Trust Corp., the Operating Partnership and the direct and indirect subsidiaries of each.

 

Our principal executive office is located at 601 Carlson Parkway, Suite 250, Minnetonka, Minnesota 55305. Our telephone number is (952) 358-4400. Our web address is www.silverbayrealtytrustcorp.com.  Our common stock is listed on the New York Stock Exchange, or the NYSE, under the symbol “SBY.” Our Manager’s executive office is located at 601 Carlson Parkway, Suite 250, Minnetonka, Minnesota 55305.

 

Business Strategy

 

Our strategy is to acquire, renovate, lease, and manage single-family properties located in select markets in order to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation. We intend to hold our properties over the long term. Although we may consider the opportunistic disposition of assets, we have no pre-set investment horizon that would require their sale.

 

Acquisitions

 

We employ a top-down selection process in our investment strategy. We start by identifying what we believe are the most attractive markets for developing a single-family rental business by evaluating existing and projected housing dynamics. Housing prices and rental demand are driven in part by macroeconomic and demographics factors. We scrutinize many of these factors, including existing supply of homes, vacancy rates, prior and projected population and household growth, prior and projected migration, regional building activity, mortgage delinquency figures, employment trends, income ratios, and price-to-rent ratios.

 

Once in a market, we acquire single-family properties through a variety of acquisition channels, including brokers, multiple listing services, short sales, foreclosure auctions, online auctions, and bulk purchases from institutions or investor groups. We focus on maintaining a disciplined property selection process that incorporates local knowledge to better understand the fundamentals of the housing markets in which we operate and we continually reevaluate the capital allocation among our markets in which we are making acquisitions. Our multi-market and multi-channel investment strategy provides flexibility in deploying capital and enables us to diversify our portfolio, mitigate risk, and avoid overexposure to any single market.

 

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Acquisitions may be financed from various sources, including proceeds from the sale of equity securities, retained cash flow, debt financings, securitizations, or the issuance of common units in the Operating Partnership.

 

Property Renovation

 

Most of the properties we acquire require renovation and standardization before they are ready for leasing. We refer to the process of possessing, renovating, marketing, and leasing a property as property stabilization. Our renovation and maintenance approach is generally consistent across our various acquisition channels. We maintain system-wide standards for our properties that are implemented at the local level and directed at increasing attractiveness to potential residents, reducing future maintenance expense, and increasing the long-term value of the property. Our Manager’s operating subsidiary uses a mix of internal project managers and third-party property managers to oversee the work of local contractors engaged to renovate our properties.

 

Operations and Management

 

The single-family rental business requires hands-on asset management capabilities and an integrated infrastructure to manage a large-scale portfolio that is geographically dispersed. Our Manager uses a structure that combines centralization of oversight and, on an increasing basis, certain other functions with a strong local presence and expertise. Our Manager uses internal teams in the Phoenix, Southeast Florida, Atlanta, and Columbus markets and relies on third parties to provide property management services in our other markets. Our leasing and management strategy seeks to maximize revenue by balancing occupancy and rental rates while minimizing our operating expenses. To meet these objectives, we focus on finding qualified residents and reducing resident turnover by providing quality and consistency in our customer service, maintenance, leasing, and marketing operations.

 

Technology

 

Technology plays an important role in assisting us to build and manage a portfolio of geographically disperse assets. Our Manager has developed and continues to develop a technological infrastructure with tools that:

 

·                  efficiently and consistently screen target properties for acquisition;

 

·                  allow us to assess the fair market value of our portfolio;

 

·                  allow real-time monitoring and management of our portfolio;

 

·                  integrate property management, accounting, and asset management systems;

 

·                  enable our residents to interact with us online; and

 

·                  use a secure cloud-based environment with mobile accessibility.

 

Our Manager

 

We are externally managed by PRCM Real Estate Advisers LLC, or our Manager. We rely on our Manager, and our Manager’s wholly-owned operating subsidiary, Silver Bay Property Corp., to provide or obtain on our behalf the personnel and services necessary for us to conduct our business as we have no employees of our own.

 

Our Manager is a joint venture between Provident Real Estate Advisors LLC, or Provident, and an affiliate of Pine River Capital Management L.P., or Pine River. Prior to our initial public offering, our Manager provided property management and acquisition services to the entities that we acquired in the Formation Transactions. Our Manager and its operating subsidiary will provide its services in managing and acquiring single-family properties exclusively to us through December 2015.

 

In addition to having exclusive access to our Manager’s technology infrastructure and its acquisition and property management teams, we benefit from the knowledge and experience that our Manager derives from its relationships with Pine River and Provident. Provident, a private capital management firm based in Minnesota, engaged in the acquisition, renovation, management and leasing of a portfolio of predominantly single-family properties between 2009 and 2012. In building and managing this portfolio, Provident developed a network of vendors, service providers, and third-party property managers along with institutional knowledge related to the acquisition and management of single-family properties. Our Manager benefited from these relationships and experience by, where prudent, further developing such relationships and by hiring key members of Provident’s management team. Pine River is a global asset management firm with institutional capabilities in asset valuation and management, capital markets, financial transactions, managing new ventures, risk management, compliance, and reporting. Pine River has valuable industry and analytical expertise, extensive long-term relationships in the financial community, and established fixed-income, mortgage and real estate investment experience. In addition, Pine River’s experience in launching and managing Two Harbors, a publicly traded mortgage REIT, provides

 

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our Manager with knowledge, expertise, and experience to assist in managing Silver Bay as a public company. Since our formation, our Manager has increased its knowledge and expertise in all areas of our business.

 

Management Agreements

 

Advisory Management Agreement

 

We have entered into an advisory management agreement with our Manager.  Pursuant to this management agreement, our Manager designs and implements our business strategy and administers our business activities and day-to-day operations, subject to oversight by our board of directors. Our Manager is responsible for, among other duties: (1) performing and administering all our day-to-day operations, (2) determining investment criteria in cooperation with our board of directors, (3) sourcing, analyzing and executing asset acquisitions, sales and financings, (4) performing asset management duties and (5) performing certain financial, accounting and tax management services. Our Manager has agreed not to provide these services to anyone other than us, our subsidiaries, and any future joint venture in which we are an investor, prior to December 19, 2015. In addition, our Manager and Pine River have agreed not to compete with us, our subsidiaries or any of our future joint ventures before December 19, 2015.

 

Under the management agreement, our Manager is compensated on a fee plus pass-through-of-expenses basis. We pay our Manager 0.375% of the daily average of our fully-diluted market capitalization for the preceding quarter (a 1.5% annual rate), less any property management fees received by our Manager’s operating subsidiary or its affiliates under the property management and acquisition services agreement described below. We also reimburse our Manager for all expenses incurred on our behalf or otherwise in connection with the operation of its business, other than compensation for our Chief Executive Officer and personnel providing data analytics directly supporting the investment function. If our Manager provides services to a party other than us or one of our subsidiaries, a portion of these expenses will be allocated to and reimbursed by such other party in a fair and equitable manner as determined by our Manager in good faith; our Manager is not currently providing such third-party services.

 

For purposes of calculating the advisory management fee, our fully-diluted market capitalization on a given day is calculated in accordance with the following formula:

 

Fully Diluted Market Capitalization = FMVCommon × (OutCommon + OutCommonEquiv) – AECommonEquiv

 

 

 

 

where:

 

 

 

 

 

 

 

 

FMVCommon =

 

(1) if our common stock is then listed on a national stock exchange, the closing price per share for the last preceding day on which there was a sale of such shares, (2) if our common stock is not then listed on a national stock exchange but is traded on an over-the-counter market, the average of the closing bid and asked prices for our common stock in such over-the-counter market for the last preceding date on which there was a sale of such shares in such market or (3) if neither (1) nor (2) applies, such value as the compensation committee of our board of directors determines in good faith

 

 

 

 

 

OutCommon =

 

the number of shares of common stock issued and outstanding on such day

 

 

 

 

 

OutCommonEquiv =

 

the maximum number of shares of common stock issuable pursuant to outstanding rights, options or warrants to subscribe for, purchase or otherwise acquire our common stock or securities convertible into our common stock (including common units of the Operating Partnership) that are in the money and held by people other than us or one of our subsidiaries on such day

 

 

 

 

 

AECommonEquiv =

 

the aggregate consideration payable to the Company upon the redemption, exercise, conversion or exchange of any outstanding rights, options or warrants to subscribe for, purchase or otherwise acquire our common stock or securities convertible into our common stock (including common units of the Operating Partnership) that are in the money and held by people other than us or one of our subsidiaries on such day

 

The value of the 10% cumulative redeemable preferred stock issued as part of the Formation Transactions and, any additional preferred stock or securities convertible into or exchangeable for, or rights, options or warrants to subscribe for, purchase or otherwise acquire our preferred stock, was determined as described in the management agreement and added to the calculation of fully-diluted market capitalization. If the Operating Partnership issues any equity interest that is not otherwise captured by the formula above, or securities convertible, redeemable, exercisable or otherwise exchangeable for any equity interest in the Operating Partnership, the value of such equity interests will be determined as described in the management agreement and added to the calculation of fully-diluted market capitalization.

 

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Under the management agreement, all intellectual property created in connection with the agreement will be the property of our Manager, and our Manager will grant us a non-exclusive, royalty-free license and right to use the intellectual property during the term of the management agreement.

 

The initial term of the management agreement expires on December 19, 2015 and will be automatically renewed for a one-year term on such date and each anniversary thereafter unless terminated. Following the initial term, the management agreement may be terminated by us upon the affirmative vote of at least two-thirds of our independent directors based upon unsatisfactory performance that is materially detrimental to us. We must provide notice of any such termination at least 180 days prior to the expiration of the then-current term and pay our Manager a termination fee as described below. We may also terminate the management agreement at any time, including during the initial term, without the payment of any termination fee, with at least 30 days’ prior written notice to our Manager for cause, as described in the management agreement, in the absence of our Manager’s timely cure. Except as stated above, we do not have the right to decline to renew the management agreement. Our Manager may terminate the agreement with at least 60 days’ prior written notice for cause, as described in the management agreement, in the absence of our timely cure, in which case we would owe a termination fee. Our Manager also may decline to renew the management agreement by providing us with 180 days’ prior notice, in which case we would not owe a termination fee. Upon termination of the management agreement by us for reasons other than cause, or by our Manager for cause that we are unwilling or unable to timely cure, we will pay our Manager a termination fee equal to 4.5% of the daily average of our fully-diluted market capitalization in the quarter preceding such termination.

 

Property Management and Acquisition Services Agreement

 

We have also entered into a property management and acquisition services agreement with our Manager’s operating subsidiary. Under this agreement, our Manager’s operating subsidiary acquires additional single-family properties on our behalf and manages our properties. Our Manager’s operating subsidiary has agreed not to provide these services to anyone other than us and our affiliates prior to December 19, 2015.

 

Our Manager’s operating subsidiary receives a property management fee equal to 5% of certain costs and expenses incurred by it in the operation of its business that are reimbursed by us. This property management fee reduces the advisory management fee paid to our Manager on a dollar for dollar basis. We reimburse our Manager’s operating subsidiary for all expenses incurred on our behalf. Additionally, for so long as it provides services exclusively to us, we will reimburse our Manager’s operating subsidiary for all costs and expenses incurred by it in the operation of its business, including the compensation of its employees. If our Manager’s operating subsidiary provides services to a party other than us or one of our subsidiaries, a portion of the corresponding expenses incurred by our Manager in doing so will be allocated to and reimbursed by such other party as reasonably determined by our Manager’s operating subsidiary in good faith; our Manager’s operating subsidiary is not currently providing any such third-party services. This agreement will continue in effect until it is terminated in accordance with its terms.

 

We also entered into separate property management agreements with our Manager’s operating subsidiary covering the properties pledged as part of the revolving credit facility. Pursuant to these agreements, we pay a property management fee equal to 10% of collected rents, which reduces our reimbursement obligations under the property management and acquisition services agreement by an equal amount eliminating any net impact on the amount we pay the Manager’s operating subsidiary for property management services.

 

Formation Transactions

 

In connection with our initial public offering in December 2012, we completed a series of contribution and merger transactions, or the Formation Transactions, through which we acquired an initial portfolio, or our Initial Portfolio, of more than 3,300 single-family properties. We acquired these properties from Two Harbors Investment Corp., or Two Harbors, and the owners of the membership interests of entities managed by Provident, or the Provident Entities, in consideration of 23,917,642 shares of our common stock, 1,000 shares of our 10% cumulative redeemable preferred stock, 27,459 common units in the Operating Partnership, and approximately $5.3 million in cash.

 

Acquisition of Two Harbors Property Investment LLC (now known as Silver Bay Property Investment LLC), or Silver Bay Property or our Predecessor, accounted for more than 2,400 properties in our Initial Portfolio. Silver Bay Property began acquiring this portfolio of single-family residential properties to rent for income and to hold for investment in the first quarter of 2012. Acquisition of the Provident Entities accounted for 881 properties in our Initial Portfolio.  Provident began acquiring, renovating, managing and overseeing the leasing of these single-family properties in 2009, acquiring properties in Arizona, Florida, Georgia, and Nevada through the Provident Entities, five private limited liability companies for which Provident served as the managing member.

 

For accounting purposes, our Predecessor was considered the acquiring or surviving entity, meaning our balance sheets reflect the historical assets and liabilities of our Predecessor at historical cost. The contribution of the Provident Entities, on the other hand, was accounted for as an acquisition under the purchase method of accounting, meaning the assets and liabilities of the Provident Entities were recorded at the estimated fair value of the acquired assets and assumed liabilities. As a result of the Formation transactions, we are considered a continuation of our Predecessor’s business operations.

 

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Financing Strategy

 

To date, we have funded our acquisitions and other capital needs through a mix of equity capital, cash generated by our operations, and borrowings under our revolving credit facility. We entered our revolving credit facility on May 10, 2013 and amended it on January 16, 2014 to increase the borrowing capacity from $200.0 million to $350.0 million. We continually explore additional capital options available to us, and our decision to pursue such options will be based on our Manager’s assessment of a variety of factors, including the relative cost of the financing, the impact on our estimated net asset value and cash flow generation, and the available growth opportunities.

 

Competition

 

The residential rental market has historically been fragmented in both its ownership and operations.  We face competition from local owners and operators, as well as an emerging class of institutional managers. When acquiring single-family properties, we face competition from individual investors, private pools of capital and other institutional buyers which may increase the prices for properties that we would like to purchase and reduce our ability to achieve our desired portfolio size or expected yields. We also compete for desirable residents against the same entities as well as multifamily lessors. We believe that having an integrated and scalable platform with local market presence and using our wealth of existing in-house expertise provides us competitive advantages.

 

Investment Guidelines

 

Our board of directors has adopted the following investment guidelines:

 

·                  no investment will be made that would cause us or any of our subsidiaries to fail to qualify as a REIT for U.S. federal income tax purposes;

 

·                  no investment will be made that would cause us to be required to register as an investment company under the Investment Company Act of 1940;

 

·                  our investments will be limited to (a) single-family properties and investments that are directly related to the acquisition, maintenance, ownership and leasing thereof, provided that bulk purchases of assets that are within this guideline may include other assets to the extent the purchase of such other assets is necessary in order to effect such bulk purchases; and (b) up to 5% of the Company’s assets may consist of other investments; and

 

·                  until appropriate investments can be identified, we may invest available cash in interest-bearing and short-term investments that are consistent with (i) our intention to qualify as a REIT and (ii) our and our subsidiaries’ exemption from “investment company” status under the Investment Company Act of 1940.

 

Our board of directors will review our investment portfolio and our compliance with our investment guidelines from time to time as it deems appropriate or necessary. These investment guidelines may be modified by our board without the approval of our stockholders, and although we are not required to, we intend to disclose any such changes or waivers to our investment guidelines in the periodic reports we file with the SEC.

 

Regulation

 

General

 

Our properties are subject to various covenants, laws, and ordinances, and certain of our properties are also subject to the rules of the various homeowners’ associations where such properties are located. We believe that we are in material compliance with such covenants, laws, ordinances and rules and our leasing terms require that our residents agree to comply with such covenants, laws, ordinances, and rules.

 

Fair Housing Act

 

The Fair Housing Act, or FHA, its state law counterparts and the regulations promulgated by U.S. Department of Housing and Urban Development and various state agencies, prohibit discrimination in housing on the basis of race or color, national origin, religion, sex, familial status (including children under the age of 18 living with parents or legal custodians, pregnant women and people securing custody of children under the age of 18) or handicap (disability) and, in some states, on financial capability and other bases. We believe that we are in compliance with the FHA and other regulations.

 

Environmental Matters

 

As an owner of real estate, we are subject to various federal, state and local environmental laws, regulations, and ordinances and also could be liable to third parties as a result of environmental contamination or noncompliance at our properties even if we no

 

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longer own such properties. See the discussion under Item 1A, “Risk Factors,” under the caption “We may be subject to unknown or contingent liabilities or restrictions related to properties that we acquire for which we may have limited or no recourse.”

 

REIT Qualification

 

We have elected to be taxed as a REIT, commencing with our initial taxable year ended on December 31, 2012. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various requirements under the Internal Revenue Code of 1986, as amended, or the Code, relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels, and the diversity of ownership of our shares. We believe that we have been organized in conformity with the requirements for qualification and taxation as a REIT under the Code, and that we conduct our operations in a manner that will enable us to meet the requirements for qualification and taxation as a REIT going forward.

 

As long as we qualify as a REIT, we generally will not be subject to U.S. federal income tax on the REIT taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lose our REIT qualification. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state, and local taxes on our income or property. In addition, any TRS we own will be subject to U.S. federal, state, and local taxes on its income or property.

 

Executive Officers

 

David N. Miller is our Chief Executive Officer, President and a member of our board of directors. Mr. Miller has been a director and executive officer since August 2012. Beginning in 2011, Mr. Miller served as a Managing Director of Pine River Capital Management L.P. and Two Harbors Investment Corp. [NYSE: TWO], where he focused on strategy and new business development, including the formation and development of Silver Bay and the single-family property rental business. From 2008 to 2011, Mr. Miller served in various roles at the U.S. Department of Treasury, including as the Chief Investment Officer of the Troubled Asset Relief Program (TARP) where he was instrumental in building various investment programs and business units and overseeing the investment portfolio. From 2007 to 2008, Mr. Miller was a portfolio manager at HBK Capital Management focusing on equity investments. From 1998 through 2007, he held various positions at Goldman, Sachs & Co., including as a Vice President in the Special Situations Investing Group (2004-2007) where he focused on proprietary investments in debt and equity and as a financial analyst in the investment banking division (1998-2001) where he focused on corporate finance and mergers and acquisitions. Mr. Miller received an MBA from Harvard Business School and a B.A. in Economics from Dartmouth College. We believe Mr. Miller is an appropriate director because of his management role and knowledge of the operations of our Manager and our Manager’s operating subsidiary as well as his general investment expertise.

 

Christine Battist is our Chief Financial Officer and Treasurer. Ms. Battist has been an executive officer since our incorporation in June 2012. Prior to this appointment, Ms. Battist served as Managing Director at Two Harbors Investment Corp. overseeing investor and media relations beginning in 2011. From 2005 to 2011, Ms. Battist served in various financial roles at The Mosaic Company [NYSE: MOS], first as Director of Financial Compliance from 2005 to 2007, leading the company’s inaugural global Sarbanes Oxley design and implementation after its merger, then as Director of Investor Relations from 2007 to 2011. Ms. Battist was instrumental in leading Mosaic’s investor relations during its formative years and through the spin-off and secondary offering of shares held by Mosaic’s largest and private stockholder in 2011. Prior to joining the Mosaic Company, Ms. Battist was Director of Internal Audit for Tuesday Morning Corporation [NASDAQ: TUES] from 2003 to 2005. Ms. Battist began her career with PricewaterhouseCoopers LLP, spending a decade in ever-increasing roles and responsibilities, overseeing financial audit engagements for public companies in the U.S. capital and debt markets, including leading acquisition and carve-out transactions. She received a B.B.A. from St. Norbert College and is licensed as a Certified Public Accountant (inactive) in the State of Texas.

 

Lawrence B. Shapiro is our Chief Operating Officer. Mr. Shapiro has served as our Chief Operating Officer since December 2013. Prior to his appointment as Chief Operating Officer, Mr. Shapiro served as Executive Vice President for Acquisitions for Silver Bay Property Corp. since its formation in December 2011. In this role, he led the acquisitions by our Predecessor and the Company. He also expanded his responsibilities to manage the Company’s renovation activities starting in June 2013. From 2007 until joining Silver Bay Property Corp., Mr. Shapiro served as President of Provident Real Estate Advisors LLC, or Provident, where he led the acquisition, renovation, and leasing activities for the Provident Entities. From 1991 to 2000, Mr. Shapiro served as chief financial officer for Rottlund Homes, a residential home builder that previously traded on the American Stock Exchange. From 2006 to 2007, Mr. Shapiro served as chief financial officer of JMS Companies, a diversified real estate firm. Mr. Shapiro holds a Masters of Business Administration from the University of Wisconsin and a Bachelor of Science in Business degree in Accounting from the University of Minnesota.

 

Timothy O’Brien is our General Counsel and Secretary. Mr. O’Brien has been an executive officer since our incorporation in June 2012. Mr. O’Brien is a Partner of Pine River and has served as General Counsel and Chief Compliance Officer of Pine River since 2007. Mr. O’Brien also served as General Counsel of Two Harbors from October 29, 2009 through March 1, 2013. From 2004

 

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to 2006, Mr. O’Brien served as Vice President and General Counsel of NRG Energy, Inc., a publicly listed power generation company [NYSE: NRG]. Mr. O’Brien served as Deputy General Counsel of NRG Energy, Inc. from 2000 to 2004 and Assistant General Counsel from 1996 to 2000. Prior to joining NRG Energy, Inc., Mr. O’Brien was an associate at the law firm of Sheppard Mullin in Los Angeles and San Diego, California. He received a J.D. from the University of Minnesota Law School and a B.A. in History from Princeton University.

 

Employees

 

We are managed by our Manager pursuant to the management agreement between our Manager and us. Each of our officers is an employee or partner of Pine River or our Manager’s operating subsidiary. We have no employees of our own.

 

Available Information

 

Our website address is www.silverbayrealtytrustcorp.com. We make available, free of charge on our website (on the Investor Relations page under “SEC Filings”), our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports, as are filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as well as our proxy statements with respect to our annual meetings of stockholders, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our Exchange Act reports filed with, or furnished to, the SEC are also available at the SEC’s website at www.sec.gov.

 

We intend to webcast our earnings calls and certain events we participate in or host with members of the investment community on our investor relations website. Additionally, we provide notifications of news or announcements regarding our financial performance, including SEC filings, investor events, press and earnings releases as part of our investor relations website. Investors and others can receive notifications of new information posted on our investor relations website in real time by signing up for email alerts and RSS feeds.  Further corporate governance information, including charters for our board committees, our Code of Business Conduct and Ethics, and our whistleblowing procedures, are available on our website on the Investor Relations page. The contents of our website referred to in this Annual Report on Form 10-K are not intended to be incorporated by reference into this Form 10-K or in any other report or document we file with the SEC, and any references to our website is intended to be inactive textual references only.

 

Item 1A.    Risk Factors.

 

Set forth below are the risks that we believe are material to our stockholders. You should carefully consider the following risks in evaluating our company and our business. The occurrence of any of the following risks could materially adversely impact our financial condition, results of operations, cash flow, the market price of our common stock and our ability, among other things, to make distributions to our stockholders, which in turn could cause our stockholders to lose all or a part of their investment. Some statements in the following risk factors constitute forward-looking statements. Please refer to the section entitled “Special Note Regarding Forward-Looking Statements” at the beginning of this Annual Report on Form 10-K.

 

Risks Related to Our Business

 

We are an early entrant employing a new and untested business model in a new industry with no proven track record, which makes our business difficult to evaluate.

 

The large-scale single-family rental industry is relatively new in the United States. Until very recently, the single-family rental business consisted primarily of private and individual investors in local markets and was managed individually or by small, local property managers. We were formed on the assumption that a company can acquire and operate single-family properties on a large-scale basis and achieve attractive yields by employing a disciplined approach to acquisitions and renovations, economies of scale in marketing and management, and developing a brand-name presence. This is a new business model that has not been tested on a national scale. Our assumptions are unproven, and if they prove to be incorrect, then we may fail to provide the financial returns that investors hope or expect to receive.

 

Our investment strategy involves purchasing a large number of residential properties and leasing them to suitable residents. No peer companies exist with an established track record from which to predict whether our investment strategy can be implemented successfully over time. While past performance is not indicative of future results, it will be difficult to evaluate our potential future performance without the benefit of established track records from companies implementing a similar investment strategy. We may encounter unanticipated problems implementing our investment strategy, which may have a material adverse effect on our results of operations and our ability to make distributions on our common stock and may cause our stock price to decline significantly. Accordingly, no assurance can be given that we will be successful in implementing our investment strategy or that we will be successful in achieving our objective of providing attractive risk-adjusted returns to our stockholders over the long term.

 

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We believe the acquisition, operation and management of multifamily residential properties is the most comparable established business model to our business, but in contrast to multifamily operations, the geographic dispersion of single-family properties creates significantly greater operational and maintenance challenges and, potentially, significantly higher per-unit operating costs. For example, although we intend to inspect our portfolio properties periodically, the geographical dispersion of our assets means we will not inspect our assets as frequently as may occur in the multifamily industry, meaning we may not become aware of conditions such as water infiltration, mold, or infestation until significant damage has been done to a property that may require extensive remediation and repairs and the provision of substitute housing for a resident. In addition, because each home has unique features, appliances and building materials, we believe the renovations, maintenance, marketing and operational tasks are far more varied and demanding than in a typical multifamily setting. We cannot provide any assurance that operating a large portfolio of single-family rental properties can be executed in a cost-effective and profitable manner or that our business plan will succeed.

 

We have a limited operating history and may not be able to operate our business successfully or generate sufficient cash flows to make or sustain distributions to our stockholders.

 

Silver Bay Realty Trust Corp. was organized in June 2012 and has a limited operating history. There is no long-term historical financial data available for Silver Bay Property, our acquired properties, or other companies in the single-family rental industry to assist investors in assessing our earnings potential or whether we can operate profitably. We cannot assure you that we will be able to operate our business successfully or implement our operating policies and strategies as described in this Annual Report. The results of our operations will depend on many factors, including:

 

·                  the availability of additional properties that meet our criteria and our ability to purchase such properties on favorable terms;

 

·                  real estate appreciation or depreciation in our target markets;

 

·                  our ability to contain renovation, maintenance, marketing, and other operating costs for our properties;

 

·                  our ability to maintain high occupancy rates and target rent levels;

 

·                  general economic conditions in our target markets, such as changes in employment and household earnings and expenses;

 

·                  costs that are beyond our control, including title litigation, litigation with residents or tenant organizations, legal compliance, real estate taxes, homeowners’ association fees, and insurance;

 

·                  judicial and regulatory developments affecting landlord-tenant relations that may affect or delay our ability to dispossess or evict occupants or increase rents;

 

·                  judicial and regulatory developments affecting banks’ and other mortgage holders’ ability to foreclose on delinquent borrowers;

 

·                  reversal of population, employment, or homeownership trends in target markets;

 

·                  interest rate levels and volatility, which may affect the accessibility of short-and long-term financing on desirable terms; and

 

·                  competition from other investors entering the single-family rental market.

 

Our Manager is still building its operational expertise and systems.

 

Our Manager continues to build its operational expertise and to establish its platform and processes related to residential management, including leasing, brand development, tracking, accounting systems, and billing and payment processing. Building operational expertise and establishing a platform are difficult, expensive, and time-consuming tasks, and we can expect problems to arise despite the best efforts of our Manager and its affiliates. There is a significant risk that operational problems will have an adverse effect upon our financial performance, especially in newer markets.

 

Our success depends, in part, upon our ability to hire and retain skilled managerial, investment, financial, and operational personnel.

 

The implementation of our business plan requires that we employ qualified personnel. Competition for skilled managerial, investment, financial, and operational personnel is intense. Other large real estate investors have entered the single-family rental business and we face increased challenges in hiring and retaining personnel. We cannot assure our stockholders that we will be successful in attracting and retaining such skilled personnel. If we are unable to hire and retain qualified personnel as required, our growth and operating results could be adversely affected.

 

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We are dependent on our executive officers and dedicated personnel, and the departure of any of our key personnel could materially and adversely affect us.

 

We rely on a small number of persons to carry out our business and investment strategies. Any of our senior management may cease to provide services to us at any time. The loss of the services of any of our key management personnel, or our inability to recruit and retain qualified personnel in the future, could have an adverse effect on our business and financial results. As we expand, we may need to attract and retain qualified additional senior management but may not be able to do so on acceptable terms or at all.

 

We are dependent on our investment in a single asset class, which exposes us to downturns in the single-family properties sector.

 

We have concentrated our investments in single-family properties and expect to continue to do so. As a result, we are subject to risks inherent in investments in a single type of property. A downturn or slowdown in the rental demand for single-family housing may have more pronounced effects on the cash available for distribution or on the value of our assets than if we had more fully diversified our investments. There are seasonal fluctuations in rental demand with demand higher in the spring and summer than in the fall and winter. Such seasonal fluctuations may impact our operating results.

 

We face significant competition in the leasing market for quality residents, which may limit our ability to rent our single-family homes on favorable terms or at all.

 

We face competition for residents from other lessors of single-family properties, apartment buildings and condominium units. The continuing development of apartment buildings and condominium units in many of our target markets increases the supply of housing and exacerbates competition for residents. Many of these competitors may successfully attract residents with better incentives and amenities, which could adversely affect our ability to obtain quality residents and lease our single-family properties on favorable terms or at all. Additionally, some competing housing options may qualify for government subsidies that may make such options more affordable and therefore more attractive than our properties.

 

We intend to continue to expand our scale of operations and make acquisitions even if the rental and housing markets are not as favorable as they have been in recent months, which could reduce our yield per share.

 

Our long-term growth depends on the availability of acquisition opportunities in our target markets at attractive prices. We believe various factors and market conditions have made homes available for purchase at prices that are below replacement cost. We expect that in the future housing prices will continue to stabilize and return to more normalized levels, and therefore future acquisitions may be more costly. There are many factors that may cause a recovery in the housing market that would result in future acquisitions becoming more expensive and possibly less attractive than recent past and present opportunities, including:

 

·                  improvements in the overall economy and job market;

 

·                  reductions in the supply of residential properties compared to demand;

 

·                  a resumption of consumer lending activity and greater availability of consumer credit;

 

·                  improvements in the pricing and terms of mortgage-backed securities;

 

·                  the emergence of increased competition for single-family assets from private investors and entities with similar investment objectives to ours; and

 

·                  tax or other government incentives that encourage homeownership.

 

Although we believe there will be benefits to increasing our scale of operations, our Manager’s acquisition platform and property management operations represent a significant ongoing expense to us. These expenses include, among others, costs associated with establishing and maintaining fully staffed regional brokerage offices, inspections and due diligence, transaction costs, landlord-tenant and legal compliance, and renovating and marketing costs. In addition, we expect that recently acquired properties in the process of stabilization will be unproductive assets generating no revenue for up to six months after acquisition.

 

We have not adopted and do not expect to adopt a policy of making future acquisitions only if they are accretive to existing yields and distributable cash. We will continue to invest significant resources developing our Manager’s acquisition and property management platforms and we plan to continue acquiring properties as long as we believe such properties offer an attractive total return opportunity through cash flow generation and asset appreciation. Accordingly, future acquisitions may have lower yield characteristics than our current portfolio and if such future acquisitions are funded through equity issuances, the yield and distributable cash per share will be reduced and the value of our common stock may decline.

 

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We will need additional capital or debt financing to expand our portfolio and such financing may not be available.

 

The acquisition of single-family properties on a large scale requires significant capital. To date, our properties have been purchased and renovated with a mix of cash and debt financing under our revolving credit facility. We may be unable to leverage our assets or obtain additional financing to the extent desired. We may also choose to fund our growth by issuing additional equity, which may be dilutive to our stockholders.

 

Our access to capital depends, in part, on:

 

·                  general business conditions;

 

·                  financial market conditions;

 

·                  the market’s perception of our business prospects and growth potential;

 

·                  our current debt levels; and

 

·                  our current and expected earnings, cash flow and distributions.

 

We cannot assure you that we will be able to obtain debt or equity financing on terms favorable or acceptable to us or at all. If we do not have sufficient capacity under our revolving credit facility or future financing agreements, or if other sources of financing (such as equity offerings) are not available to us, we may be required to cease future acquisitions of single-family properties, or dispose of certain properties in our portfolio at inopportune times, in order to meet liquidity and other requirements.

 

Debt service obligations could adversely affect our operating results, may require us to sell properties, and could adversely affect our ability to make or sustain distributions to our stockholders and the market price of our common stock.

 

Our financing strategy contemplates the use of secured or unsecured debt, including our revolving credit facility, to finance long-term growth. Our governing documents contain no limitations on the amount of debt that we may incur. As a result, we may incur substantial debt in the future.

 

Incurring debt could subject us to many risks, including the risks that:

 

·                  our cash flows from operations will be insufficient to make required payments of principal and interest;

 

·                  our debt may increase our vulnerability to adverse economic and industry conditions;

 

·                  we will be subject to restrictive covenants that require us to satisfy and remain in compliance with certain financial requirements, that impose limitations on the type or extent of activities we conduct, or that restrict the amount of additional debt we may employ;

 

·                  we may be required to dedicate a substantial portion of our cash flows from operations to payments on our debt, thereby reducing cash available for distribution to our stockholders, operations and capital expenditures, future business opportunities, or other purposes; and

 

·                  the terms of any refinancing may not be as favorable as the terms of the debt being refinanced.

 

If we do not have sufficient funds to repay any debt we incur when it matures, we may need to refinance the debt or raise additional equity. If, at the time of any refinancing, prevailing interest rates or other factors result in higher interest rates on refinancing, increases in interest expense could adversely affect our cash flows and, consequently, cash available for distribution to our stockholders. In addition, our revolving credit facility accrues interest at a varying rate based on LIBOR. To the extent this interest rate increases, the cost of our borrowings will increase as well. To the extent we are required to raise additional equity to satisfy such debt, existing stockholders would see their interests diluted. If we are unable to refinance our debt or raise additional equity on acceptable terms, we may be forced to dispose of substantial numbers of properties on disadvantageous terms, potentially resulting in losses.

 

To the extent we cannot meet any future debt service obligations, we will risk losing some or all of our properties that may be pledged to secure our obligations to foreclosure. Any unsecured debt agreements we enter into may contain specific cross-default provisions with respect to specified other indebtedness, giving the unsecured lenders the right to declare a default if we are in default under other loans in some circumstances.

 

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Our revolving credit facility permits us to incur significant indebtedness, which could require that we generate significant cash flow to satisfy the payment and other obligations under our revolving credit facility.

 

We may incur significant indebtedness in connection with draws under our revolving credit facility. This indebtedness may exceed our cash on hand or our cash flows from operating activities. Our ability to meet the payment and other obligations under our revolving credit facility depends on our ability to generate sufficient cash flow in the future. Our ability to generate cash flow, to some extent, is subject to general economic, financial, competitive, legislative, and regulatory factors, as well as other factors that are beyond our control. It is possible that our business will not generate cash flow from operations, or that future borrowings will not be available to us, in amounts sufficient to enable us to meet our payment obligations under our revolving credit facility. If we are not able to generate sufficient cash flow to service our revolving credit facility and other debt obligations, as well as satisfy the REIT distribution requirement, we may need to refinance or restructure our debt, reduce or delay capital investments, or seek to raise additional capital. If we are unable to implement one or more of these alternatives, we may not be able to meet our payment obligations under our revolving credit facility, which could materially and adversely affect our liquidity.

 

Failure to hedge effectively against interest rate changes may adversely affect our results of operations and our ability to make shareholder distributions.

 

In connection with our revolving credit facility, we have obtained interest rate caps, and subject to complying with the requirements for REIT qualification, we may obtain in the future one or more additional forms of interest rate protection—in the form of swap agreements, interest rate cap contracts or similar agreements—to hedge against the possible negative effects of interest rate fluctuations. However, we cannot assure you that any hedging will adequately relieve the adverse effects of interest rate increases or that counterparties under these agreements will honor their obligations thereunder. In addition, we may be subject to risks of default by hedging counterparties. Adverse economic conditions could also cause the terms on which we borrow to be unfavorable. We could be required to liquidate one or more of our investments at times which may not permit us to receive an attractive return on our investments in order to meet our debt service obligations.

 

We face significant competition for acquisitions of our target properties, which may limit our strategic opportunities and increase the cost to acquire those properties.

 

We face significant competition for attractive acquisition opportunities in our target markets from other large real estate investors, some of which have greater financial resources and a lower cost of capital than we do. Several REITs and other funds have and continue to deploy, and others are expected to deploy in the near future, significant amounts of capital to purchase single-family homes and may have investment objectives that overlap and compete with ours, including in our target markets. This activity has adversely impacted our level of purchases in certain of our target markets. If our business model or a similar model proves to be successful, we can expect competition to intensify significantly. As a result, the purchase price of potential acquisition properties may be significantly elevated, or we may be unable to acquire properties on desirable terms or at all.

 

Our dependence upon third parties for key services may harm our operating results or reputation if the third parties fail to perform.

 

We rely on local, third-party vendors and service providers other than our Manager, including third-party house improvement professionals, maintenance providers, leasing agents, and property management companies in situations where it is cost-effective to do so or if our Manager’s internal staff is unable to perform these functions. For example, we currently use third-party property managers for approximately half of our current properties. We do not have exclusive or long-term contractual relationships with any of these third-party providers, and we can provide no assurance that we will have uninterrupted or unlimited access to their services. Furthermore, selecting, managing, and supervising these third-party service providers requires significant management resources and expertise. Poor performance by third-party service providers, especially those who interact with residents in our properties, will reflect poorly on us and could significantly damage our reputation among desirable residents. If our Manager does not select, manage, and supervise appropriate third parties for these services, our brand and reputation and operating results may suffer. Moreover, notwithstanding our efforts to implement and enforce strong policies and practices regarding service providers, we may not successfully detect and prevent fraud, incompetence, or theft by our third-party service providers, which could expose us to material liability or responsibility for associated damages, fines, or penalties.

 

In addition, any delay in identifying a third-party service provider or removal or termination of existing third-party service providers would require us to seek new vendors or providers, which would create delays and adversely affect our operating results.

 

Many factors affect the single-family residential rental market and if rents in our target markets do not increase sufficiently to keep pace with rising costs of operations, our income and distributable cash will decline.

 

The success of our business model will depend, in part, on conditions in the single-family rental market in our target markets. Our asset acquisitions will be premised on assumptions about occupancy and rent levels, and if those assumptions prove to be inaccurate, our cash flows and profitability will be reduced. Rental rates and occupancy levels have benefited in recent periods from macro trends affecting the U.S. economy and residential real estate markets in particular, including:

 

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·                  a tightening of credit that has made it more difficult to finance home purchases, combined with efforts by consumers generally to reduce their exposure to credit;

 

·                  weak economic and employment conditions that have increased foreclosure rates and made it more difficult for families to remain in their homes that were purchased prior to the housing market downturn;

 

·                  declining real estate values that have challenged the traditional notion that homeownership is a stable investment; and

 

·                  the unprecedented level of vacant housing comprising the real estate owned, or REO, inventory held for sale by banks, government-sponsored entities, and other mortgage lenders or guarantors.

 

We do not expect these favorable trends to continue indefinitely. Eventually, a strengthening of the U.S. economy and job growth, coupled with government programs designed to keep home owners in their homes or other factors may contribute to a stabilization or reversal of the current trend that favors renting rather than homeownership. In addition, we expect that as investors like us increasingly seek to capitalize on opportunities to purchase undervalued housing assets and convert them to productive uses, the supply of single-family rental properties available for purchase will decrease and the competition for residents may intensify. A softening of the rental market in our target areas would reduce our rental income and profitability.

 

Mortgage loan modification programs and future legislative action may adversely affect the number of available properties that meet our investment criteria.

 

The U.S. government, through the Federal Reserve, the FHA and the Federal Deposit Insurance Corporation, has implemented a number of programs designed to provide home owners with assistance in avoiding residential mortgage loan foreclosures, including the Home Affordable Modification Program, which seeks to provide relief to home owners whose mortgages are in or may be subject to foreclosure, and the Home Affordable Refinance Program, which allows certain borrowers who are underwater on their mortgage but current on their mortgage payments to refinance their loans. Several states, including states in which our current target markets are located, have adopted or are considering similar legislation. These programs and other loss mitigation programs may involve, among other things, the modification or refinancing of mortgage loans or providing home owners with additional relief from loan foreclosures. Such loan modifications and other measures are intended and designed to lead to fewer foreclosures, which will decrease the supply of properties that meet our investment criteria.

 

The pace of residential foreclosures is unpredictable and subject to numerous factors. In recent periods there has been a backlog of foreclosures due to a combination of volume constraints and legal actions, including those brought by the U.S. Department of Justice, or DOJ, the Department of Housing and Urban Development, or HUD, and State Attorneys General against mortgage servicers alleging wrongful foreclosure practices. Financial institutions have also been subjected to regulatory restrictions and limitations on foreclosure activity by the Federal Deposit Insurance Corporation. Legal claims brought or threatened by the DOJ, HUD and 49 State Attorneys General against the five largest residential mortgage servicers in the country were settled in 2012. As part of this approximately $25 billion settlement, a portion of the settlement funds will be directed to home owners seeking to avoid foreclosure through mortgage modifications, and servicers are required to adopt specified measures to reduce mortgage obligations in certain situations. It is expected that the settlement will help many home owners avoid foreclosures that would otherwise have occurred in the near term, and with lower monthly payments and mortgage debts, for years to come. It is also foreseeable that other residential mortgage servicing companies that were not among the five included in the initial $25 billion settlement will agree to similar settlements that will further reduce the supply of houses in the process of foreclosure.

 

In addition, numerous federal and state legislatures have considered, proposed, or adopted legislation to constrain foreclosures, or may do so in the future. For example, in 2012, California enacted a law imposing new limitations on foreclosures while a request for a loan modification is pending. The Dodd-Frank Act also created the Consumer Financial Protection Bureau, which supervises and enforces federal consumer protection laws as they apply to banks, credit unions, and other financial companies, including mortgage servicers. It remains uncertain as to whether any of these measures will have a significant impact on foreclosure volumes or what the timing of that impact would be. If foreclosure volumes were to decline significantly, we would expect REO inventory levels to decline or to grow at a slower pace, which would make it more difficult to find target assets at attractive prices and might constrain our growth or reduce our long-term profitability. Also, the number of families seeking rental housing might be reduced by such legislation, reducing rental housing demand in our target markets.

 

Claims of deficiencies in the foreclosure process may result in rescission of our purchases at auction or reduce the supply of foreclosed properties available to us.

 

Allegations of deficiencies in foreclosure practices could result in claims challenging the validity of some foreclosures that have occurred to date, potentially placing our claim of ownership to the properties at risk. Our title insurance policies may not provide adequate protection in such instances or such proceedings may result in a complete loss without compensation.

 

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Each state has its own laws governing the procedures to foreclose on mortgages and deeds of trust, and state laws generally require strict compliance with these laws in both judicial and non-judicial foreclosures. Recently, courts and administrative agencies have been more actively involved in enforcing state laws governing foreclosures, and in some circumstances have imposed new rules and requirements regarding foreclosures. Some courts have delayed or prohibited foreclosures based on alleged failures to comply with proper transfers of title, notice, identification of parties in interest, documentation, and other legal requirements. Further, foreclosed owners and their legal representatives, including some prominent and well-financed legal firms, have brought litigation questioning the validity and finality of foreclosures that have already occurred. These developments may slow or reduce the supply of foreclosed houses available to us for purchase and may call into question the validity of our title to houses acquired at foreclosure, or result in rescission rights or other borrower remedies, which could result in a loss of a property purchased by us that may not be covered by title insurance, an increase in litigation costs incurred with respect to properties obtained through foreclosure, or delays in stabilizing and leasing such properties promptly after acquisition.

 

Our underwriting criteria and evaluation of properties involves a number of assumptions that may prove inaccurate, which may cause us to overpay for our properties or incur significant costs to renovate and market a property.

 

In determining whether a particular property meets our investment criteria, we make a number of assumptions, including assumptions related to estimated time of possession and estimated renovation costs and time frames, annual operating costs, market rental rates and potential rent amounts, time from purchase to leasing, and resident default rates. These assumptions may prove inaccurate, causing us to pay too much for properties we acquire or to overvalue our properties, or our properties may fail to perform as we expect. Adjustments to the assumptions we make in evaluating potential purchases may result in fewer properties qualifying under our investment criteria. Reduction in the supply of properties that meet our investment criteria may adversely affect our ability to implement our investment strategy and operating results.

 

Furthermore, the properties we acquire are likely to vary materially in terms of time to possession, renovation, quality, and type of construction, location, and hazards. Our success depends on our ability to estimate accurately the time and expense required to possess, renovate, repair, upgrade, and rent properties and to keep them maintained in rentable condition. In addition, market and regulatory environments relating to single-family residential properties have been changing rapidly, making future trends difficult to forecast. For example, an increasing number of home owners now wait for an eviction notice or eviction proceedings to commence before vacating foreclosed premises, which significantly increases the period between the acquisition and leasing of a foreclosed property. Such changes affect the accuracy of our assumptions and, in turn, may adversely affect our operating results.

 

The types of properties on which our acquisition strategy focuses have an increased risk of damage due to vandalism, mold and infestation, which may require extensive renovation prior to renting.

 

Our acquisition strategy predominately targets distressed single-family properties that often involve defaults by home owners on their home loan obligations. For multiple reasons, distressed properties may be in worse physical condition than other similar properties. When a homeowner falls behind on a mortgage, the homeowner may cease to maintain the property in good condition, may vandalize it, or may abandon the property altogether. Vacant and neglected homes are subject to increased risks of vandalism, theft, mold, infestation, general deterioration, illegal occupation, and other maintenance problems that may worsen without appropriate attention and remediation. We generally will not hire independent third-party home inspectors to inspect properties before purchase and will instead rely primarily on the acquisition employees of our Manager’s operating subsidiary to conduct detailed interior visual inspections when possible. These factors could cause our renovation costs to significantly exceed estimates, which may adversely affect our operating results.

 

Certain of our older properties may contain lead-based paint, which we may be required to remove or could expose us to liability, either of which would adversely affect our operating results.

 

Approximately 37% of the properties we owned as of December 31, 2013 are over 30 years old, and those premises may contain lead-based paint. The existence of lead paint is especially a concern in residential units and can cause health problems, particularly for children. A structure built prior to 1978 may contain lead-based paint and may present a potential exposure to lead; however, structures built after 1978 are not likely to contain lead-based paint. Federal and state laws impose certain disclosure requirements and restrict and regulate renovation activities on housing built before 1978. Violation of these restrictions could result in fines or criminal liability, and we could be subject to liability arising from lawsuits alleging personal injury or related claims. Although we attempt to comply with all such regulations, we have not conducted tests on the properties in our Initial Portfolio to determine the presence of lead-based paint and we cannot guarantee that we will not incur any material liabilities as a result of the presence of lead paint in our properties.

 

A substantial portion of our properties are purchased at auction, where we generally are not able to conduct a thorough inspection before purchasing the properties, and we may not accurately assess the extent of renovations required.

 

Over 60% of our properties owned as of December 31, 2013 were purchased at auction and we may purchase properties at auction in the future. When we purchase properties at auction, we generally do not have the opportunity to conduct interior inspections

 

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and may not be able to access a property to conduct more than the most cursory of exterior inspections. These inspection processes may fail to reveal major defects associated with properties we acquire, which may result in renovation and maintenance costs and time frames that exceed our estimates and negatively affect our financial results and earnings.

 

Properties acquired through bulk sales may subject us to the risk of acquiring properties that do not fit our target investment criteria and may be costly or time consuming to divest, which may adversely affect our operating results.

 

We have acquired and expect to continue to acquire properties purchased as portfolios in bulk from other owners of single-family properties. To the extent the management and leasing of such properties has not been consistent with our property management and leasing standards, we may be subject to a variety of risks, including risks relating to the condition of the properties, the credit quality and employment stability of the residents, and compliance with applicable laws, among others. In addition, financial and other information provided to us regarding such portfolios during our due diligence may be inaccurate, and we may not discover such inaccuracies until it is too late to seek remedies against such sellers. To the extent we timely pursue such remedies, we may not be able to successfully prevail against the seller in an action seeking damages for such inaccuracies. If we conclude that certain properties purchased in bulk portfolios do not fit our target investment criteria, we may decide to sell, rather than renovate and rent, these properties, which could take an extended period of time and may not result in a sale at an attractive price.

 

The costs and time to secure possession and control of a newly acquired property may exceed our current assumptions, increasing the costs and delaying our receipt of revenue from the property.

 

Upon acquiring a new property, we may have to evict occupants who are in unlawful possession before we can secure possession and control of the property. The holdover occupants may be the former owners or residents of a property, or they may be squatters or others who are illegally in possession. Securing control and possession from these occupants can be both costly and time-consuming. If these costs and delays exceed our expectations in a large proportion of our newly acquired properties, our financial performance may suffer because of the increased expenses or the unexpected delays incurred in turning the properties into revenue-producing assets.

 

We may not have control over timing and costs arising from renovation of properties, which may adversely affect our operating results and ability to make distributions to our stockholders.

 

Nearly all of our properties require some level of renovation immediately upon their acquisition or in the future following expiration of a lease or otherwise. We may acquire properties that we plan to extensively renovate. We may also acquire properties that we expect to be in good condition only to discover unforeseen defects and problems that require extensive renovation and capital expenditures. In addition, we will be required to make ongoing capital improvements and replacements and may need to perform significant renovations and repairs from time to time that resident deposits and insurance may not cover.

 

Our properties have infrastructure and appliances of varying ages and conditions. Consequently, we expect that our Manager will routinely retain independent contractors and trade professionals to perform physical repair work, and we will be exposed to all of the risks inherent in property renovation, including potential cost overruns, increases in labor and materials costs, delays by contractors in completing work, delays in the timing of receiving necessary work permits, certificates of occupancy, and poor workmanship. Although we do not expect that renovation difficulties on any individual property will be significant to our overall results, if our assumptions regarding the costs or timing of renovation across our portfolio prove to be materially inaccurate, our operating results and ability to make distributions to our stockholders may be adversely affected.

 

We may be subject to unknown or contingent liabilities or restrictions related to properties that we acquire for which we may have limited or no recourse.

 

Assets and entities that we have acquired or may acquire in the future may be subject to unknown or contingent liabilities for which we may have limited or no recourse against the sellers. Unknown or contingent liabilities might include liabilities for or with respect to liens attached to properties, unpaid real estate tax, utilities, or homeowners’ association, or HOA, charges for which a subsequent owner remains liable, clean-up or remediation of environmental conditions or code violations, claims of customers, vendors, or other persons dealing with the acquired entities, and tax liabilities. Purchases of single-family properties acquired at auction, in short sales, from lenders, or in bulk purchases typically involve few or no representations or warranties with respect to the properties and may allow us limited or no recourse against the sellers. Such properties also often have unpaid tax, utility, and HOA liabilities for which we may be obligated but fail to anticipate. As a result, the total amount of costs and expenses that we may incur with respect to liabilities associated with acquired properties and entities may exceed our expectations, which may adversely affect our operating results and financial condition.

 

Additionally, these properties may be subject to covenants, conditions, or restrictions that restrict the use or ownership of such properties, including prohibitions on leasing. We may not discover such restrictions during the acquisition process and such restrictions may adversely affect our ability to operate such properties as we intend.

 

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Our operating performance is subject to risks associated with the real estate industry that could reduce the rent we receive, decrease the value of our properties, or adversely affect our financial condition.

 

Real estate investments are subject to various risks and fluctuations and cycles in value and demand, many of which are beyond our control. Certain events may decrease cash available for dividends as well as the value of our properties. These events include:

 

·                  adverse changes in national or local real estate, economic, or demographic conditions;

 

·                  vacancies or our inability to rent our homes on favorable terms or at favorable rental rates;

 

·                  bankruptcies or adverse changes in the financial conditions of the residents of our properties;

 

·                  resident turnover or our inability to collect rent from residents;

 

·                  reduced demand for single-family home rentals and changes in the relative popularity of properties and neighborhoods;

 

·                  increased supply of single-family homes and availability of financing;

 

·                  increases in expenses, including insurance costs, labor costs, energy prices, real estate assessments, and other taxes and costs of compliance with laws, regulations, and governmental policies to the extent that we are unable to pass on these increases to our residents;

 

·                  changes in interest rates, availability, and terms of debt financing;

 

·                  the illiquidity of real estate investments generally;

 

·                  residents’ perceptions of the safety, convenience, and attractiveness of our properties and the neighborhoods where they are acquired;

 

·                  the ability or unwillingness of residents to pay rent increases;

 

·                  the effects of rent controls, stabilization laws and other laws or covenants regulating rental rates; and

 

·                  changes in, and changes in enforcement of, laws, regulations and governmental policies, including health, safety, environmental, rental property, zoning and tax laws, governmental fiscal policies, and the Americans with Disabilities Act of 1990.

 

In addition, periods of economic slowdown or recession, rising interest rates or declining demand for real estate, or the public perception that any of these events may occur, could result in a general decline in rents or an increased incidence of defaults under existing leases. If we cannot operate our properties to meet our financial expectations, our financial condition, results of operations, cash flow, per share trading price of our common stock, ability to satisfy our debt service obligations and ability to pay dividends to stockholders could be adversely affected.

 

Short-term leases of residential property may expose us to the effects of declining market rents.

 

Substantially all of our leases are of a duration of less than two years and are one year in the majority of cases. Because these leases permit the residents to leave at the end of the lease term without penalty, our rental revenues may be affected by declines in market rents more quickly than if our leases were for longer terms. Short-term leases may result in high turnover, which involves costs such as restoring the properties, marketing costs, and lower occupancy levels. Because we have a very limited operating history, we cannot accurately predict our turnover rate or the associated costs we will incur. Moreover, we cannot assure you that our leases will be renewed on equal or better terms or at all. If our residents do not renew their leases or abandon their leases during the lease term, we may experience lower than expected occupancy rates and some homes may remain vacant for extended periods of time.  Extended vacancy terms may apply downward pressure to rental rates as we may accept rental rates below our targets in order to incentivize residents to choose our homes or prevent the value of our homes from becoming impaired as a result of extended vacancy periods.  If either of our occupancy rates or rental rates decreases, our ability to generate positive cash flows may be negatively affected.

 

Our revenue and expenses are not directly correlated, and because a large percentage of our costs and expenses are fixed, we may not be able to adapt our cost structure to offset declines in our revenue.

 

Many of the expenses associated with our business, such as acquisition costs, renovation and maintenance costs, real estate taxes, HOA fees, personal and property taxes, insurance, utilities, personnel costs and benefits, and other general corporate expenses are fixed and do not necessarily decrease with a reduction in revenue from our business. Our assets are also prone to depreciation and will require a significant amount of ongoing capital expenditures. Our expenses and ongoing capital expenditures will also be affected by inflationary increases and certain of our cost increases may exceed the rate of inflation. By contrast, as described above, our rental income will be affected by many factors beyond our control such as the availability of alternative rental housing and economic

 

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conditions in our target markets. In addition, state and local regulations may require us to maintain properties that we own, even if the cost of maintenance is greater than the value of the property or any potential benefit from renting the property. As a result, we may not be able to fully offset rising costs and capital spending by raising rents, which could have a material adverse effect on our results of operations and cash available for distribution.

 

Our portfolio consists of properties that are geographically concentrated and any adverse developments in local economic conditions, the demand for single-family rental homes in these markets, or natural disasters may negatively affect our operating results.

 

Our portfolio consists of properties that are geographically concentrated in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, and Texas. As of December 31, 2013, approximately 60% of our properties were concentrated in only three markets — Phoenix, Atlanta, and Tampa. As such, we are susceptible to local economic conditions, other regulations, the supply of and demand for single-family rental properties, and natural disasters in these areas. If there is a downturn in the local economies, an oversupply of or decrease in demand for single-family rental properties in these markets or natural disasters in these geographical areas, our business could be materially adversely affected to a greater extent than if we owned a real estate portfolio that was more geographically diversified. We base an important part of our business plan on our belief that property values and operating fundamentals for single-family properties in most of our markets will improve significantly over the next several years. However, most of our markets experienced substantial economic downturns in recent years and could experience similar or worse economic downturns in the future. We can provide no assurance as to the extent property values and operating fundamentals in these markets will improve, if at all. If the recent economic downturn in these markets persists or if we fail to accurately predict the timing of economic improvement in these markets, the value of our properties could decline and our ability to execute our business plan may be adversely affected, which could adversely affect our financial condition, operating results and ability to make distributions to our stockholders.

 

A significant number of our residential properties are part of HOAs and we and our residents are subject to the rules and regulations of such HOAs, which may be arbitrary or restrictive, and violations of such rules may subject us to additional fees and penalties and litigation with such HOAs, which would be costly.

 

A significant number of the properties in our portfolio are located within HOAs, which are private entities that regulate the activities of and levy assessments on properties in a residential subdivision. HOAs in which we own properties may have or enact onerous or arbitrary rules that restrict our ability to renovate, market, or lease our properties or require us to renovate or maintain such properties at standards or costs that are in excess of our planned operating budgets. Such rules may include requirements for landscaping, limitations on signage promoting a property for lease or sale, or the use of specific construction materials used in renovations. Some HOAs also impose limits on the number of property owners who may rent their homes, which if met or exceeded, would cause us to incur additional costs to resell the property and opportunity costs of lost rental income. Many HOAs impose restrictions on the conduct of occupants of homes and the use of common areas, and we may have residents who violate HOA rules and for which we may be liable as the property owner. The boards of directors of the HOAs in which we own properties may not make important disclosures about the properties or may block our access to HOA records, initiate litigation, restrict our ability to sell our properties, impose assessments, or arbitrarily change the HOA rules. We may be unaware of or unable to review or comply with HOA rules before purchasing a property and any such excessively restrictive or arbitrary regulations may cause us to sell such property at a loss, prevent us from renting such property, or otherwise reduce our cash flow from such property, which would have an adverse effect on our returns on the property.

 

We may be subject to losses that are uninsurable, not economically insurable, or in excess of our insurance coverage.

 

We currently attempt to ensure that all of the properties we acquire are adequately insured to cover casualty losses. However, many of the policies covering casualty losses may be subject to substantial deductibles and carveouts, and we will be self-insured up to the amount of the deductibles and carveouts. Since some claims against us will not exceed the deductibles under our insurance policies, we will be effectively self-insured for some claims. We may not carry or may discontinue certain types of insurance coverage on some or all of our properties if the cost of premiums for such insurance in our judgment exceeds the value of the coverage discounted for the risk of loss.

 

Our properties may be damaged by adverse weather conditions and natural disasters such as earthquakes, tsunamis, wind, hail, floods, landslides, and fires. In addition, our properties may be subject to environmental liabilities and we will be exposed to personal liability for accidents which may occur on our properties. Our insurance may not be adequate to cover all damages or losses from these events, or it may not be economically prudent to purchase insurance for certain types of losses, such as hurricanes or earthquakes. As a result, we may incur significant costs in the event of adverse weather conditions and natural disasters or events which result in damage or injury. Because we tend to concentrate ownership in target markets, if we own numerous properties in an area affected by a natural disaster or similar catastrophic event, it could damage or destroy a substantial portion of our properties, and expose us to liabilities to our affected residents to immediately repair or replace their leaseholds on non-economic terms.

 

If we experience losses that are uninsured or exceed policy limits, we could incur significant uninsured costs or liabilities, lose the capital invested in the properties, and lose the anticipated future cash flows from those properties. In addition, our environmental or personal liability may result in losses substantially in excess of the value of the related property.

 

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New or existing laws, regulations, and covenants that are applicable to our properties, including permit, license, and zoning requirements, may adversely affect our ability to make future acquisitions or renovations, result in significant costs or delays, and adversely affect our growth strategy.

 

Our properties are subject to various covenants and local laws and regulatory requirements, including permitting and licensing requirements. Local regulations, including municipal or local ordinances, zoning restrictions and restrictive covenants imposed by community developers or HOAs, may restrict our use of our properties and may require us to obtain approval from local officials or community standards organizations at any time with respect to our properties, including prior to acquiring a property or when undertaking renovations. Among other things, these restrictions may relate to fire and safety, seismic, asbestos cleanup, or hazardous material abatement requirements. Existing regulatory policies may adversely affect the timing or cost of our future acquisitions or renovations, and additional regulations may increase such delays or result in additional costs. Our failure to obtain permits, licenses, and zoning approvals on a timely basis could have a material adverse effect on our business, financial condition, and results of operations.

 

Acquiring properties during periods when the single-family home sector is experiencing substantial inflows of capital and intense competition may result in inflated purchase prices and increase the likelihood that our properties will not appreciate in value and may, instead, decrease in value.

 

The allocation of substantial amounts of capital for investment in the single-family home sector and significant competition for income producing real estate may inflate the purchase prices for such assets. To the extent we purchased, or in the future purchase, real estate in such an environment, it is possible that the value of our properties may not appreciate and may, instead, decrease in value, perhaps significantly, below the amount we paid for such properties. In addition to macroeconomic and local economic factors, technical factors, such as a decrease in the amount of capital allocated to the single-family home sector and the number of investors participating in the sector, could cause the value of our properties to decline.

 

We are subject to tenant relief laws that may negatively affect our rental income and profitability.

 

Distressed properties that we purchase at auction are often occupied and may require us to evict the prior occupant of the premises. As landlord, we will also regularly be in the situation of having to evict residents who are not paying their rent or are otherwise in material violation of the terms of their leases. Eviction activities will impose legal and managerial expenses that will raise our costs. The eviction process is typically subject to legal barriers, mandatory “cure” policies and other sources of expense and delay. Additionally, state and local landlord-tenant laws may impose legal duties to assist tenants in relocating to new housing, or restrict the landlord’s ability to recover certain costs or charge residents for damage. Because such laws vary by state and locality, our regional and local property managers will need to be familiar with and take all appropriate steps to comply with all applicable landlord-tenant laws, and we will need to incur supervisory and legal expenses to insure such compliance. To the extent that we do not comply with state or local laws, we may be subjected to civil litigation filed by individuals, class action claims, or claims by state or local law enforcement.

 

Class action, tenant rights, and consumer demands and litigation may result in increased expenses and harm our financial results.

 

Numerous tenants’ rights and consumer rights organizations exist throughout the country and operate in our target markets, and as we grow in scale, we may attract attention from some of these organizations and become a target of legal demands or litigation. Many such consumer organizations have become more active and better funded in connection with mortgage foreclosure-related issues, and with the large settlements identified above and the increased market for single-family rentals arising from displaced homeownership, some of these organizations may shift their litigation, lobbying, fundraising and grass roots organizing activities to focus on landlord-tenant issues. While we intend to conduct our business lawfully and in compliance with applicable landlord-tenant and consumer laws, such organizations might work in conjunction with trial and pro bono lawyers in one state or multiple states to attempt to bring claims against us on a class action basis for damages or injunctive relief. We cannot anticipate what form such legal actions might take, or what remedies they may seek. Additionally, these organizations may lobby local county and municipal attorneys or state attorneys general to pursue enforcement or litigation against us, or may lobby state and local legislatures to pass new laws and regulations to constrain our business operations. If they are successful in any such endeavors, they could directly limit and constrain our business operations, and may impose on us significant litigation expenses, including settlements to avoid continued litigation or judgments for damages or injunctions.

 

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Poor resident selection and defaults by renters may negatively affect our financial performance and reputation.

 

Our success depends in large part upon our ability to attract and retain qualified residents. This will depend, in turn, upon our ability to screen applicants, identify good residents, and avoid residents who may default. We will inevitably make mistakes in our selection of residents, and we may rent to residents whose default on our leases or failure to comply with the terms of the lease or HOA regulations negatively affect our financial performance, reputation, and the quality and value of our properties. For example, residents may default on payment of rent, make unreasonable and repeated demands for service or improvements, make unsupported or unjustified complaints to regulatory or political authorities, make use of our properties for illegal purposes, damage or make unauthorized structural changes to our properties which may not be fully covered by security deposits or insurance, refuse to leave the property when the lease is terminated, engage in domestic violence or similar disturbances, disturb nearby residents with noise, trash, odors or eyesores, fail to comply with HOA regulations, sublet to less desirable individuals in violation of our leases, or permit unauthorized persons to live with them.

 

In the event of a resident default or bankruptcy, we may experience delays in enforcing our rights as landlord and obtaining possession of the premises, may incur legal, maintenance, and other costs in protecting our investment. In addition, we will incur turnover costs associated with re-leasing the properties such as marketing and brokerage commissions, will not collect revenue while the property sits vacant, and may be unable to re-lease the property at the rental rate previously received.

 

The process of evicting a defaulting resident from a family residence can be adversarial, protracted, and costly. Furthermore, some residents facing eviction may damage or destroy the property. Damage to our properties may significantly delay re-leasing after eviction, necessitate expensive repairs, or impair the rental income or value of the property, resulting in a lower than expected rate of return. Although our Manager attempts to work with residents to prevent such damage or destruction, there can be no assurance that our Manager will be successful. Such residents cause us not to achieve our financial objectives for the properties in which they live, may subject us to liability, and may damage our reputation with our other residents and in the communities where we do business.

 

Declining real estate valuations and impairment charges could adversely affect our earnings and financial condition.

 

We periodically review the value of our properties to determine whether their value, based on market factors, projected income and generally accepted accounting principles, has permanently decreased such that it is necessary or appropriate to take an impairment loss in the relevant accounting period. Such a loss would cause an immediate reduction of net income in the applicable accounting period and would be reflected in a decrease in our balance sheet assets. The reduction of net income from impairment losses could lead to a reduction in our dividends, both in the relevant accounting period and in future periods. Even if we do not determine that it is necessary or appropriate to record an impairment loss, a reduction in the intrinsic value of a property would become manifest over time through reduced income from the property and would therefore affect our earnings and financial condition.

 

A prolonged economic slowdown or a lengthy or severe recession or stagnation or decline in home values could impair our assets and harm our operations.

 

The risks associated with our business are more severe during periods of economic slowdown or recession. For example, the ability of residents to pay their rent typically depends on the income or assets of the residents. During an economic slowdown, unemployment rises and increasing numbers of residents have difficulty making payments on their obligations, including rent. Any sustained period of increased payment delinquencies or defaults could adversely affect our revenues, results of operations, financial condition, business prospects and ability to make distributions to stockholders. Thus any prolonged economic slowdown or a lengthy or severe recession, whether caused by global unrest, acts or threats of terrorism, breakdowns in the financial system or otherwise, could impair our assets or the performance of our assets and harm our operations.

 

Title defects could lead to material losses on our investments in our properties.

 

Our title to a property, especially those acquired at auction, may be challenged for a variety of reasons including allegations of defects in the foreclosure process. Title insurance may not prove adequate in these instances. We may continue to acquire a number of our homes on an “as is” basis at auctions or otherwise. When acquiring properties on an “as is” basis, title commitments are often not available prior to purchase, and title reports or title information may not reflect all senior liens, which may increase the possibility of acquiring houses outside predetermined acquisition and price parameters, purchasing residences with title defects and deed restrictions, HOA restrictions on leasing, or purchasing the wrong residence without the benefit of title insurance prior to closing. Although our Manager utilizes various policies, procedures, and practices to assess the state of title prior to purchase, there can be no assurance that these policies and procedures will be completely effective, which could lead to a material if not complete loss on our investment in such properties.

 

For properties we acquire through the foreclosure auction process, we do not obtain title commitments prior to purchase, and we are not able to perform the type of title review that is customary in acquisitions of real property. As a result, our knowledge of potential title issues will be limited, and no title insurance protection will be in place. This lack of title knowledge and insurance protection may result in third parties having claims against our title to such properties that may materially and adversely affect the values of the properties or call into question the validity of our title to such properties. Without title insurance, we are fully exposed to, and would have to defend ourselves against, such claims. Further, if any such claims are superior to our title to the property we acquired, we risk loss of the property purchased.

 

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Increased scrutiny of title matters, particularly in the case of foreclosures, could lead to legal challenges with respect to the validity of the sale. In the absence of title insurance, the sale may be rescinded and we may be unable to recover our purchase price, resulting in a complete loss. Title insurance obtained subsequent to purchase offers little protection against discoverable defects because they are typically excluded from such policies. In addition, even if we are able to acquire title insurance on a property, the insurance may not cover all defects or the significant legal costs associated with obtaining clear title.

 

Any of these risks could adversely affect our operating results, cash flows, and ability to make distributions to our stockholders.

 

Eminent domain could lead to material losses on our investments in our properties.

 

Governmental authorities may exercise eminent domain to acquire land on which our properties are built. Any such exercise of eminent domain would allow us to recover only the fair value of the affected property. Our acquisition strategy is premised on the concept that this “fair value” will be substantially less than the real value of the property for a number of years, and we could effectively have no profit potential from properties acquired by the government through eminent domain. Several cities are also exploring proposals to use eminent domain to acquire mortgages to assist homeowners to remain in their homes, potentially reducing the supply of single-family properties in our markets.

 

We are currently involved in a variety of legal actions and administrative proceedings as a result of which we may incur significant costs.

 

We are currently involved in a variety of legal actions and administrative proceedings that arise from time to time in the ordinary course of business. These matters include eviction proceedings and other landlord-tenant disputes, challenges to title and ownership rights (including actions brought by prior owners alleging wrongful foreclosure by their lender or servicer) and issues with local housing officials arising from the condition or maintenance of the property. While we intend to vigorously defend any non-meritorious claim or proceeding, no assurance can be given that we will not incur significant costs or be subject to material losses as a result.

 

Increasing real estate taxes, HOA fees, and insurance costs may negatively affect our financial results.

 

As a result of our substantial real estate holdings, the cost of real estate taxes and insuring our properties is a significant component of our expenses. In addition, a significant portion of the properties in our portfolio are subject to HOAs, which have the power to increase monthly charges and make assessments for capital improvements and common area repairs. Real estate taxes, HOA fees, and insurance premiums are subject to significant increases, which can be outside of our control. If the costs associated with real estate taxes, HOA fees, and assessments or insurance should rise significantly and we are unable to raise rents to offset such increases, our results of operations would be negatively impacted.

 

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

 

In the ordinary course of our business we acquire and store sensitive data, including intellectual property, our proprietary business information and personally identifiable information of our prospective and current residents, our employees and third-party service providers in our branch offices and on our networks and website. The secure processing and maintenance of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, regulatory penalties, disruption to our operations and the services we provide to customers or damage to our reputation, which could adversely affect our results of operations and competitive position.

 

As a public company, we are obligated to develop and maintain proper and effective internal control over financial reporting. We may not complete our analysis of our internal control over financial reporting in a timely manner, or these internal controls may not be determined to be effective, which may adversely affect investor confidence in our company and, as a result, the value of our common stock.

 

Each year, we are required, pursuant to Section 404 of the Sarbanes-Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment includes disclosure of any material weaknesses identified by our management in our internal control over financial reporting, as well as a statement that our independent registered public accounting firm has issued an opinion on our internal control over financial reporting. We may not be able to complete our evaluation, testing, and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to assert that our internal controls are effective.

 

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If we are unable to assert that our internal control over financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls, investors could lose confidence in the accuracy and completeness of our financial reports, which could cause the price of our common stock to decline, and we may become subject to investigation or sanctions by the SEC. We are required to disclose changes made in our internal control and procedures on a quarterly basis. However, our independent registered public accounting firm is not required to formally attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 until we are no longer an “emerging growth company,” as defined in the Jumpstart Our Business Startups Act of 2012, or the JOBS Act, for so long as we take advantage of the exemptions contained in the JOBS Act. We will remain an “emerging growth company” for up to five years after our initial public offering, although if the market value of our common stock that is held by non-affiliates exceeds $700 million as of any June 30 before that time, we would cease to be an “emerging growth company” as of the following December 31. At such time, our independent registered public accounting firm may issue a report that is adverse in the event it is not satisfied with the level at which our controls are documented, designed, or operating. Our remediation efforts may not enable us to avoid a material weakness in the future. In addition, to comply with the requirements of being a public company, we may need to undertake various actions, such as implementing new internal controls and procedures and hiring accounting or internal audit staff.

 

We may not be able to effectively manage our growth, which requires significant resources, and failure to do so may have an adverse effect on our business and our financial results may be adversely affected.

 

We have a limited operating history and plan to continue to grow our own property portfolio and refine our operations. Our future operating results depend upon our ability to effectively manage this growth, which is dependent, in part, upon the ability of our Manager to:

 

·                  stabilize and manage an increasing number of properties and resident relationships while maintaining a high level of customer service and building and enhancing our brand;

 

·                  identify and supervise suitable third parties and internal offices on which our Manager relies to provide certain services to our properties;

 

·                  continue to improve our operational and financial controls and reporting procedures and systems; and

 

·                  scale our technology and other infrastructure platforms to adequately service new properties.

 

We cannot assure you that our Manager will be able to achieve these results or that we may otherwise be able to manage our growth effectively. Any failure to do so may have an adverse effect on our business and financial results.

 

There are risks inherent in valuing large acquisitions, including the Formation Transactions, that may adversely affect our financial results.

 

We determine the fair market value of properties we acquire as part of large portfolios, including the properties we acquired in the Formation Transactions, based on a number of estimates and assumptions. We did not obtain opinions of fair value from independent third party appraisers for the properties acquired through the Formation Transactions, nor do we typically obtain such appraisals for our bulk purchases. The estimates and assumptions we use when we make bulk purchases may prove incorrect or there may be unknown or unforeseen liabilities associated with the properties that could result in the fair market value of the properties being materially lower than our estimate.

 

Additionally, if we suffer harm as a result of the sellers of large portfolios breaching any of the representations, warranties, or covenants made by them in the documents governing the Formation Transactions, we may not be fully indemnified or have other recourse against them. Further, to the extent that we do have any claims at law or equity against them for such breaches, we cannot assure you that we will be able to obtain or enforce a judgment in our favor. Therefore, any breaches of their representations, warranties or covenants could adversely affect the value of the properties we acquired in the Formation Transactions and our financial results.

 

Risks Related to Our Relationship with Our Manager

 

We are dependent upon our Manager, our Manager’s operating subsidiary and their key personnel, who provide services to us through the management agreement and the property management and acquisition services agreement, and we may not find suitable replacements if these agreements are terminated or these key personnel leave our Manager or our Manager’s operating subsidiary or otherwise become unavailable to us.

 

We have no employees and no separate facilities. Instead, we are completely dependent upon our Manager and our Manager’s operating subsidiary, which have significant discretion as to the implementation and execution of our investment and operating policies and business strategies. Our success depends upon the efforts, experience, diligence, skill and network of business

 

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contacts of the officers and key personnel of our Manager and our Manager’s operating subsidiary. The departure of any of the officers or key personnel of our Manager or our Manager’s operating subsidiary could have a material adverse effect on our performance.

 

Our Manager and our Manager’s operating subsidiary are not obligated to dedicate any specific personnel exclusively to us. Some of the officers of our Manager or Manager’s operating subsidiary have significant responsibilities for the other business of Pine River and as a result, these individuals may not always be willing or able to devote sufficient time to the management of our business.

 

The initial terms of the management agreement with our Manager and the property management and acquisition services agreement with our Manager’s operating subsidiary only extend until December 19, 2015 and December 19, 2014, respectively. If these agreements are terminated and no suitable replacement is found to manage us, we may not be able to execute our business plan.

 

We are dependent upon Pine River and its personnel, but cannot be assured of their continuing availability.

 

Our Manager has entered into a shared services and facilities agreement with Pine River pursuant to which Pine River provides our Manager with a portion of our Manager’s personnel, services and resources necessary for our Manager to perform its obligations and responsibilities under the management agreement. Because we are not a party to the shared services and facilities agreement, we will not have any recourse against Pine River if it does not fulfill its obligations under the shared services and facilities agreement or if Pine River and our Manager choose to amend or terminate the shared services and facilities agreement.

 

Our Manager and certain of its affiliates may have interests that diverge from the interests of our stockholders.

 

We are subject to conflicts of interest arising out of our relationship with our Manager, our Manager’s operating subsidiary, Pine River, Provident and each of their affiliates. Our Manager is a joint venture owned by Pine River and Provident. Each of Brian C. Taylor (a director), Thomas Siering (a director) and Timothy O’Brien (our General Counsel and Secretary) is a partner and owner of equity interests in Pine River. Irvin R. Kessler (a director) is the managing member and owner of equity interests in Provident. These individuals, as well as our other executive officers and the employees of our Manager and its affiliates on whom we rely, could make substantial profits as a result of investment opportunities allocated to entities other than us. As a result, these individuals could pursue transactions that may not be in our best interest, which could have a material adverse effect on our operations.

 

After the end of the exclusivity periods with our Manager and our Manager’s operating subsidiary, our Manager and our Manager’s operating subsidiary may manage other single-family real estate portfolios, which may result in conflicts of interest that could have an adverse effect on our business.

 

The management agreement and the property management and acquisition services agreement each provide that our Manager and our Manager’s operating subsidiary, as applicable, may only manage single-family real estate portfolios that are owned by us, our subsidiaries, and any future joint venture in which we are an investor prior to December 19, 2015. After the expiration of this exclusivity period, however, our Manager and our Manager’s operating subsidiary will be free to manage single-family real estate portfolios owned by others. Our Manager and our Manager’s operating subsidiary have developed and will continue to develop expertise, systems, and relationships with third parties with respect to the acquisition, management, and leasing of single-family real estate in our target markets. If our Manager and our Manager’s operating subsidiary or another entity affiliated with these individuals were to manage other residential assets in the future, they may leverage the expertise and skills garnered as our Manager or our Manager’s operating subsidiary to compete directly with us for acquisition opportunities, financing opportunities, residents and in other aspects of our business, which could have an adverse effect on our business. Neither our Manager nor our Manager’s operating subsidiary have any fiduciary duties to us and there is no assurance that any conflicts of interest will be resolved in favor of our stockholders.

 

We believe that the success of our business requires a significantly higher level of hands-on day-to-day attention from our Manager and our Manager’s operating subsidiary. If our Manager and our Manager’s operating subsidiary were to manage other residential assets in the future, they would have less time available to devote to our business and may be unable to effectively allocate their time and other resources among multiple portfolios. Accordingly, the quality of services provided to us by our Manager or our Manager’s operating subsidiary could decline, which could adversely impact all aspects of our business, including our growth prospects, resident retention, occupancy or our results of operations.

 

The management agreement with our Manager and the property management and acquisition services agreement with our Manager’s operating subsidiary were not negotiated on an arm’s-length basis and may not be as favorable to us as if they had been negotiated with unaffiliated third parties.

 

The management agreement with our Manager and the property management and acquisition services agreement with our Manager’s operating subsidiary were negotiated between related parties, and their terms, including fees payable to our Manager and our Manager’s operating subsidiary, may not be as favorable to us as if they had been negotiated with unaffiliated third parties. The terms of these agreements and similar agreements may not solely reflect stockholders’ best interests and may be overly favorable to the other party to such agreements, including in terms of the substantial compensation to be paid to these parties under these agreements. Further, we may choose not to enforce, or to enforce less vigorously, our rights under the management agreement or the

 

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property management and acquisition services agreement because of our desire to maintain our ongoing relationships with our Manager, our Manager’s operating subsidiary, Pine River, and Provident.

 

Our Manager may assign its obligations under the management agreement to its affiliates, who may not have the same expertise or provide the same level of service as our Manager.

 

Under the management agreement, our Manager may subcontract and assign its responsibilities under the agreement to any of its affiliates, or it may assign the management agreement to any of its affiliates without the approval of our independent directors. Although our Manager has informed us that it has no current intention to effect such an assignment, if there is such an assignment or transfer, the assignee may not have comparable operational expertise, have sufficient personnel, or manage our company as well as our Manager.

 

Under our management agreement, our Manager has a contractually defined duty to us rather than a fiduciary duty, which may cause our Manager to devote fewer resources to managing us than if it had a statutory duty.

 

Under the management agreement, our Manager maintains a contractual as opposed to a fiduciary relationship with us which limits our Manager’s obligations to us to those specifically set forth in the management agreement. The ability of our Manager (or its personnel) and its officers and employees to engage in other business activities may reduce the time our Manager spends managing us. In addition, unlike for directors, there is no statutory standard of conduct under the Maryland General Corporation Law, or the MGCL, for officers of a Maryland corporation. Instead, officers of a Maryland corporation, including officers who are employees of our Manager, are subject to general agency principals, including the exercise of reasonable care and skill in the performance of their responsibilities, as well as the duties of loyalty, good faith, and candid disclosure.

 

Our Manager and its employees and members have a conflict of interest because the advisory management fee is based on our fully diluted market capitalization, not our financial performance, and because our Manager passes through most of its costs and expenses to us regardless of performance or efficiency.

 

Our Manager is entitled to receive an advisory management fee that is based on the market capitalization of our common stock at the end of each quarter, regardless of our financial performance. Accordingly, significant advisory management fees will be payable to our Manager even if we experience losses. The advisory management fee structure gives our Manager the incentive to maximize market capitalization by the issuance of new common stock and the expansion of our scale of operations, regardless of the effect of this action on existing stockholders. In other words, the advisory management fee structure rewards our Manager primarily based on the equity value of our company, and not based on our returns to stockholders. Our advisory management fee structure rewards our Manager for issuances of common stock in the future, even if the net proceeds of such offerings cannot be invested in single-family properties with attractive yield characteristics. Any such offering would dilute our earnings and reduce distributions to our then-existing stockholders, but would provide economic benefits to our Manager. In addition, our Manager has an economic incentive to fund future growth through the issuance of equity capital as opposed to employing debt. Although the use of debt would be expected to increase returns on equity, which might make our stock price rise and, consequently, increase our market capitalization, debt financing would not be expected to have the same direct and immediate impact on advisory management fees as equity financing.

 

In addition to the risk that our Manager may have financial incentives to take actions that are contrary to the interests of our stockholders, there is a risk that our advisory management fee structure does not provide adequate incentives to ensure that our Manager will devote its time and efforts to contain costs and maximize distributable cash. Because market capitalization can be increased through additional sales of common stock at reduced prices that provide new investors with an appropriate yield, there is a significant risk that our Manager could receive higher levels of compensation despite a failure to maximize distributable cash or achieve an attractive yield for our investors.

 

Pursuant to the management agreement we must pay all costs and expenses of our Manager incurred in providing services to us except for certain expressly defined employee costs. Pursuant to the property management and acquisition services agreement, we must pay all costs and expenses incurred on our behalf in the operation of our Manager’s operating subsidiary, including all personnel costs. The right of our Manager and our Manager’s operating subsidiary to such reimbursement reduces their incentive to negotiate favorable contracts with third parties and minimize costs and expenses in operating our business, which could negatively affect our financial results.

 

Our management agreement requires us to pay our Manager a substantial fee in the event of a termination of the management agreement, which may adversely affect our inclination to end our relationship with our Manager.

 

Termination of the management agreement with our Manager without cause is difficult and costly. The term “cause” is limited to certain specifically described circumstances. The management agreement provides that, in the absence of cause, we may only terminate it upon the vote of at least two-thirds of all of our independent directors in the event of unsatisfactory performance that is materially detrimental to us and after giving 180 days’ notice and providing our Manager with an opportunity to remedy any unsatisfactory performance.

 

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Additionally, upon a termination by us without cause (or upon a termination by our Manager due to our material breach), the management agreement requires us to pay our Manager a termination payment equal to 4.5% of the daily average of our fully diluted market capitalization in the quarter preceding such termination. This provision increases the effective cost to us of terminating our relationship with our Manager, even if we believe that our Manager’s performance is not satisfactory.

 

Our Manager is only contractually committed to serve us until December 19, 2015. Thereafter, the management agreement is automatically renewed on an annual basis; provided, however, that our Manager may terminate the management agreement annually upon 180 days’ prior notice. If the management agreement is terminated and no suitable replacement is found to manage us, we may not be able to execute our business plan.

 

The liability of our Manager, Pine River, and Provident are limited under the management agreement, and we have agreed to indemnify our Manager and its affiliates and advisers, including Pine River and Provident, against certain liabilities. As a result, we could experience poor performance or losses for which our Manager, Pine River and Provident would not be liable.

 

Pursuant to the management agreement, our Manager does not assume any responsibility other than to render the services called for thereunder and is not responsible for any action of our board of directors in following or declining to follow its advice or recommendations. Our Manager and its officers, stockholders, members, managers, personnel and directors, any person controlling or controlled by our Manager and any person providing sub-advisory services to our Manager (which include Pine River and Provident) will not be liable to us, any of our subsidiaries, any of our directors, stockholders or partners or any subsidiary’s stockholders, members or partners for acts or omissions performed in accordance with or pursuant to the management agreement, except by reason of acts constituting reckless disregard of our Manager’s duties under the management agreement that have a material adverse effect on us, bad faith, fraud, willful misconduct or gross negligence, as determined by a final non-appealable order of a court of competent jurisdiction. We have agreed to indemnify our Manager and its affiliates, including Pine River and Provident, with respect to all expenses, losses, damages, liabilities, demands, charges and claims arising from acts or omissions of such indemnified parties not constituting reckless disregard of our Manager’ duties under the management agreement that have a material adverse effect on us, bad faith, fraud, willful misconduct or gross negligence. As a result, if we experience poor performance or losses, our Manager would not be liable.

 

Our board of directors has approved very broad investment guidelines and we do not expect the board to review or approve each acquisition decision made by our Manager.

 

Our board of directors periodically reviews and updates our investment guidelines and also reviews our portfolio of residential real estate and short-term investments, but it does not review or approve specific property acquisitions. Our Manager has great latitude within the broad parameters of the investment guidelines set by our board of directors in determining our acquisition strategies, which could result in net returns that are substantially below expectations or that result in material losses.

 

Our board of directors may change any of our strategy or investment guidelines, financing strategy or debt policies without stockholder consent.

 

Our board of directors may change any of our strategies, policies or procedures with respect to property acquisitions and divestitures, asset allocation, growth, operations, indebtedness, financing and distributions at any time without the consent of stockholders, which could result in our acquiring properties that are different from, and possibly riskier than, the types of single-family residential real estate investments described in this Annual Report. These changes could adversely affect our financial condition, risk profile, results of operations, the market price of our common stock and our ability to make distributions to stockholders.

 

Risks Related to Our Common Stock

 

Sales of common stock in the future may have adverse effects on our share price.

 

Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional authorized shares of common stock and preferred stock (or securities which are convertible or exchangeable for common stock or preferred stock) on the terms and for the consideration it deems appropriate. We cannot predict the effect, if any, of future sales of our common stock, or the effect, if any, of the availability of shares for future sales, on the market price of our common stock. We may expand the scale of our operations and may utilize the proceeds of future equity offerings to accomplish that strategy. To the extent the proceeds of any future equity offering are invested in residential assets that have less favorable yield characteristics than our then existing portfolio, our stockholders will suffer dilution in their yield and distributable cash per share.

 

The trading volume and market price of our common stock may be volatile and could decline substantially in the future.

 

We cannot assure stockholders that the market price of our common stock will not fluctuate or decline significantly in the future, including as a result of factors unrelated to our operating performance or prospects. Some of the factors that could negatively affect the market price or increase the volatility of our common stock include:

 

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·                  our actual or projected operating results, financial condition, cash flows and liquidity or changes in business strategy or prospects;

 

·                  actual or perceived conflicts of interest with our Manager, our Manager’s operating subsidiary or their affiliates and individuals, including our executives;

 

·                  equity issuances by us, or share resales by our stockholders, or the perception that such issuances or resales may occur;

 

·                  actual or anticipated accounting problems;

 

·                  publication of research reports about us or the real estate industry;

 

·                  changes in market valuations of similar companies;

 

·                  adverse market reaction to any increased indebtedness we incur in the future;

 

·                  additions to or departures of our Manager’s or our Manager’s operating subsidiary’s key personnel;

 

·                  speculation in the press or investment community;

 

·                  our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;

 

·                  increases in market interest rates, which may lead investors to seek alternative investments paying higher dividends or interest, or to demand a higher distribution yield for our common stock, and which would result in increased interest expense on our variable rate debt, if any;

 

·                  failure to maintain our REIT qualification;

 

·                  price and volume fluctuations in the stock market generally; and

 

·                  general market and economic conditions, including the current state of the credit and capital markets.

 

We have not established a minimum distribution payment level and we cannot assure you of our ability to pay distributions in the future.

 

We are generally required to distribute to our stockholders at least 90% of our taxable income each year in order to qualify as a REIT under the Code, which requirement we currently intend to satisfy through quarterly cash distributions of all or substantially all of our REIT taxable income in such year, subject to certain adjustments. We have not established a minimum distribution payment level and our ability to pay distributions may be adversely affected by a number of factors, including the risk factors described in this Annual Report. All distributions will be made at the discretion of our board of directors and will depend on our earnings, financial condition, maintenance of our REIT qualification and other factors that our board of directors may deem relevant from time to time. As a result, no assurance can be given that we will be able to make distributions to our stockholders at any time or that the level of any distributions will achieve any specific market yield or will increase or be maintained over time. Any failure to achieve expected distributions could materially and adversely affect the price of our common stock.

 

Our revolving credit facility and any other debt we may employ in the future could expose us to additional risks, may impair our ability to pay dividends, and may adversely affect the market price of our common stock.

 

Our current revolving credit facility requires us to comply with various financial tests, including those relating to total liquidity and net worth. Future debt agreements we may enter into may have similar or additional provisions. In the event that we are unable to satisfy these requirements, we could be required to sell properties at a loss which could materially and adversely affect us. In addition, our current revolving credit facility documents contain, and we expect future debt agreements will contain, events of default, including payment defaults, covenant defaults, breaches of representations and warranties, bankruptcy and insolvency, judgments, change of control and cross-default with certain other indebtedness and other events of default customary for these types of agreements. Because credit agreements typically contain cross-default provisions, a default that occurs under any one agreement could allow the lenders under our other agreements to also declare a default. Any losses we incur on our repurchase agreements could materially and adversely affect us.

 

The costs and fees associated with any such incurrence of debt and ongoing interest expense will reduce the amount of funds available to common stockholders. Because our decision to issue debt will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our incurrence and any such incurrence could reduce the market price of our common stock.

 

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We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.

 

We currently qualify as an “emerging growth company” as defined in the JOBS Act, and may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies,” including not being required to comply with the auditor attestation requirements of section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.

 

Risks Related to Our Organization and Structure

 

Certain provisions of Maryland law could inhibit changes in control, preventing our stockholders from realizing a potential premium over the market price of our stock in a proposed acquisition.

 

Certain provisions of the MGCL may have the effect of deterring a third party from making a proposal to acquire us or of impeding a change in control under circumstances that otherwise could provide the holders of our common stock with the opportunity to realize a premium over the then-prevailing market price of our common stock. We are subject to the “business combination” provisions of the MGCL that, subject to limitations, prohibit certain business combinations (including a merger, consolidation, share exchange, or, in circumstances specified in the statute, an asset transfer or issuance or reclassification of equity securities) between us and an “interested stockholder” (defined generally as any person who beneficially owns 10% or more of our then outstanding voting capital stock or an affiliate or associate of ours who, at any time within the two-year period prior to the date in question, was the beneficial owner of 10% or more of our then outstanding voting capital stock, provided that our board of directors did not approve in advance the transaction by which the stockholders otherwise would have become an interested stockholder) or an affiliate thereof for five years after the most recent date on which the stockholder becomes an interested stockholder. After the five-year prohibition, any business combination between us and an interested stockholder generally must be recommended by our board of directors and approved by the affirmative vote of at least (1) 80% of the votes entitled to be cast by holders of outstanding shares of our voting capital stock; and (2) two-thirds of the votes entitled to be cast by holders of voting capital stock of the corporation other than shares held by the interested stockholder with whom or with whose affiliate the business combination is to be effected or held by an affiliate or associate of the interested stockholder. These super-majority vote requirements do not apply if our common stockholders receive a minimum price, as defined under Maryland law, for their shares in the form of cash or other consideration in the same form as previously paid by the interested stockholder for its shares. These provisions of the MGCL do not apply, however, to business combinations that are approved or exempted by a board of directors prior to the time that the interested stockholder becomes an interested stockholder. Pursuant to the statute, our board of directors has by resolution exempted business combinations between us and any other person, provided that such business combination is first approved by our board of directors (including a majority of our directors who are not affiliates or associates of such person), and between us and Pine River, Provident, Two Harbors, or any of their respective affiliates, without the need for additional board approval.

 

The “control share” provisions of the MGCL provide that “control shares” of a Maryland corporation (defined as shares which, when aggregated with other shares controlled by the stockholder (except solely by virtue of a revocable proxy), entitle the stockholder to exercise one of three increasing ranges of voting power in electing directors) acquired in a “control share acquisition” (defined as the direct or indirect acquisition of ownership or control of “control shares”) have no voting rights except to the extent approved by our stockholders by the affirmative vote of at least two-thirds of all the votes entitled to be cast on the matter, excluding votes entitled to be cast by the acquiror of control shares, our officers and our personnel who are also our directors. Our bylaws contain a provision exempting from the control share acquisition statute any and all acquisitions by any person of shares of our stock. There can be no assurance that this provision will not be amended or eliminated at any time in the future.

 

The “unsolicited takeover” provisions of the MGCL permit our board of directors, without stockholder approval and regardless of what is currently provided in our charter or bylaws, to implement certain provisions if we have a class of equity securities registered under the Exchange Act (which we have) and at least three independent directors. These provisions may have the effect of inhibiting a third party from making an acquisition proposal for us or of delaying, deferring or preventing a change in control of us under the circumstances that otherwise could provide the holders of shares of common stock with the opportunity to realize a premium over the then current market price. Our charter contains a provision whereby we have elected to be subject to the provisions of Title 3, Subtitle 8 of the MGCL relating to the filling of vacancies on our board of directors.

 

Our authorized but unissued shares of common and preferred stock may prevent a change in our control.

 

Our charter authorizes our board of directors to issue additional authorized but unissued shares of common or preferred stock. In addition, our board of directors may, without stockholder approval, amend our charter to increase the aggregate number of our shares of stock or the number of shares of stock of any class or series that we have authority to issue and classify or reclassify any

 

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unissued shares of common or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board of directors may establish a series or class of shares of common or preferred stock that could delay or prevent a transaction or a change in control that might involve a premium price for our shares of common stock or otherwise be in the best interest of our stockholders.

 

Risks Related to Our Taxation as a REIT

 

If we do not qualify as a REIT or fail to remain qualified as a REIT, we will be subject to federal income tax as a regular corporation and could face a substantial tax liability, which would reduce the amount of cash available for distribution to our stockholders.

 

If we were to fail to qualify as a REIT in any taxable year, we would be subject to federal (and applicable state and local) income tax, including any applicable alternative minimum tax, on our taxable income at regular corporate rates. Dividends paid to our stockholders would not be deductible by us in computing our taxable income and would be taxable to our stockholders under the rules generally applicable to corporate distributions. The corporate tax liability arising from this inability to deduct dividends paid could be substantial and would reduce the amount of cash available for distribution to our stockholders, which in turn could have an adverse impact on the value of our common stock. Unless we were entitled to relief under certain Code provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year in which we failed to qualify as a REIT. The rule disqualifying us from taxation as a REIT following a loss of REIT status would also apply to us if Two Harbors fails to qualify as a REIT, and we are treated as a successor to Two Harbors for federal income tax purposes.

 

Dividends payable by REITs do not generally qualify for the reduced tax rates available for some dividends.

 

The federal income tax rate on certain corporate dividends paid to individuals and other non-corporate taxpayers is at a reduced rate of 15% or 20%, depending on the recipient’s income. Dividends paid by REITs to individuals and other non-corporate stockholders are not generally eligible for the reduced rate. This may cause investors to view REITs investments to be less attractive than non-REIT investments, which in turn may adversely affect the value of stock of REITs, including our common stock.

 

REIT distribution requirements could adversely affect our economic performance.

 

We generally must distribute annually at least 90% of our taxable income, subject to certain adjustments and excluding any net capital gain, in order to comply with REIT requirements. To the extent that we satisfy this distribution requirement, but distribute less than 100% of our taxable income, we will be subject to federal corporate income tax on our undistributed taxable income. In addition, we will be subject to a 4% nondeductible excise tax if the actual amount that we pay out to our stockholders in a calendar year is less than a minimum amount required under the Code. We intend to make distributions to our stockholders to comply with the REIT requirements of the Code.

 

Compliance with the REIT distribution requirements may hinder our ability to grow, which could adversely affect the value of our common stock. Furthermore, we may find it difficult or impossible to meet distribution requirements in certain circumstances. The requirement to distribute most of our taxable income could cause us to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be used to make future acquisitions or capital expenditures, or (iv) make a taxable distribution of our shares as part of a distribution in which stockholders may elect to receive shares or cash, in order to comply with REIT requirements. These alternatives could adversely affect our economic performance.

 

If the initial tax basis that we established for our assets is challenged by the IRS, we may have to distribute additional amounts in order to satisfy the REIT distribution requirements.

 

We established our initial tax basis in the assets received in the Formation Transactions in part by reference to the trading price of our common stock. The IRS could assert that our initial tax basis is less than the amount determined by us (or is a carryover basis). If the IRS were successful in sustaining such an assertion, this would result in decreased depreciation deductions and increased gain on any asset dispositions, and thus increased taxable income, as compared to the amounts we had originally calculated and reported. This could result in our being required to distribute additional amounts in order to maintain our REIT status and avoid corporate taxes and also could result in our owing interest and penalties.

 

The stock ownership limit imposed by the Code for REITs and our charter may restrict our business combination opportunities.

 

In order for us to maintain our qualification as a REIT under the Code, not more than 50% in value of our outstanding stock may be owned, directly or indirectly, by five or fewer individuals (as defined in the Code to include certain entities) at any time during the last half of each taxable year following our first year. Our charter, with certain exceptions, authorizes our board of directors to take the actions that are necessary and desirable to preserve our qualification as a REIT. Our charter provides that, unless exempted by our board of directors, no person may own more than 9.8% of the aggregate value of our outstanding capital stock. Our board may grant an exemption in its sole discretion, subject to such conditions, representations and undertakings as it may determine. The ownership limits imposed by the tax law are based upon direct or indirect ownership by “individuals,” but only during the last half of a tax year. The ownership limits contained in our charter key off of the ownership at any time by any “person,” which term includes entities. These ownership limitations in our charter are common in REIT charters and are intended to provide added assurance of compliance with the tax law requirements and to minimize administrative burdens. However, these ownership limits might also delay or prevent a

 

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transaction or a change in our control that might involve a premium price for our common stock or otherwise be in the best interest of our stockholders.

 

Even if we qualify as a REIT, we may face other tax liabilities that reduce our cash flow.

 

Even if we qualify for taxation as a REIT, we may be subject to certain federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes. In addition, we could, in certain circumstances, be required to pay an excise tax or penalty tax (which could be significant in amount) in order to utilize one or more of the relief provisions under the Code to maintain our qualification as a REIT. In addition, in order to meet the REIT qualification requirements or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from sales of “dealer property,” we may hold some of our assets or conduct activities through subsidiary corporations that will be subject to corporate-level income tax at regular rates (a “taxable REIT subsidiary,” or TRS). In addition, if we lend money to a TRS, the TRS may be unable to deduct all or a portion of the interest paid to us, which could result in an even higher corporate level tax liability. Any of these taxes would decrease cash available for distribution to our stockholders.

 

Furthermore, the Code imposes a 100% tax on certain transactions between a TRS and its parent REIT that are not conducted on an arm’s-length basis. We will structure our transaction with any TRS on terms that we believe are arm’s-length to avoid incurring the 100% excise tax described above. There can be no assurances, however, that we will be able to avoid application of the 100% tax.

 

Complying with REIT requirements may cause us to forgo otherwise attractive opportunities.

 

To qualify as a REIT for federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our stockholders and the ownership of our stock. We may be required to make distributions to stockholders at disadvantageous times or when we do not have funds readily available for distribution, and may be unable to pursue investments that would be otherwise advantageous to us in order to satisfy the source-of-income or asset-diversification requirements for qualifying as a REIT. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments.

 

We may in the future choose to pay dividends in our own stock, in which case our stockholders may be required to pay income taxes in excess of the cash dividends they receive.

 

We may in the future distribute taxable dividends that are payable in cash and shares of our common stock at the election of each stockholder, but subject to a limitation on the amount of cash that may be distributed. Taxable stockholders receiving such dividends will be required to include the full amount of the dividend, whether received as cash or shares of our common stock, as ordinary income to the extent of our current and accumulated earnings and profits for federal income tax purposes. As a result, stockholders may be required to pay income taxes with respect to such dividends in excess of the cash dividends received. If a U.S. stockholder sells the stock that it receives as a dividend in order to pay this tax, the sales proceeds may be less than the amount included in income with respect to the dividend, depending on the market price of our stock at the time of the sale. Furthermore, with respect to certain non-U.S. stockholders, we may be required to withhold U.S. tax with respect to such dividends, including in respect of all or a portion of such dividend that is payable in stock. In addition, if a significant number of our stockholders determine to sell shares of our common stock in order to pay taxes owed on dividends, it may put downward pressure on the trading price of our common stock.

 

Under a previously applicable Revenue Procedure, 90% of taxable cash/stock dividends of a REIT could be paid in stock. It is unclear whether and to what extent we will be able to pay taxable dividends in cash and stock. Moreover, various aspects of such a taxable cash/stock dividend are uncertain and have not yet been addressed by the IRS. No assurance can be given that the IRS will not impose additional requirements in the future with respect to taxable cash/stock dividends or assert that the requirements for such taxable cash/stock dividends have not been met.

 

The REIT rules relating to prohibited transactions could affect our disposition of assets and adversely affect our profitability.

 

From time to time, we may choose to transfer or dispose of some of the properties in our portfolios. A REIT’s net income from “prohibited transactions” is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, held primarily for sale to customers in the ordinary course of business, or “dealer property.” We intend to conduct our activities so as not to generate prohibited transaction income. However, the avoidance of this tax on prohibited transactions could cause us to undertake less substantial sales of property than we would otherwise undertake in order to maximize our profits. In addition, we may have to sell numerous properties to a single or a few purchasers, which could cause us to be less profitable than would be the case if we sold properties on a property-by-property basis.

 

If the Operating Partnership fails to qualify as a partnership for federal income tax purposes, we could fail to qualify as a REIT and suffer other adverse consequences.

 

We believe that the Operating Partnership is organized and operates in a manner so as to be treated as a partnership and not an association or a publicly traded partnership taxable as a corporation, for federal income tax purposes. As a partnership, the Operating Partnership is not subject to federal income tax on its income. Instead, each of the partners is allocated its share of the

 

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Operating Partnership’s income. No assurance can be provided, however, that the IRS will not challenge the Operating Partnership’s status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating the Operating Partnership as an association or publicly traded partnership taxable as a corporation for federal income tax purposes, we could fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, could cease to qualify as a REIT. Also, the failure of the Operating Partnership to qualify as a partnership would cause it to become subject to federal corporate income tax, which would reduce significantly the amount of its cash available for distribution to its partners, including us.

 

Distributions to tax-exempt investors may be classified as unrelated business taxable income.

 

Neither ordinary nor capital gain distributions with respect to our common stock nor gain from the sale of common stock should generally constitute unrelated business taxable income to a tax-exempt investor. However, there are certain exceptions to this rule. In particular:

 

·                  part of the income and gain recognized by certain qualified employee pension trusts with respect to our common stock may be treated as unrelated business taxable income if shares of our common stock are predominantly held by qualified employee pension trusts, and we are required to rely on a special look-through rule for purposes of meeting one of the REIT ownership tests, and we are not operated in a manner to avoid treatment of such income or gain as unrelated business taxable income;

 

·                  part of the income and gain recognized by a tax-exempt investor with respect to our common stock would constitute unrelated business taxable income if the investor incurs debt in order to acquire the common stock; and

 

·                  part or all of the income or gain recognized with respect to our common stock by social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts and qualified group legal services plans which are exempt from federal income taxation under the Code may be treated as unrelated business taxable income.

 

Qualifying as a REIT involves highly technical and complex provisions of the Code and a violation of these provisions could jeopardize our REIT status.

 

Qualification as a REIT involves the application of highly technical and complex Code provisions for which only limited judicial and administrative authorities exist. Even a technical or inadvertent violation could jeopardize our REIT qualification. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, stockholder ownership and other requirements on a continuing basis. In addition, our ability to satisfy the requirements to qualify as a REIT may depend in part on the actions of third parties over which we may have no control or only limited influence, including in cases where we own an equity interest in an entity that is classified as a partnership for federal income tax purposes.

 

New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT.

 

The present federal income tax treatment of REITs may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the federal income tax treatment of an investment in us. The federal income tax rules relating to REITs are constantly under review by persons involved in the legislative process, the IRS and the U.S. Treasury Department, which results in frequent statutory changes and revisions to regulations and interpretations. Revisions in federal tax laws and interpretations thereof could adversely affect us or cause us to change our investments and commitments and affect the tax considerations of an investment in us.

 

Item 1B.    Unresolved Staff Comments.

 

None.

 

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Item 2.    Properties.

 

The following table provides a summary of our portfolio of single-family properties as of December 31, 2013:

 

Market

 

Number of
Properties (1)

 

Aggregate Cost
Basis (2)
(thousands)

 

Average Cost
Basis Per
Property
(thousands)

 

Average Age (in
years) (3)

 

Average
Square
Footage

 

Phoenix

 

1,424

 

198,889

 

$

140

 

24.2

 

1,636

 

Atlanta

 

1,000

 

123,938

 

124

 

16.9

 

2,011

 

Tampa

 

924

 

130,791

 

142

 

23.5

 

1,657

 

Northern CA (4) 

 

384

 

71,902

 

187

 

44.4

 

1,401

 

Las Vegas

 

290

 

40,800

 

141

 

16.7

 

1,719

 

Columbus

 

284

 

29,651

 

104

 

35.7

 

1,417

 

Dallas

 

227

 

28,804

 

127

 

20.2

 

1,652

 

Orlando

 

215

 

32,632

 

152

 

24.9

 

1,681

 

Tucson

 

209

 

17,134

 

82

 

40.0

 

1,330

 

Southeast FL (5)

 

165

 

33,262

 

202

 

34.3

 

1,688

 

Southern CA (6) 

 

156

 

23,383

 

150

 

43.0

 

1,346

 

Jacksonville

 

131

 

17,002

 

130

 

30.4

 

1,568

 

Charlotte

 

130

 

16,961

 

130

 

11.8

 

1,980

 

Houston

 

103

 

11,155

 

108

 

29.8

 

1,698

 

 

 

 

 

 

 

 

 

 

 

 

 

Totals

 

5,642

 

$

776,304

 

138

 

25.6

 

1,675

 

 


(1)                                 Total properties exclude properties held for sale or sold by our TRS and any properties acquired in previous periods in sales that have been subsequently rescinded or vacated.

 

(2)                                 Aggregate cost includes all capitalized costs, determined in accordance with GAAP, incurred through December 31, 2013 for the acquisition, stabilization, and significant post-stabilization renovation of properties, including land, building, possession costs, and renovation costs.  Aggregate cost does not include accumulated depreciation.

 

(3)                                 As of December 31, 2013, approximately 19% of the properties in the combined portfolio were less than 10 years old, 26% were between 10 and 20 years old, 18% were between 20 and 30 years old, 17% were between 30 and 40 years old, 9% were between 40 and 50 years old, and 11% were more than 50 years old.

 

(4)                                 Northern California market currently consists of Contra Costa, Napa, and Solano counties.

 

(5)                                 Southeast Florida market currently consists of Miami-Dade, Broward, and Palm Beach counties.

 

(6)                                 Southern California market currently consists of Riverside and San Bernardino counties.

 

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The following table summarizes the leasing status of our properties as of December 31, 2013:

 

Market

 

Number of
Properties

 

Number of
Stabilized
Properties (1)

 

Properties
Leased

 

Properties Vacant

 

Aggregate
Portfolio
Occupancy
Rate

 

Stabilized
Occupancy
Rate

 

Average
Monthly
Rent (2)

 

Phoenix

 

1,424

 

1,423

 

1,350

 

74

 

94.8

%

94.9

%

$

1,026

 

Atlanta

 

1,000

 

950

 

840

 

160

 

84.0

%

88.4

%

1,165

 

Tampa

 

924

 

916

 

902

 

22

 

97.6

%

98.5

%

1,215

 

Northern CA

 

384

 

383

 

370

 

14

 

96.4

%

96.6

%

1,478

 

Las Vegas

 

290

 

290

 

278

 

12

 

95.9

%

95.9

%

1,150

 

Columbus

 

284

 

193

 

104

 

180

 

36.6

%

53.9

%

1,112

 

Dallas

 

227

 

207

 

186

 

41

 

81.9

%

89.9

%

1,241

 

Orlando

 

215

 

194

 

189

 

26

 

87.9

%

97.4

%

1,247

 

Tucson

 

209

 

207

 

192

 

17

 

91.9

%

92.8

%

829

 

Southeast FL

 

165

 

124

 

117

 

48

 

70.9

%

94.4

%

1,760

 

Southern CA

 

156

 

155

 

145

 

11

 

92.9

%

93.5

%

1,148

 

Jacksonville

 

131

 

112

 

101

 

30

 

77.1

%

90.2

%

1,083

 

Charlotte

 

130

 

120

 

112

 

18

 

86.2

%

93.3

%

1,155

 

Houston

 

103

 

91

 

87

 

16

 

84.5

%

95.6

%

1,180

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Totals

 

5,642

 

5,365

 

4,973

 

669

 

88.1

%

92.7

%

$

1,162

 

 


(1)         We consider a property stabilized at the earlier of (i) its first authorized occupancy or (ii) 90 days after the renovations for such property are complete regardless of whether the property is leased. Properties acquired with in-place leases are considered stabilized even though such properties may require future renovation to meet our standards and may have existing residents who would not otherwise meet our resident screening requirements.

 

(2)         Average monthly rent for leased properties was calculated as the average of the contracted monthly rent for all leased properties as of December 31, 2013 and reflects rent concessions amortized over the life of the related lease.

 

Item 3.    Legal Proceedings.

 

From time to time, we are party to claims and routine litigation arising in the ordinary course of our business. We do not believe that the results of any such claims or litigation individually, or in the aggregate, will have a material adverse effect on our business, financial position, or results of operations.

 

Item 4.    Mine Safety Disclosures.

 

Not applicable.

 

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Table of Contents

 

PART II

 

Item 5.    Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information

 

Our common stock has been listed on the NYSE, under the symbol “SBY” since December 14, 2012.  Below is a summary of the high and low prices for our common stock for each quarterly period during calendar years ended December 31, 2013 and December 31, 2012, as reported on the NYSE:

 

Quarter Ended

 

High

 

Low

 

December 31, 2012

 

$

19.84

 

$

18.00

 

March 31, 2013

 

$

22.40

 

$

18.56

 

June 30, 2013

 

$

21.84

 

$

15.54

 

September 30, 2013

 

$

17.66

 

$

15.36

 

December 31, 2013

 

$

16.34

 

$

15.10

 

 

Holders

 

As of March 3, 2014, we had 134 holders of record of our common stock.  However, because many of our common shares are held by brokers and other institutions on behalf of stockholders, there are substantially more beneficial holders of our common stock than record holders.

 

Dividends

 

The following table presents cash dividends declared on our common stock from December 14, 2012 through December 31, 2013:

 

Declaration Date

 

Record Date

 

Payment Date

 

Cash Dividend
per Share

 

March 21, 2013

 

April 1, 2013

 

April 12, 2013

 

$

0.01

 

June 20, 2013

 

July 1, 2013

 

July 12, 2013

 

0.01

 

September 19, 2013

 

October 1, 2013

 

October 11, 2013

 

0.01

 

December 19, 2013

 

December 30, 2013

 

January 10, 2014

 

0.01

 

 

We intend to make quarterly distributions to our common stockholders. U.S. federal income tax law requires that a REIT distribute annually at least 90% of its net taxable income, excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its REIT taxable income, including capital gains.

 

Dividends and other distributions will be authorized by our board of directors in its sole discretion out of funds legally available therefor and will be dependent upon a number of factors, including actual results of operations, restrictions under Maryland law and our financial condition. See Item 1A, “Risk Factors,” and Item 7, “Management’s Discussion and Analysis of Financial Conditions and Results of Operations,” including “Liquidity and Capital Resources — Revolving Credit Facility,” of this Annual Report on Form 10-K, for information regarding the sources of funds used for dividends and for a discussion of factors, if any, which may adversely affect our ability to pay dividends in 2014 and thereafter.

 

Securities Authorized for Issuance under Equity Compensation Plans

 

The following table provides information as of December 31, 2013 with respect to shares of our common stock that may be issued under our equity compensation plans.

 

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Table of Contents

 

Plan Category

 

Number of securities to
be issued upon exercise
of outstanding stock
awards

 

Weighted-average
exercise price of
outstanding stock
awards

 

Number of securities remaining
available for future issuance under
equity compensation plans (excluding
securities reflected in first column)

 

Equity compensation plans approved by security holders

 

 

 

783,833

 

Equity compensation plans not approved by security holders

 

 

 

 

Total

 

 

 

783,833

 

 

Unregistered Sales of Equity Securities

 

On August 27, 2012, in connection with our organization, we issued 1,000 shares of our common stock to our Manager for total consideration of $1,000 in cash in order to provide for our initial capitalization. Such issuance was exempt from the registration requirements of the Securities Act of 1933, as amended, or the Securities Act, pursuant to Section 4(2) thereof.  On December 19, 2012, we repurchased these shares from our Manager for $1,000.

 

On December 19, 2012, in connection with the Formation Transactions, we issued an aggregate of 23,917,642 shares of common stock and 27,459 common units in the Operating Partnership with an aggregate value of approximately $443.0 million, based on the initial public offering price of $18.50, to affiliates of Two Harbors and Provident in consideration for their contribution to us of equity interests in entities which owned residential real properties. In addition, we issued to Two Harbors 1,000 shares of our cumulative redeemable preferred stock with a $1.0 million aggregate liquidation preference in connection with the Formation Transactions. The issuance of such shares and common units was effected in reliance upon exemptions from registration provided by Section 4(2) of the Securities Act.

 

On December 31, 2013, we redeemed all limited partners in our Operating Partnership other than us and our affiliates by issuing 27,459 shares of common stock to such limited partners in exchange for a like number of common units in our Operating Partnership. The issuance of such shares was effected in reliance upon exemptions from registration provided by Section 4(2) of the Securities Act.

 

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

 

Period

 

Total Number of
Shares
Purchased

 

Average Price
Paid Per Share (1)

 

Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs (2)

 

Maximum number of shares
that may yet be purchased
under the plans or programs

 

October 1, 2013 — October 31, 2013

 

 

 

 

2,000,000

 

November 1, 2013 — November 30, 2013

 

204,530

 

$

15.2930

 

204,530

 

1,795,470

 

December 1, 2013 — December 31, 2013(3)

 

53,823

 

$

15.6474

 

46,238

 

1,749,232

 

Total

 

258,353

 

$

15.3668

 

250,768

 

1,749,232

 

 


(1)   Includes commissions

(2)   These shares were repurchased under the Company’s share repurchase program announced on July 1, 2013, pursuant to which the Company is authorized to repurchase up to 2,500,000 shares of its common stock

(3)   Includes 7,585 shares withheld to settle tax withholding obligations related to the vesting of restricted stock awards at a price of $15.93 per share

 

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Table of Contents

 

Performance Graph

 

The following graph compares the stockholders’ cumulative total return, assuming $100 invested at December 14, 2012 (the first day of trading), with all reinvestment of dividends, as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the Standard and Poor’s 500 Stock Index (“S&P 500”); and (iii) the stocks included in the MSCI REIT Index.

 

 

 

 

Period Ending

 

Index

 

12/14/2012

 

12/31/2012

 

3/31/2013

 

6/30/2013

 

9/30/2013

 

12/31/2013

 

SILVER BAY REALTY TRUST CORP.

 

$

100.00

 

$

101.78

 

$

113.54

 

$

90.89

 

$

86.01

 

$

86.64

 

S&P 500

 

$

100.00

 

$

100.97

 

$

111.68

 

$

114.93

 

$

120.96

 

$

133.66

 

MSCI REIT INDEX

 

$

100.00

 

$

103.10

 

$

111.42

 

$

109.69

 

$

106.40

 

$

105.68

 

 

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Table of Contents

 

Item 6.     Selected Financial Data.

 

Our selected financial data set forth below should be read in conjunction with our consolidated financial statements and the accompanying notes included under Item 8 of this Annual Report on Form 10-K.  Our 2012 consolidated financial results include Silver Bay Property since it commenced formal operations and the Provident Entities since December 19, 2012, the date we acquired those entities. As a consequence, our financial results for 2012 are not indicative of future performance as they largely reflect the operations of Silver Bay Property, which began formal operations in February 2012 when it began acquiring single-family properties, and includes 12 days of results for the more stabilized portfolio of the Provident entities.

 

 

 

At or for the Years Ended December 31,

 

(in thousands, except other data)

 

2013

 

2012

 

Statement of Operations and Comprehensive Loss Data:

 

 

 

 

 

Revenue:

 

 

 

 

 

Rental income

 

$

47,953

 

$

3,584

 

Other income

 

1,640

 

32

 

Total revenue

 

49,593

 

3,616

 

Expenses:

 

 

 

 

 

Property operating and maintenance

 

12,472

 

1,868

 

Real estate taxes

 

6,893

 

1,273

 

Homeowners’ association fees

 

1,129

 

391

 

Property management

 

11,991

 

459

 

Depreciation and amortization

 

20,235

 

2,106

 

Advisory management fee - affiliates

 

9,775

 

2,159

 

General and administrative

 

7,453

 

881

 

Interest Expense

 

2,911

 

 

Other

 

1,284

 

 

Net loss

 

$

(24,550

)

$

(5,521

)

 

 

 

 

 

 

Per Common Share and Share Information:

 

 

 

 

 

Loss per share (1) - basic and diluted:

 

 

 

 

 

Net loss attributable to common shares

 

$

(0.63

)

$

(0.04

)

Weighted average common shares outstanding

 

39,073,994

 

37,328,213

 

Dividends declared per common share

 

$

0.04

 

$

 

Balance Sheet Data:

 

 

 

 

 

Investments in real estate, net

 

$

757,407

 

$

418,693

 

Assets held for sale

 

6,382

 

 

Cash

 

43,717

 

228,139

 

Escrow deposits (2) 

 

24,461

 

19,727

 

Total assets

 

846,078

 

677,302

 

Revolving credit facility

 

164,825

 

 

Total liabilities

 

187,118

 

16,889

 

10% cumulative redeemable preferred stock

 

1,000

 

1,000

 

Total equity

 

657,960

 

659,413

 

 

 

 

 

 

 

Other Data:

 

 

 

 

 

Net operating income (3)

 

$

19,872

 

$

(365

)

Funds from operations (4)

 

(3,637

)

(3,407

)

Total properties owned

 

5,642

 

3,405

 

Aggregate occupancy percentage

 

88

%

50

%

Average monthly rent per leased property

 

$

1,162

 

$

1,148

 

Stabilized Properties (5):

 

 

 

 

 

Stabilized properties owned

 

5,365

 

 

 

Stabilized leased properties

 

4,973

 

 

 

Occupancy percentage

 

93

%

 

 

 


(1)         Silver Bay calculated the 2012 loss per share only for the period its common stock was outstanding during the year, referred to as the post-formation period.  Prior to its initial public offering and formation transactions, Silver Bay did not have any publicly

 

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Table of Contents

 

issued common stock.  The Formation Transactions closed on December 19, 2012, therefore Silver Bay has defined the post-formation period to be the date of the formation transactions through December 31, 2012, or 12 days of activity.

 

(2)         Escrow deposits include refundable and non-refundable cash and earnest money on deposit with the Manager’s operating subsidiary and certain third party property managers for property purchases and renovation costs, earnest money deposits, and, at times, monies held at certain municipalities for property purchases. Escrow deposits in 2013 also include cash held in reserve at financial institutions, as required by the revolving credit facility.

 

(3)         We define net operating income, or NOI, as total revenue less property operating and maintenance, real estate taxes, homeowners’ association fees, property management expenses and certain other non-recurring, non-cash or unrelated non-operating expenses. NOI excludes depreciation and amortization, advisory management fees, general and administrative expenses, interest expense, and other expense.  Additionally, NOI excludes the 5% property management fee on certain costs and expenses incurred by our Manager’s operating subsidiary that are reimbursed by us, expensed acquisition fees and costs, and certain other non-recurring property management costs. 

 

We consider NOI to be a meaningful financial measure, when considered with the financial statements determined in accordance with generally accepted accounting principles, or GAAP. We believe NOI is helpful to investors in understanding the core performance of our real estate operations. A reconciliation of NOI to net loss as determined in accordance with GAAP is located in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Net Operating Income,” in this Annual Report on Form 10-K

 

(4)         Funds From Operations, or FFO, is a non-GAAP financial measure that we believe, when considered with the financial statements determined in accordance with GAAP, is helpful to investors in understanding our performance because it captures features particular to real estate performance by recognizing that real estate generally appreciates over time or maintains residual value to a much greater extent than do other depreciable assets.  The National Association of Real Estate Investment Trusts, or NAREIT, defines FFO as net income (loss), computed in accordance with GAAP, excluding gains from sales of, and impairment losses recognized with respect to, depreciable property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated on the same basis to determine FFO. We calculate FFO attributable to common stockholders (diluted) by subtracting, if dilutive, redemption or repurchase related preferred stock issuance costs and dividends on preferred stock and adding back dividends/distributions on dilutive preferred securities and premiums or discounts on preferred stock redemptions or repurchases.

 

FFO should not be considered an alternative to net income (loss) or net cash flows from operating activities, as determined in accordance with GAAP, as indications of our performance or as measures of liquidity. This non-GAAP measure is not necessarily indicative of cash available to fund future cash needs. In addition, although we use this non-GAAP measure for comparability in assessing our performance against other REITs, not all REITs compute the same non-GAAP measure. A reconciliation of FFO to net loss attributable to common stockholders as determined in accordance with GAAP is located in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Funds From Operations,” in this Annual Report on Form 10-K

 

(5)         We consider a property stabilized at the earlier of (i) its first authorized occupancy or (ii) 90 days after the renovations for such property are complete regardless of whether the property is leased. Properties acquired with in-place leases are considered stabilized even though such properties may require future renovation to meet our standards and may have existing residents who would not otherwise meet our resident screening requirements.

 

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Table of Contents

 

Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

The following discussion should be read in conjunction with the financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. This report, including the following Management’s Discussion and Analysis of Financial Conditions and Results of Operations, contains forward-looking statements regarding future events or trends that should be read in conjunction with the factors described under “Special Note Regarding Forward-Looking Statements” included in this report. In addition, our actual results could differ materially from those projected in such forward-looking statements as a result of the factors discussed under “Special Note Regarding Forward-Looking Statements” as well as the risk factors described in Item 1A, “Risk Factors,” of this report.

 

Overview

 

We are an externally-managed Maryland corporation focused on the acquisition, renovation, leasing, and management of single-family properties in select markets in the United States. Our objective is to generate attractive risk-adjusted returns for our stockholders over the long term through dividends and capital appreciation. We generate virtually all of our revenue by leasing our portfolio of single-family properties. As of December 31, 2013, we owned 5,642 single-family properties, excluding properties held for sale, in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, and Texas, 88.1% of which were leased.

 

We are externally managed by our Manager. We rely on our Manager to provide or obtain on our behalf the personnel and services necessary for us to conduct our business as we have no employees of our own. Our Manager is a joint venture of Pine River and Provident, and our Manager and its operating subsidiary together provide us with a comprehensive suite of investment, acquisition, and property management services, utilizing the combined expertise of Pine River and Provident.

 

We have elected to be treated as a real estate investment trust, or REIT, for U.S. federal tax purposes, commencing with, and in connection with the filing of our federal tax return for, our taxable year ended December 31, 2012. As a REIT, we generally are not subject to federal income tax on the taxable income that we distribute to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject to federal income tax at regular corporate rates. Even if we qualify for taxation as a REIT, we may be subject to some federal, state and local taxes on our income or property.  In addition, the income of any taxable REIT subsidiary, or TRS, that we own will be subject to taxation at regular corporate rates.

 

Silver Bay Realty Trust Corp. conducts its business and owns all of its properties through Silver Bay Operating Partnership L.P., or the Operating Partnership, a Delaware limited partnership. Silver Bay Realty Trust Corp.’s wholly owned subsidiary, Silver Bay Management LLC, or the General Partner, is the sole general partner of the Operating Partnership. Silver Bay Realty Trust Corp. has no material assets or liabilities other than its investment in the Operating Partnership.  As of December 31, 2013, Silver Bay Realty Trust Corp. owned, through a combination of direct and indirect interests, 100.0% of the partnership interests in the Operating Partnership.

 

Recent Highlights

 

We completed our initial public offering on December 19, 2012 in which we received net proceeds of approximately $263.0 million (including the closing of the underwriters’ overallotment option on January 7, 2013 by which we received net proceeds of approximately $34.5 million). In connection with our initial public offering, we also completed the Formation Transactions through which we acquired our Initial Portfolio of more than 3,300 single-family properties from Two Harbors and the owners of the Provident Entities.

 

In 2013, we grew our portfolio by 2,237 properties, increasing our gross investment in real estate by $355.7 million to $776.3 million. We also stabilized a significant number of properties, increasing the total number of stabilized properties to 5,365 with an occupancy rate as of December 31, 2013 of 92.7%. This increase drove aggregate portfolio occupancy from 50% at December 31, 2012 to 88.1% at December 31, 2013 and contributed to the revenue growth and margin expansion throughout the year. We reported Funds From Operations, or FFO, of $1.5 million in the fourth quarter of 2013, our first positive quarter of FFO.

 

In May 2013, certain of our subsidiaries entered into a $200.0 million revolving credit facility, which was amended on January 16, 2014 to increase the borrowing capacity to $350.0 million.  We have used the revolving credit facility for the acquisition, financing, and renovation of properties and for other general purposes. As of December 31, 2013, we had drawn down $164.8 million under our revolving credit facility.

 

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Property Portfolio

 

Our real estate investments consist of single-family properties in select markets. As of December 31, 2013, we owned 5,642 single-family properties, excluding properties held for sale, in the following markets:

 

Market

 

Number of
Properties (1)

 

Aggregate Cost
Basis (2)
(thousands)

 

Average Cost
Basis Per
Property
(thousands)

 

Average Age (in
years) (3)

 

Average
Square
Footage

 

Phoenix

 

1,424

 

198,889

 

$

140

 

24.2

 

1,636

 

Atlanta

 

1,000

 

123,938

 

124

 

16.9

 

2,011

 

Tampa

 

924

 

130,791

 

142

 

23.5

 

1,657

 

Northern CA (4) 

 

384

 

71,902

 

187

 

44.4

 

1,401

 

Las Vegas

 

290

 

40,800

 

141

 

16.7

 

1,719

 

Columbus

 

284

 

29,651

 

104

 

35.7

 

1,417

 

Dallas

 

227

 

28,804

 

127

 

20.2

 

1,652

 

Orlando

 

215

 

32,632

 

152

 

24.9

 

1,681

 

Tucson

 

209

 

17,134

 

82

 

40.0

 

1,330

 

Southeast FL (5)

 

165

 

33,262

 

202

 

34.3

 

1,688

 

Southern CA (6) 

 

156

 

23,383

 

150

 

43.0

 

1,346

 

Jacksonville

 

131

 

17,002

 

130

 

30.4

 

1,568

 

Charlotte

 

130

 

16,961

 

130

 

11.8

 

1,980

 

Houston

 

103

 

11,155

 

108

 

29.8

 

1,698

 

 

 

 

 

 

 

 

 

 

 

 

 

Totals

 

5,642

 

$

776,304

 

138

 

25.6

 

1,675

 

 


(1)                                 Total properties exclude properties held for sale or sold by our TRS and any properties acquired in previous periods in sales that have been subsequently rescinded or vacated.

 

(2)                                 Aggregate cost includes all capitalized costs, determined in accordance with GAAP, incurred through December 31, 2013 for the acquisition, stabilization, and significant post-stabilization renovation of properties, including land, building, possession costs and renovation costs.  Aggregate cost does not include accumulated depreciation.

 

(3)                                 As of December 31, 2013, approximately 19% of the properties in the combined portfolio were less than 10 years old, 26% were between 10 and 20 years old, 18% were between 20 and 30 years old, 17% were between 30 and 40 years old, 9% were between 40 and 50 years old, and 11% were more than 50 years old.

 

(4)                                 Northern California market currently consists of Contra Costa, Napa and Solano counties.

 

(5)                                 Southeast Florida market currently consists of Miami-Dade, Broward and Palm Beach counties.

 

(6)                                 Southern California market currently consists of Riverside and San Bernardino counties.

 

Factors likely to affect Silver Bay Results of Operations

 

Our results of operations and financial condition will be affected by numerous factors, many of which are beyond our control. The key factors we expect to impact our results of operations and financial condition include our pace and costs of acquisitions, the time and costs required to stabilize a newly-acquired property and convert the same to rental use, the age of our properties, rental rates, the varying costs of internal and external property management, occupancy levels, rates of resident turnover, home price appreciation, changes in homeownership rates, changes in homeowners’ association fees and real estate taxes, our expense ratios and our capital structure. Certain of these factors are described in greater detail below in Item 7 of this Annual Report on Form 10-K.

 

Industry Outlook

 

The housing market environment in our markets remains attractive for single-family property acquisitions and rentals. Pricing for housing in certain markets remains attractive and demand for housing is growing. At the same time, we continue to face relatively steady competition for new properties and residents from local operators and institutional managers.

 

Housing prices across all of our core markets have appreciated over the past year. Despite these gains, we believe housing in certain of our markets continues to provide attractive acquisition opportunities and remains inexpensive relative to replacement cost and affordability metrics.

 

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MSA Home Price Appreciation (“HPA”)(1)

Source: Corelogic as of December 2013

 

Market

 

HPA
(Peak to
Trough)
(2)

 

HPA
(Peak to
Current)

 

HPA
(prior 12
months)

 

HPA
(Prior 3
months)

 

Phoenix, AZ

 

-53

%

-32

%

14

%

0

%

Tucson, AZ

 

-43

%

-33

%

7

%

-1

%

Northern CA (3)

 

-60

%

-42

%

27

%

5

%

Southern CA (4)

 

-53

%

-36

%

22

%

2

%

Jacksonville, FL

 

-40

%

-30

%

9

%

1

%

Orlando, FL

 

-55

%

-39

%

14

%

0

%

Southeast FL (5)

 

-53

%

-39

%

14

%

1

%

Tampa, FL

 

-48

%

-37

%

10

%

-1

%

Atlanta, GA

 

-34

%

-15

%

15

%

0

%

Charlotte, NC

 

-17

%

-1

%

6

%

-1

%

Las Vegas, NV

 

-60

%

-42

%

25

%

1

%

Columbus, OH

 

-18

%

-9

%

4

%

-1

%

Dallas, TX

 

-14

%

1

%

10

%

1

%

Houston, TX

 

-13

%

4

%

11

%

1

%

National

 

-33

%

-18

%

11

%

0

%

 


(1)                       “MSA” means Metropolitan Statistical Areas, which is generally defined as one or more adjacent counties or county equivalents that have at least one urban core area of at least a 50,000-person population, plus adjacent territory that has a high degree of social and economic integration with the core as measured by commuting ties.

(2)                       Peak refers to highest historical home prices in a particular market prior to the start of the housing recovery. Trough refers to lowest home prices in a particular market since the peak.

(3)                       MSA used for Northern California is Fairfield-Vallejo, which most closely approximates the geographic area in which we purchase homes in Northern California. This MSA is comprised of Solano County and the most populous cities in the MSA are Vallejo, Fairfield, Vacaville, Suisun and Benicia.

(4)                       MSA used for Southern California is Riverside-San Bernardino-Ontario. This MSA is comprised of Riverside and San Bernardino Counties and the most populous cities in the MSA are Riverside, San Bernardino, Fontana and Moreno.

(5)                       MSA used for Southeast FL is Fort Lauderdale-Pompano Beach-Deerfield Beach.

 

On the demand side, we anticipate continued strong rental demand for single-family homes. While new building activity has begun to increase, it remains below historical averages and we believe substantial under-investment in residential housing over the past six years will create upward pressure on home prices and rents as demand exceeds supply. We expect this will take time and will be uneven across markets, but we believe pricing will revert to replacement cost over time, which would be favorable to our total return profile.

 

Acquisitions

 

Our Manager’s ability to identify and acquire single-family properties that meet our investment criteria will be affected by home prices in our markets, the inventory of properties available through our acquisition channels, competition for our target assets, and our capital available for investment. We increased the number of properties in our portfolio by 67 and 2,237 properties in the three and twelve months ended December 31, 2013, respectively. Our acquisition rate decreased substantially beginning in the second quarter of 2013. We significantly curtailed new acquisitions in the third quarter of 2013 while we continued to focus on renovating and leasing our existing inventory. We began purchasing again at the end of the third quarter of 2013 in certain key markets and continued limited acquisitions in the fourth quarter of 2013 having substantially deployed available capital. On January 16, 2014, we increased the borrowings available under our revolving credit facility and intend to continue acquisitions in select markets in 2014 subject to the availability of additional debt or equity capital, among other factors.

 

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Throughout 2013, the percentage of properties purchased at auction decreased substantially as our use of broker and bulk purchases increased. Auction purchases accounted for the acquisition of approximately 14% of the properties acquired in the second half of 2013. By comparison, 20% of the properties acquired in the second quarter of 2013, 55% of the properties acquired in the first quarter of 2013, and 70% of the properties acquired in 2012 were acquired at auction. We anticipate that auction purchases will continue to represent a decreasing percentage of 2014 acquisitions, which should allow us to take possession and renovate properties quicker and with better predictability in renovation costs than if we continued acquiring significant numbers of auction properties. For purposes of this discussion, “broker” refers to a purchase of a single property directly from the owner, including REO, short sales, and properties listed on a multiple listing service; “auction” refers to properties purchased at trustee or judicial auctions; and “bulk” refers to purchases of more than one property in a single sale directly from the owner, often an investor group, financial institution, or governmental agency, and may include future acquisitions of entire legal entities holding single-family properties.

 

Stabilization, Renovation, and Leasing

 

For most periods of 2013, many properties in our portfolio were not yet generating rental income.  Before an acquired property becomes an income producing asset, we must possess, renovate, market, and lease the property.  We refer to this process as property stabilization. We consider a property stabilized at the earlier of (i) its first authorized occupancy or (ii) 90 days after the renovations for such property are complete regardless of whether the property is leased. Properties acquired with in-place leases are considered stabilized even though such properties may require future renovation to meet our standards and may have existing residents who would not otherwise meet our resident screening requirements.

 

We stabilized 569 and 3,484 properties in the three and twelve months ended December 31, 2013, respectively. The average time to stabilization for our properties on a historical basis was 146 days (excluding properties acquired from the Provident Entities), and the average time to stabilization for properties stabilized in the fourth quarter of 2013 was 209 days, each increasing from the comparable average stabilization times as of September 30, 2013. This increased stabilization time on a sequential quarter basis and the higher quarterly average as compared to the portfolio average are each a function of our historic acquisition activity outpacing our historic renovation and leasing activity during our ramp-up, which resulted in our stabilizing longer held properties, many of which had increased renovation needs or longer times to possession as a result of evictions or challenges to our auction purchases, in the fourth quarter of 2013 as compared to the third quarter. Of the properties stabilized in the fourth quarter of 2013, the average time from acquisition to completion of renovation was 150 days and the average time from the completion of renovation until the lease effective date was 52 days compared to averages of 136 days and 39 days, respectively, for properties stabilized in the third quarter of 2013. The sequential quarter increase in the average time from acquisition to completion of renovation is attributable to the same factor that caused our average stabilization time to increase in sequential quarters as described above. The sequential quarter increase in the average time from completion of renovation to lease is attributable in part to a seasonal slowdown. The sum of the average time from acquisition to completion of renovation and the average time from completion of renovation to lease (202 days) differs from the average time to stabilization (209 days) because stabilized properties includes properties where renovations have been completed for at least 90 days even though they have not yet been leased and this cohort of properties had a shorter average time from acquisition to completion of renovation.

 

We do not believe the average renovation and stabilization times described above are indicative of our future renovation and stabilization capabilities. In the second half of 2013, we began taking steps to shorten the time between our acquisition of a property and the time it becomes a revenue-generating asset. As part of this change, we focused our new acquisitions predominately on broker transactions, which reduced many of the delays we historically faced in taking possession of properties purchased at auction and allowed us to start renovation within days of acquisition. These changes show promising results. The properties acquired in the third quarter were renovated in less than half the time as the average for those properties stabilized in the fourth quarter of 2013, and we expect the properties acquired in the fourth quarter of 2013 will have even better average renovation and stabilization times.

 

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The following table summarizes the leasing status of our properties as of December 31, 2013:

 

Market

 

Number of
Properties

 

Number of
Stabilized
Properties (1)

 

Properties

Leased

 

Properties Vacant

 

Aggregate
Portfolio
Occupancy
Rate

 

Stabilized
Occupancy
Rate

 

Average
Monthly
Rent (2)

 

Phoenix

 

1,424

 

1,423

 

1,350

 

74

 

94.8

%

94.9

%

$

1,026

 

Atlanta

 

1,000

 

950

 

840

 

160

 

84.0

%

88.4

%

1,165

 

Tampa

 

924

 

916

 

902

 

22

 

97.6

%

98.5

%

1,215

 

Northern CA

 

384

 

383

 

370

 

14

 

96.4

%

96.6

%

1,478

 

Las Vegas

 

290

 

290

 

278

 

12

 

95.9

%

95.9

%

1,150

 

Columbus

 

284

 

193

 

104

 

180

 

36.6

%

53.9

%

1,112

 

Dallas

 

227

 

207

 

186

 

41

 

81.9

%

89.9

%

1,241

 

Orlando

 

215

 

194

 

189

 

26

 

87.9

%

97.4

%

1,247

 

Tucson

 

209

 

207

 

192

 

17

 

91.9

%

92.8

%

829

 

Southeast FL

 

165

 

124

 

117

 

48

 

70.9

%

94.4

%

1,760

 

Southern CA

 

156

 

155

 

145

 

11

 

92.9

%

93.5

%

1,148

 

Jacksonville

 

131

 

112

 

101

 

30

 

77.1

%

90.2

%

1,083

 

Charlotte

 

130

 

120

 

112

 

18

 

86.2

%

93.3

%

1,155

 

Houston

 

103

 

91

 

87

 

16

 

84.5

%

95.6

%

1,180

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Totals

 

5,642

 

5,365

 

4,973

 

669

 

88.1

%

92.7

%

$

1,162

 

 


(1)         We consider a property stabilized at the earlier of (i) its first authorized occupancy or (ii) 90 days after the renovations for such property are complete regardless of whether the property is leased. Properties acquired with in-place leases are considered stabilized even though such properties may require future renovation to meet our standards and may have existing residents who would not otherwise meet our resident screening requirements.

 

(2)         Average monthly rent for leased properties was calculated as the average of the contracted monthly rent for all leased properties as of December 31, 2013 and reflects rent concessions amortized over the life of the related lease.

 

Stabilized occupancy decreased slightly to 92.7% as of December 31, 2013 as compared to 94.7% as of September 30, 2013 as a result of poor leasing activity by our third party manager in Columbus. Our Manager’s operating subsidiary internalized management of this market in December 2013, and we expect improved leasing activity going forward.

 

In the quarter ended December 31, 2013, 374 properties turned over. This turnover number includes move-outs, evictions and lease breaks on our stabilized portfolio but excludes evictions of unauthorized residents at time of acquisition. Quarterly turnover for the three months ended December 31, 2013 was 7.0%. Quarterly turnover represents the number of properties turned over in the period divided by the number of properties in stabilized status as of quarter end (i.e. 5,365 properties for the three months ended December 31, 2013). We believe that our turnover rate is not indicative of future results on a stabilized portfolio and that the turnover rate will be higher in future periods because the large number of recently-leased and stabilized properties in our current portfolio results in a disproportionately small number of properties with expiring leases and thus lower potential turnover attributable to resident move-out. The total number of properties with lease expirations in the three months ended December 31, 2013 was 821, including properties with month-to-month occupancy in the period. Of these properties, 223 properties turned over (implying a 27.2% turnover rate).

 

Results of Operations

 

Comparisons to 2012 presented in our financial statements are not representative of a full year of operating activity and are not generally meaningful as our predecessor did not have substantial operations in 2012.  Additionally, our 2012 results included revenue and expenses related to properties owned by the Provident Entities for only 12 days of activity, from the date of the Formation Transactions through year-end.

 

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The following are our results of operations for the years ended December 31, 2013 and 2012 along with the three months ended December 31, 2013 (unaudited) and September 30, 2013 (unaudited):

 

 

 

 

 

 

 

 

 

 

 

Sequential Quarter Comparison

 

Income Statement Data (unaudited)

 

Year Ended
December 31,

 

Three Months Ended
December 31,

 

Three Months Ended
September 30,

 

Three Months Ended
December 31, 2013 vs September 30, 2013

 

(amounts in thousands except share data)

 

2013

 

2012

 

2013

 

2013

 

$ Change

 

% Change

 

Revenue:

 

 

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

47,953

 

$

3,584

 

$

16,409

 

$

13,923

 

$

2,486

 

17.86

%

Other income

 

1,640

 

32

 

300

 

563

 

(263

)

(46.71

)%

Total revenue

 

49,593

 

3,616

 

16,709

 

14,486

 

2,223

 

15.35

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Property operating and maintenance

 

12,472

 

1,868

 

3,848

 

4,280

 

(432

)

(10.09

)%

Real estate taxes

 

6,893

 

1,273

 

2,000

 

1,761

 

239

 

13.57

%

Homeowners’ association fees

 

1,129

 

391

 

282

 

286

 

(4

)

(1.40

)%

Property management

 

11,991

 

459

 

2,818

 

3,675

 

(857

)

(23.32

)%

Depreciation and amortization

 

20,235

 

2,106

 

6,174

 

5,683

 

491

 

8.64

%

Advisory management fee - affiliates

 

9,775

 

2,159

 

2,179

 

2,166

 

13

 

0.60

%

General and administrative

 

7,453

 

881

 

2,110

 

1,866

 

244

 

13.08

%

Interest expense

 

2,911

 

 

1,764

 

989

 

775

 

78.36

%

Other

 

1,284

 

 

594

 

142

 

452

 

318.31

%

Total expenses

 

74,143

 

9,137

 

21,769

 

20,848

 

921

 

4.42

%

Net loss

 

(24,550

)

(5,521

)

(5,060

)

(6,362

)

1,302

 

(20.47

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to noncontrolling interests - Operating Partnership

 

17

 

4

 

3

 

5

 

(2

)

(40.00

)%

Net loss attributable to controlling interests

 

(24,533

)

(5,517

)

(5,057

)

(6,357

)

1,300

 

(20.45

)%

Preferred stock distributions

 

(100

)

(3

)

(25

)

(25

)

 

 

Net loss attributable to common stockholders

 

$

(24,633

)

$

(5,520

)

$

(5,082

)

$

(6,382

)

$

1,300

 

(20.37

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss per share - basic and diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss attributable to common shares

 

$

(0.63

)

$

(0.04

)

$

(0.13

)

$

(0.16

)

$

0.03

 

(18.50

)%

Weighted average common shares outstanding

 

39,073,994

 

37,328,213

 

38,705,311

 

39,095,200

 

(389,889

)

(1.00

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(24,550

)

$

(5,521

)

$

(5,060

)

$

(6,362

)

$

1,302

 

(20.47

)%

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

Change in fair value of interest rate cap agreements

 

(276

)

 

(33

)

(243

)

210

 

(86.42

)%

Other comprehensive loss

 

$

(276

)

$

 

$

(33

)

$

(243

)

$

210

 

(86.42

)%

Comprehensive loss

 

(24,826

)

(5,521

)

(5,093

)

(6,605

)

1,512

 

(22.89

)%

Less comprehensive loss attributable to noncontrolling interests - Operating Partnership

 

17

 

4

 

3

 

5

 

(2

)

(40.00

)%

Comprehensive loss attributable to controlling interests

 

$

(24,809

)

$

(5,517

)

$

(5,090

)

$

(6,600

)

$

1,510

 

(22.88

)%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Data (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

Net operating income

 

$

19,872

 

$

(365

)

$

8,292

 

$

5,619

 

$

2,673

 

47.57

%

Funds from operations

 

(3,637

)

(3,407

)

1,459

 

(628

)

2,087

 

(332.43

)%

 


(1)             Net operating income, or NOI, and funds from operations, or FFO, are non-GAAP financial measures we believe, when considered with the financial statements determined in accordance with GAAP, are helpful to investors in understanding our performance as a REIT.  Reconciliations of NOI and FFO to net loss and net loss attributable to common stockholders prepared in accordance with GAAP, respectively, are found in this Item 7 under the headings “Net Operating Income” and “Funds From Operations”.

 

Revenue

 

We earn revenue primarily from rents collected from residents under lease agreements for our single-family properties.  These include short-term leases that we enter into directly with our residents, which generally have a term of one year.  The most important drivers of revenue (aside from portfolio growth) are rental and occupancy rates.  Our revenue may be affected by macroeconomic, local and property level factors, including market conditions, seasonality, resident defaults or vacancies, timing of renovation activities and occupancy of properties and timing to re-lease vacant properties.

 

Total revenue increased $2.2 million, or 15.4%, in the fourth quarter of 2013 on a sequential quarter basis.  Total revenue for 2013 increased $46.0 million over the prior year.  These increases were due primarily to the increase in the number of properties leased at December 31, 2013, as compared to the prior period ends.  We owned 4,973 leased properties as of December 31, 2013 as compared to 4,521 and 1,705 leased properties as of September 30, 2013 and December 31, 2012, respectively.  We achieved an average monthly rent for leased properties in our portfolio of $1,162 and $1,161 in the fourth and third quarters of 2013, respectively.

 

Expenses

 

Property Operating and Maintenance Expenses.  Property operating and maintenance expenses decreased $432,000, or 10.1%, in the fourth quarter of 2013 on a sequential quarter basis and increased $10.6 million in the year ended December 31, 2013,

 

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over the prior year.  Included in property operating and maintenance expenses are property insurance, bad debt, utilities and landscape maintenance on market ready properties not leased, repairs and maintenance, and expenses associated with resident turnover.  The decrease in this expense on a sequential quarter basis was due to reduced levels of carrying costs on market ready properties driven by our continued leasing activity, as well as property insurance recoveries received in the fourth quarter of 2013 related to damages incurred in previous quarters.

 

The increase in property operating and maintenance expenses from the prior year was attributable to the significant increase in the number of properties owned as of December 31, 2013 as compared to the prior year, as well as the full year of recognition of expenses on properties acquired from the Provident Entities.

 

Real Estate Taxes and Homeowners’ Association Fees.  Real estate taxes and homeowners’ association fees are expensed once a property is market ready.  Real estate taxes increased $239,000, or 13.6%, on a sequential quarter basis and increased $5.6 million in the year ended December 31, 2013 over the prior year.  The increase in real estate taxes was primarily attributable to the increase in the number of properties owned and in service in the three and twelve months ended December 31, 2013 as compared to the prior periods.

 

Homeowners’ association fees were flat in the fourth quarter of 2013 on a sequential quarter basis as substantially all properties located within homeowners’ associations were placed in service by the second quarter of 2013.  Homeowners’ association fees increase of $738,000 for the year ended December 31, 2013 over the prior year was primarily attributable to the increase in the number of properties owned and placed in service.

 

Property Management. We utilize a hybrid approach for property management, using our Manager’s operating subsidiary’s internal teams in Phoenix, Atlanta, Southeast Florida, and, as of December 2013, Columbus.  We use third party property managers in all our other markets.  The internal markets represent approximately half of our properties owned.

 

Expenses incurred for property management decreased $857,000, or 23.3%, in the fourth quarter of 2013 on a sequential quarter basis and increased $11.5 million in 2013 over 2012. The sequential quarter decrease in property management expenses was primarily due to a net decrease in personnel and consultant costs, a decrease in non-recurring software implementation costs related to our new property management system, a decrease in office costs, and a decrease in the 5% property management fee.  These decreases were partially off-set by an increase in property management fees paid to third parties due to a higher base of leased properties.  Non-recurring software implementation costs related to the new property management system totaled $280,000 and $970,000 for the three and twelve months ended December 31, 2013, respectively.  The increase in property management in 2013 over 2012 was due to the growth in our property management platform, inclusive of personnel, system, and office costs, as well as higher fees to third-party property managers corresponding with the increase in leased properties.

 

Rather than compensating our Manager’s operating subsidiary with commissions or fees based on rental income, we reimburse all costs and expenses of our Manager’s operating subsidiary incurred on our behalf, including the compensation of its property management, project management, and acquisition staff and related overhead, such as property management system costs.  In addition to these costs, we pay a property management fee to our Manager’s operating subsidiary equal to 5% of certain compensation and overhead costs incurred as a result of providing services to us, which reduces the amount of the advisory management fee paid to our Manager by the same amount. As a result of the pass-through arrangement under the property management and acquisition services agreement, the costs related to the property management, project management, and acquisition services provided in the markets where our Manager’s operating subsidiary uses an internal team are largely tied to the compensation and related overhead of our Manager’s operating subsidiary’s property management and acquisitions staff as opposed to a fee based upon rented properties. Of the $2.8 million and $12.0 million in property management expenses incurred in the three and twelve months ended December 31, 2013, approximately $2.0 million and $9.7 million were attributable to amounts owing to our Manager or our Manager’s operating subsidiary for the services described above, including $116,000 and $645,000, respectively, attributable to the 5% property management fee. The property management fees incurred in the three and twelve months ended December 31, 2013 related to our Manager’s internal property management teams as a proportion of revenue for the period are not representative of a steady-state portfolio because of the need for a larger leasing infrastructure in our ramp up mode, because of certain non-recurring costs related to our property management software system implementation, and because our Manager’s existing oversight and internal property management infrastructure has capacity to support more leased and stabilized properties. We expect our leverage of the internal property management cost structure to continue to improve as we reach steady-state operations and as we streamline our leasing operations.

 

In addition to the $2.0 million and $9.7 million incurred for our Manager’s property management services in the three and twelve months ended December 31, 2013, respectively, we incurred charges with the Manager’s operating subsidiary of $237,000 and $4.1 million, respectively, in acquisition and project management fees related to renovation which were capitalized as part of property acquisition and renovation costs, and $42,000 and $212,000 for leasing services, respectively, which are reflected as other assets and are being amortized over the life of the related leases (typically one year).

 

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The remaining amounts in property management fees of approximately $770,000 and $2.3 million for the three and twelve months ended December 31, 2013, respectively, were incurred to reimburse our Manager’s operating subsidiary for expenses payable to third-party property managers or as payments due directly to third-party property managers. The sequential quarter increase in third-party property management fees of $100,000 is attributable to the increase in rental income on properties managed by third parties during the three months ended December 31, 2013 as compared to the prior quarter.  Property management and acquisition fees in markets where we use third parties to perform services are based on our contractual arrangements with these third parties, which generally have one-year terms with month-to-month renewals.  Certain third parties providing acquisition services are paid a commission based upon properties acquired on our behalf.  Third-party property management arrangements include fees based on a percentage of rental income and other fees collected from our residents and, in some cases, fees for renovation oversight and leasing activities.

 

Depreciation and amortization.  Depreciation and amortization includes depreciation on real estate assets placed in service and amortization of deferred lease fees and in-place leases.  Depreciation and amortization increased $491,000, or 8.6%, on a sequential quarter basis, primarily as a result of the increased number of properties being depreciated in the fourth quarter of 2013.  Depreciation and amortization increased $18.1 million in 2013, as compared to 2012, primarily as a result of the increased number of properties placed in service and amortization of the Provident in-place leases acquired in the Formation Transactions.  Amortization expense for the Provident in-place leases, which are substantially amortized as of December 31, 2013, was $227,000 and $2.0 million for the three and twelve months ended December 31, 2013, respectively.  We expect depreciation expense will increase in future periods as we continue to acquire additional properties and place them into service.

 

Advisory Management Fee.  We rely on our Manager to provide or obtain on our behalf the personnel and services necessary for us to conduct our business because we have no employees of our own.  Our Manager performs these services for us, and together with our Manager’s operating subsidiary, provides us with a suite of investment, acquisition, and property management services, utilizing the combined expertise of Pine River and Provident. We pay our Manager a quarterly advisory management fee equal to 0.375% (a 1.5% annual rate) of our average fully-diluted market capitalization during the preceding quarter less any property management fee paid to our Manager’s operating subsidiary.

 

As part of the Formation Transactions, we were required to make payments of cash to both Two Harbors and the prior members of the Provident Entities as additional purchase price consideration.  The total amount paid to Two Harbors and the prior members of the Provident Entities was equal to 50% of the advisory management fee payable to the Manager during the first year after our initial public offering (before adjustment for the 5% property management fees received by our Manager’s operating subsidiary), subject to an aggregate amount payable to Two Harbors of no more than $4.0 million. The cash payments were required to be made quarterly in conjunction with the payment of the advisory management fee and reduced the amounts payable to our Manager by the same amount, thus the payments did not have a net impact on our obligations.  The amounts paid to Two Harbors and the prior members of the Provident Entities was based upon the relative values they each provided as part of the Formation Transactions, which were approximately 73.6% and 26.4% respectively.

 

Advisory management fees, net of the 5% property management fee described above, increased $13,000, or .6%, in the fourth quarter of 2013 on a sequential quarter basis as a result of a slight increase in our average fully-diluted market capitalization due to the increase in our stock price in the fourth quarter of 2013, partially off-set by a 1.0% reduction in average shares outstanding due to our stock buy-back program.

 

During the fourth quarter of 2013, we expensed $2.2 million in advisory management fees, net of the 5% property management fee.  This included $264,000 and $734,000, respectively, in advisory management fees to the prior members of the Provident Entities and Two Harbors, as additional consideration, and $1.2 million in advisory management fees to our Manager.  The advisory management fees expensed in the fourth quarter and payable to the prior members of the Provident Entities and Two Harbors represent the final consideration to said entities as part of the Formation Transactions.

 

During 2013, we expensed $9.8 million in advisory management fees, net of the 5% property management fee. This included $1.3 million and $3.7 million, respectively, in advisory management fees to the prior members of the Provident Entities and Two Harbors, as additional consideration, and $4.8 million in advisory management fees to our Manager.

 

Prior to the Formation Transactions, advisory management fees incurred by our Predecessor were allocated from Two Harbors to our Predecessor based on 1.5% of contributed capital on an annualized basis and are not generally comparable to the advisory management fees incurred by us in 2013.  During 2012, we incurred $2.2 million in advisory management fees, of which $1.8 million was incurred prior to the Formation Transactions and $400,000 was incurred under our new agreement.  Of the $400,000 incurred under our new agreement, $49,000 and $136,000 was owed to the prior members of the Provident Entities and Two Harbors, respectively, and $175,000 was due to our Manager.

 

General and Administrative Expense.  General and administrative costs include those costs related to being a public company and costs incurred under the management agreement with our Manager. Under the management agreement, we pay all costs and expenses of our Manager incurred in the operation of its business, including all costs and expenses of running the company, all

 

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compensation costs (other than for our Chief Executive Officer and personnel providing data analytics directly supporting the investment function), and all costs under the shared services and facilities agreement between our Manager and Pine River. General and administrative expense increased $244,000, or 13.1%, in the fourth quarter of 2013 on a sequential quarter basis as a result of an increase in public company costs and certain one-time legal and professional fees, offset by a decrease in certain consulting and personnel costs. General and administrative expense increased $6.6 million in 2013 over 2012 as a result of increased reimbursement obligations to our Manager for compensation and other expenses in addition to increased public company expenses and professional fees.  Prior to the Formation Transactions, Two Harbors allocated certain direct general and administrative expenses (primarily professional fees and travel costs) to the Company.  General and administrative expenses incurred by our Predecessor prior to our formation are not generally comparable to those we incur today.

 

Interest Expense.  Our revolving credit facility was executed in late May 2013 and we had no interest expense in 2012 because we had no debt.  Interest expense includes interest incurred on the outstanding balance of our revolving credit facility, an unused line fee on the undrawn amount of the revolving credit facility, and amortization of deferred financing fees, net of certain amounts capitalized for properties undergoing renovation activities.  Interest expense increased $775,000, or 78.4%, on a sequential quarter basis as a result of the increase in the amount outstanding on the revolving credit facility and a decrease in the amount of interest capitalized for the quarter, driven by the declining number of properties subject to renovation.  While it will remain subject to our renovation activity, we expect interest expense will increase in future periods as we continue to draw on our revolving credit facility, which had the borrowing capacity increased to $350.0 million from $200.0 million in the first quarter of 2014.

 

Critical Accounting Policies

 

The preparation of financial statements in accordance with generally accepted accounting principles requires us to make certain judgments and assumptions, based on information available at the time of our preparation of the financial statements, in determining accounting estimates used in preparation of the statements. Our significant accounting policies are described below.

 

Accounting estimates are considered critical if the estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made and if different estimates reasonably could have been used in the reporting period or changes in the accounting estimate are reasonably likely to occur from period to period that would have a material impact on our financial condition, results of operations or cash flows.

 

Revenue Recognition

 

We lease our single-family properties under operating leases. The lease periods are generally short-term in nature (one or two years) and reflect market rental rates.  Generally, credit investigations are performed for prospective residents and security deposits are obtained. Rental income, net of concessions and sales tax, is recognized on a straight-line basis over the term of the lease.

 

Real Estate Acquisition Valuation

 

Property acquired not subject to an existing lease is recorded at the purchase price, including acquisition costs, allocated between land and building based upon their fair values at the date of acquisition. Property acquired with an existing lease is recorded at fair value (which usually approximates the purchase price), allocated to land, building and the existing lease based upon their fair values at the date of acquisition, with acquisition costs expensed as incurred. Fair value is determined under the guidance of ASC 820, Fair Value Measurements and Disclosures, primarily based on unobservable market data inputs, which are categorized as Level 3 valuations. In making our estimates of fair value for purposes of allocating purchase price, we utilize our own market knowledge and published market data. We utilize information obtained from county tax assessment records to develop regional averages to allocate the fair value to land and building. The estimated fair value of acquired in-place leases are the costs we would have incurred to lease the property at the date of acquisition, based upon our current leasing activity.

 

Capitalized Costs

 

We capitalize certain costs incurred in connection with successful property acquisitions and associated stabilization activities, including tangible property improvements and replacements of existing property components. Included in these capitalized costs are certain personnel costs associated with time spent by certain personnel in connection with the planning, execution and oversight of all capital additions activities at the property level as well as third party acquisition agreement fees. Indirect costs are allocations of certain department costs, including personnel costs that directly relate to capital additions activities. We also capitalize property taxes and homeowners’ association dues during periods in which property stabilization is in progress. We charge to expense as incurred costs that do not relate to capital additions activities, including ordinary repairs, maintenance, resident turnover costs and general and administrative expenses.

 

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Impairment of Real Estate

 

We evaluate our long-lived assets for impairment at least annually or whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. If an impairment indicator exists, we compare the expected future undiscounted cash flows against the net carrying amount of a property. Significant indicators of impairment may include declines in homes values, rental rate and occupancy and significant changes in the economy. We make our assessment at the individual property level because it represents the lowest level of cash flows. We prepare our future undiscounted cash flow analysis using estimates based on current rental rates, renewals and occupancy and using inputs from our annual long-range planning process and historical performance.

 

When preparing these estimates, we consider each property’s historical results, current operating trends, current market conditions, anticipated future capital expenditures and remaining useful life. These estimates may be impacted by variable factors including inflation, expected rental rates, the general health of the economy and market competition. If the sum of the estimated undiscounted cash flows is less than the net carrying amount of the property, we record an impairment loss for the difference between the estimated fair value of the individual property and the carrying amount of the property at that date. To determine the estimated fair value, we consider both recent comparable homes sales and the use of discounted projected future cash flows. The rates used to discount projected future cash flows reflect a weighted average cost of capital that a market participant would incur.

 

For long-lived assets to be disposed of, an impairment loss is recognized when the estimated fair value of the asset, less the estimated cost to sell, is less than the carrying amount of the asset at the time we have determined to sell the asset. Long-lived assets held for sale and their related liabilities are separately reported, with the long-lived assets reported at the lower of their carrying amount or their estimated fair value, less their costs to sell and any operations associated with the properties is reflected as discontinued operations. Assets held for sale are not depreciated nor are they included in our operating metrics at period end.

 

Depreciation of Investment in Real Estate

 

Our real estate assets are carried on the balance sheets at cost less accumulated depreciation.  Depreciation of real estate is computed on the straight-line basis over the estimated useful lives of the assets, which is generally 27.5 years, with no salvage value.