Item 1. Business.
We are an internally-managed Maryland corporation that focuses 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, 2016, we owned 9,044 single-family properties in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, South Carolina and Texas, excluding properties reflected as assets held for sale on our consolidated balance sheets.
We have elected to be treated as a real estate investment trust ("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 continue to 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 our taxable REIT subsidiaries ("TRSs") is subject to taxation at regular corporate rates.
Silver Bay Realty Trust Corp. was incorporated in Maryland in June 2012. Silver Bay Realty Trust Corp. conducts its business and owns all of its properties through Silver Bay Operating Partnership L.P. (the "Operating Partnership"), a Delaware limited partnership. Silver Bay Realty Trust Corp.'s wholly owned subsidiary, Silver Bay Management LLC (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, 2016, Silver Bay Realty Trust Corp. owned, through a combination of direct and indirect interests, 94.1% of the partnership interests in 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 3300 Fernbrook Lane North, Suite 210, Plymouth, Minnesota 55447. 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 ("NYSE") under the symbol “SBY.”
Recent Developments
On February 27, 2017, Silver Bay Realty Trust Corp. the General Partner, and the Operating Partnership (Silver Bay Realty Trust Corp., the Operating Partnership and the General Partner collectively referred to as the “Company Parties”), entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Tricon Capital Group, Inc., a company incorporated under the laws of the Province of Ontario (“Tricon Ultimate Parent”), TAH Acquisition Holdings LLC, a Delaware limited liability company (“Tricon Parent”), and TAH Acquisition LP, a Delaware limited partnership (“Tricon LP” and, together with Tricon Ultimate Parent and Tricon Parent, the “Tricon Parties”). Under the Merger Agreement, Silver Bay Realty Trust Corp. will merge with and into Tricon Parent, with Tricon Parent being the surviving entity (the “Merger”). The board of directors of Silver Bay Realty Trust Corp. has unanimously approved the Merger Agreement, the Merger and the other transactions contemplated by the Merger Agreement.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger, each outstanding share of Silver Bay Realty Trust Corp. common stock, par value $0.01 per share (other than shares held by any Tricon Party or any subsidiary thereof or any wholly-owned subsidiary of the Company), will be converted into the right to receive an amount in cash equal to $21.50, without interest (as the same may be adjusted, the “Merger Consideration”), subject to any applicable withholding tax, and each outstanding share of Silver Bay Realty Trust Corp. 10% cumulative redeemable preferred stock, par value $0.01 per share, will be converted into the right to receive an amount in cash equal to $1,000 per share, plus an amount equal to all dividends accrued and unpaid on such share of preferred stock immediately prior to the Merger effective time, without interest, subject to applicable withholding tax. The Merger Agreement also provides for the merger of Tricon LP with and into the Operating Partnership, with the Operating Partnership being the surviving entity (the “Partnership Merger”).
The completion of the Merger and the Partnership Merger is subject to customary conditions, including, among others: (i) approval by a majority of Silver Bay Realty Trust Corp.’s stockholders; (ii) the absence of a material adverse effect on the Company; (iii) the receipt of a tax opinion relating to REIT status of the Company and (iv) the absence of any order, action or law by a governmental authority preventing, prohibiting, enjoining or making illegal the consummation of the Merger and the Partnership Merger.
The Company anticipates the Merger and Partnership Merger will close in the second quarter of 2017. For additional information regarding the Merger, Partnership Merger, or the Merger Agreement, see the Company’s Current Report on Form 8-K filed on February 27, 2017 and additional future filings and disclosures it will make with respect to the transaction.
The following description of the Company’s business ignores any impact of the Merger, the Partnership Merger, or the Merger Agreement.
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 predetermined investment horizon that would require their sale.
Management Overview
Our approach to management relies on centralization of corporate oversight and certain property management functions. Immediate property management functions for properties are performed at the local level by our local employees or, in some markets, by third-party local property management contractors. As of December 31, 2016, we had 187 employees and managed 94.5% of our properties directly without the use of third-party property managers in ten markets (Atlanta, Phoenix, Tampa, Charlotte, Orlando, Dallas, Jacksonville, Southeast Florida, Northern California and Columbus). In markets managed by third parties, our regional asset management personnel oversee the local property managers in their performance of local property management functions. Our centralized platform consists of teams dedicated to (1) property management; (2) customer service and resident communication; (3) information technology; (4) marketing; (5) property renovations and maintenance; (6) acquisitions; and (7) treasury, accounting, legal and corporate matters.
Acquisitions
Our 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 employ a top-down selection process in our investment strategy which starts with 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 demographic 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, portfolio purchases from institutions or investor groups, foreclosure auctions and online auctions (although we have not used the auction channel in the past two years). 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 seek to optimize returns both within and across markets.
We conduct diligence on and underwrite each property we purchase. As part of the diligence process, our personnel conduct on-site assessments for broker and portfolio-sourced properties and drive-by inspections for auction-sourced properties. We also receive title commitments prior to closing for purchases outside the auction process and use a network of title insurance providers to conduct preliminary title work before purchasing properties through the auction channel. When underwriting a property, our personnel determine the maximum purchase price at which a property would meet our net yield requirements using a model that incorporates factors such as estimated rent, renovation costs, operating expenses, ongoing capital expenditures, and vacancy. Our underwriting process assumes that the property will be held for an indefinite period of time and does not reflect an assumed rental growth rate. This net-yield based price is then compared to the market price of the property, which is determined using comparable sales analysis, and reduced to the market price if the market price is less than the net yield based price.
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. Availability of
financing from such sources on acceptable terms will greatly impact our pace of acquisitions, as will our current preference for portfolio acquisitions, which are inherently less predictable than purchases through other channels.
Property Renovation
Most of our properties have required renovation and standardization before they are ready for resident occupancy. 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 local project management personnel oversee the renovation of our properties in all of our markets.
Following the acquisition of a property, our project managers use Silver Bay’s renovation standards, including any market-specific requirements, to prepare a project scope for initial renovation. Project managers then circulate the project scopes for bid to our approved contractors and vendors. All final bids are approved by construction managers. Once renovation work commences, local project management personnel oversee its quality of work and timely completion. Following completion of a renovation, our personnel perform a detailed quality control inspection to validate that the agreed-upon work has been completed and to determine that the property is in rent-ready condition.
Operations and Management
General. 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. Our approach to management and operations relies on centralization of corporate oversight and certain property management functions. Immediate property management functions for properties are performed at the local level in internally managed markets by our local employees or, in some markets, by third-party property managers.
Marketing. We establish the rental rates at which properties will be offered based on comparable rent analyses conducted by local property managers and reviewed by our regional property managers or chief operating officer. Factors considered in conducting comparable rent analyses include the size, age, condition, bedroom and bath count, and various qualitative factors, such as neighborhood characteristics and access to quality schools, transportation, employment centers and services of the subject home and the comparable properties.
We conduct marketing activities for all internally managed markets from a centralized location to achieve consistency and quality in our advertising. We advertise available properties through yard signage, internet-based services, our website, multiple listing services and local leasing contacts. In markets with third-party property management, local managers use similar advertising channels for properties they manage. We use third-party leasing agents to show our properties to prospective residents. In markets with third-party property management, local managers schedule showings for properties they manage and use a mix of employees or third-party leasing agents.
Lease Applications and Approvals. In markets that are internally managed, we receive lease applications online by means of our website, and applications are centrally processed for consistency and efficiency. Through our technology, much of the screening process for prospective residents is automated, which reduces processing time for any lease applicant in internally managed markets. In markets that are managed by third-party managers, a similar process is followed. Our underwriting criteria and leasing standards are used to screen all prospective residents and determine whether to approve or deny any lease application. Third-party property managers follow a similar process when screening for the properties they manage and are provided our screening criteria for use in screening prospective residents. The application and evaluation process in all markets includes obtaining appropriate identification, an evaluation of credit and income, a review of the applicant’s rental history, a background check for criminal activity and income verification. Waivers of any threshold underwriting criteria or leasing standards must be approved centrally in accordance with our policies.
Rent Collection. We have established centralized collections for all of our markets. Residents may pay rent online via automatic clearing house, debit or credit card or through a variety of other electronic methods, or by check mailed to a lockbox. Residents who do not pay rent by the end of the grace period are sent a notice and assessed a late fee. Receivables are monitored centrally on a regular basis. If an eviction action becomes necessary in markets that we manage internally, we engage local counsel to assist in processing the eviction in compliance with local laws. Third-party property managers follow a similar process.
Resident Relations and Property Maintenance. As part of our ongoing property management, we perform routine repairs and maintenance as appropriate and manage resident relations to maximize long-term rental income and cash flows from our properties. We use a centralized call center for resident inquiries and maintenance requests. Residents can also contact us through the resident portal on our website in markets we directly manage. In markets with third-party property management, these third party managers handle repairs and maintenance and resident relations under the oversight of our regional managers.
Renewal and Turnover. We manage the lease renewal process centrally for all internally-managed markets. Prior to expiration of a lease, local managers receive a list of upcoming lease expirations and use comparable rent analyses to propose an appropriate renewal rate and new rent should the property become vacant. These rates are reviewed and approved by our regional property managers or chief operating officer. If a resident elects not to renew the lease, generally the resident will be allowed to remain in occupancy under a month-to-month tenancy with a rent at, or above, the existing rent. In markets managed by third-party property managers, a similar process is followed.
In the event of turnover, each property is inspected after the resident vacates to determine the necessary scope of repair work, and where applicable, offset the costs of such repairs against resident deposits. We use an extensive move-in and move-out checklist to determine what repairs are necessary in preparation for re-leasing the properties. Marketing begins in advance of the lease-ready date to minimize the number of days the home is on the market. Third-party property managers use similar processes in the event of a turnover in the markets they manage. Turnover work is processed in a similar manner to an initial renovation with approval of certain high cost turnovers in all markets, oversight of turnover by the local property manager and use of a detailed quality control checklist. In markets with third-party managers, our third-party managers follow similar processes and receive approval for certain high cost turnovers.
Technology
Technology plays an important role in assisting us to build and manage a portfolio of geographically dispersed assets. We have developed and continue to develop a technological infrastructure with tools that:
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centrally aggregate information from employees and third-party property managers;
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provide our employees and third-party property managers with tools to facilitate their various roles, including mobile applications that reduce the need for time spent in the office;
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screen target properties for acquisition;
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allow real-time monitoring and management of the portfolio;
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integrate property management, accounting and asset management systems;
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enable the residents to interact with us online; and
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use a secure and scalable cloud-based environment with mobile accessibility.
Dispositions
We periodically sell properties after determining the property or related market no longer fit our portfolio and may sell properties when we view market conditions are favorable given other potential uses of capital. One unique feature of single-family rental properties derives from the dual market for the assets: the investor market and the owner-occupant market. When comparing the two markets, selling into the investor market typically has the advantage of lower transaction costs, faster execution and a limited period of time (if any) during which we hold the properties without generating positive cash flow. Selling into the owner-occupant market often results in greater gross selling prices, the extent to which varies greatly market-by-market, but also involves higher transaction costs and a period of time from move-out of the prior resident to sale during which we incur costs without corresponding revenue. When we decide to sell an entire market portfolio, we generally solicit competing bids from investors, consider the sales price of each proposal and compare such price to our estimate of pricing in the owner-occupant market. We then execute the sales type that we believe will provide the greatest value. When we decide to sell an individual property, we generally sell the property into the owner-occupant market using the applicable multiple listing service.
Financing Strategy
To date, we have funded our acquisitions and other capital needs through a mix of equity capital, cash generated by our operations, borrowings under our revolving credit facility and borrowings in connection with our securitization. We entered our current revolving credit facility on May 10, 2013 and amended it on February 18, 2015 to increase the borrowing capacity from $200.0 million to $400.0 million and extend its term. The revolving period ended on February 18, 2017, and we are no longer able to draw additional amounts under the revolving credit facility. We closed our securitization transaction on August 12, 2014, which involved the sale of $312.7 million of certificates. See Item 7, "Management's Discussion and Analysis of Financial Conditions and Results of Operations," including "Liquidity and Capital Resources" of this Annual Report on Form 10-K, for additional information regarding our revolving credit facility and securitization transaction. We continually explore additional capital options available to us, and our decision to pursue such options will be based on our 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 provide us competitive advantages.
Seasonality
We believe that our business and related operating results will be impacted by seasonal factors throughout the year. In particular, we have experienced higher levels of resident move-outs during the summer months, which impacts both our rental revenues and related turnover costs. Further, our property operating costs and stabilized capital expenditures have been seasonally impacted in most markets for expenditures related to HVAC repairs during the summer season.
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 ("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 material compliance with the FHA and related 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 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 (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 continue 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 will 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, each TRS we own is subject to U.S. federal, state, and local taxes on its income or property.
Investment Company Act of 1940
We intend to conduct our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the Investment Company Act of 1940, as amended, or the 1940 Act.
Employees
As of December 31, 2016, we had 187 full-time employees, which we supplement with temporary and contract resources. None of our personnel are covered by a collective bargaining agreement.
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 (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 may webcast 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 Securities and Exchange Commission ("SEC"), and any references to our website is intended to be inactive textual references only.
Item 1A.
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 Pending Merger and Partnership Merger
The announcement and pendency of our agreement to be acquired by the Tricon Parties could have an adverse effect on our
business.
Uncertainty about the effect of the proposed Merger and Partnership Merger on our employees, residents and other parties may have an adverse effect on our business and operations that may be material to our company. Our employees may experience uncertainty about their roles following the Merger and Partnership Merger. There can be no assurance that our employees, including key personnel, can be retained to the same extent that we have previously been able to attract and retain employees. Any loss or distraction of such employees could have a material adverse effect on our business, operations and financial position. In addition, we have diverted, and will continue to divert, significant management resources towards the completion of the transaction, which could materially adversely affect our business and operations.
Parties with which we do business may experience uncertainty associated with the Merger and Partnership Merger, including with respect to current or future business relationships with us. Such uncertainty could cause partners, tenants, vendors and others to seek to change existing business relationships or delay or defer certain business decisions with us and could have a material adverse effect on our business, operations and financial position.
Pursuant to the terms of the Merger Agreement, we are subject to certain restrictions on the conduct of our business, including the ability in certain cases to enter into contracts, acquire or dispose of assets, incur indebtedness or incur capital expenditures, until the Merger and Partnership Merger close or the Merger Agreement terminates. The restrictions may prevent us from pursuing otherwise attractive business opportunities and taking other actions with respect to our business that we may consider advantageous and result in our inability to respond effectively to competitive pressures and industry developments, and may otherwise harm our business and operations.
Failure to complete the Merger with the Tricon Parties could adversely affect our business.
Completion of the Merger and Partnership Merger with the Tricon Parties is subject to certain conditions, including, among others, the receipt of the requisite approval of the Company’s stockholders and other customary closing conditions set forth in the Merger Agreement. The Merger and Partnership Merger also require that the Tricon Parties obtain sufficient financing to pay the Merger Consideration. While it is currently anticipated that the Merger and Partnership Merger will be completed during the second quarter of 2017, there can be no assurance that such conditions will be satisfied in a timely manner or at all, that the Tricon Parties will obtain adequate funding to pay the Merger Consideration, or that an event, development or change will not transpire that could delay or prevent these conditions from being satisfied. Either the Company or the Tricon Parties may terminate the Merger Agreement if the Merger and Partnership Merger have not been consummated by July 27, 2017.
If the Merger and Partnership Merger or a similar transaction are not completed, the share price of our common stock may drop to the extent that the current market value price reflects an assumption that a transaction will be completed. In addition, under circumstances specified in the Merger Agreement, we may be required to pay a termination fee of $24.5 million in the event the Merger and Partnership Merger is not consummated. Further, a failure to complete the Merger and Partnership Merger may result in negative publicity and a negative impression of us in the investment community. Any disruption to our business resulting from the announcement and pendency of the Merger and Partnership Merger, including any adverse changes in our relationships with our employees, customers and vendors, could continue or accelerate in the event of a failure to complete the Merger and Partnership Merger. There can be no assurance that our business, these relationships or our financial condition will not be adversely affected, as compared to the condition prior to the announcement of the Merger and Partnership Merger, if the Merger and Partnership Merger are not consummated.
The Merger Agreement contains provisions that could discourage a potential competing acquirer of the Company or could result in any competing acquisition proposal being at a lower price than it might otherwise be.
The Merger Agreement contains provisions that, subject to limited exceptions necessary to comply with the fiduciary duties of the Company’s board of directors, restrict the ability of the Company to initiate, solicit or knowingly facilitate any third-party proposals to acquire all or a significant part of the Company.
These provisions could discourage a potential competing acquirer that might have an interest in acquiring all or a significant part of the Company from considering or proposing a competing acquisition, even if the potential competing acquirer was prepared to pay consideration with a higher per share cash value than the value proposed to be received or realized in the Merger and Partnership Merger.
Some of the directors and executive officers of the Company have interests in seeing the Merger and Partnership Merger completed that are different from, or in addition to, those of the other Company stockholders.
Some of the directors and executive officers of the Company have arrangements that provide them with interests in the Merger and Partnership Merger that are different from, or in addition to, those of the stockholders of the Company generally. These interests include, among other things, acceleration of stock awards which would be cashed out in the Merger and Partnership Merger or a sizeable severance payment if terminated upon, or following, consummation of the Merger and Partnership Merger. These interests, among other things, may influence or may have influenced the directors and executive officers of the Company to support or approve the Merger and Partnership Merger.
Risks Related to Our Business
We are 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 2012, 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. 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. Peer companies have a limited 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 is difficult to evaluate our potential future performance without the benefit of established track records from companies implementing a similar investment strategy.
Our investment strategy involves accumulating a large number of residential properties and leasing them to suitable residents. 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. 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.
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 geographic 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 us, 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:
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the availability of additional properties that meet our criteria and our ability to purchase such properties on favorable terms;
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real estate appreciation or depreciation in our markets;
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our ability to contain renovation, maintenance, turnover, marketing, and other operating costs for our properties;
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our ability to maintain high occupancy rates and target rent levels;
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general economic conditions in our markets, such as changes in employment and household earnings and expenses;
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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;
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judicial and regulatory developments affecting landlord-tenant relations that may affect or delay our ability to dispossess or evict occupants or increase rents;
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judicial and regulatory developments affecting banks’ and other mortgage holders’ ability to foreclose on delinquent borrowers;
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reversal of population, employment, or homeownership trends in our markets;
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interest rate levels and volatility, which may affect the accessibility of short-and long-term financing on desirable terms; and
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competition from other investors entering the single-family rental market.
We are still building our operational expertise and systems.
We continue to build our operational expertise and to establish our 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 our best efforts. There is a significant risk that operational problems will have an adverse effect upon our financial performance.
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. Several 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.
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. In the future, we may need to attract and retain qualified additional senior management but may not be able to do so on favorable 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. 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 depend on rental income from residents for substantially all of our revenues. As a result, our success depends in large part upon our ability to attract and retain qualified residents for our properties. 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 markets increases the supply of housing and increases competition for residents. Many of these competitors may successfully attract residents by offering 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 to certain residents than our properties.
If rents and occupancy levels in our markets do not increase sufficiently to keep pace with rising costs of operations or otherwise decline, our income and distributable cash will decline.
The success of our business model depends, in part, on conditions in the single-family rental market in our markets. Our asset acquisitions have been 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 a declining homeownership rate.
We do not expect these favorable trends to continue indefinitely and some have begun to reverse. Eventually, a strengthening of the U.S. economy and job growth, coupled with government programs designed to encourage homeownership or to keep homeowners in their homes, continuing low interest rates, or other factors, may contribute to a stabilization or reversal of the current trend that favors renting rather than homeownership. In addition, as investors like us have sought and continue to 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 has decreased and will continue to 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.
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, homeowners' association ("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 conditions in our 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.
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 qualified residents, and avoid residents who may default. We rely on information supplied by prospective residents in their rental applications to make leasing decisions and we cannot be certain this information is accurate. We may not successfully screen applicants, and as a result, we may rent to residents who default on our leases or fail to comply with the terms of the lease or HOA regulations, which may 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 and 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.
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 the majority of a duration of one year. 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 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.
We may have difficulty selling our real estate investments or may be restricted from selling property, and we may choose to use all or a portion of the net proceeds from a sale of property for other purposes rather than distribute such proceeds to our stockholders.
Real estate investments are relatively illiquid and, as a result, we may have a limited ability to sell our properties. When we sell any of our properties, we may recognize a loss on such sale. We may elect not to distribute any proceeds from the sale of properties to our stockholders. Instead, we may use such proceeds for other purposes, including:
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purchasing additional properties;
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repaying debt or buying back stock;
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buying out interests of any co-venturers or other partners in any joint venture in which we are a party;
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creating working capital reserves; or
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making repairs, maintenance or other capital improvements or expenditures to our remaining properties.
Our ability to sell our properties may also be limited by our need to avoid the 100% prohibited transactions tax that is imposed on gain recognized by a REIT from the sale of property characterized as dealer property. In order to ensure that we avoid such characterization, we may be required to hold our properties for a minimum period of time and comply with certain other requirements in the Code or dispose of our properties through a TRS.
We will need additional capital or debt financing 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 and securitization loan. 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:
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general business conditions;
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financial market conditions;
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the market’s perception of our business prospects and growth potential;
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our current debt levels and prevailing interest rates; and
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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 not be able to resume future acquisitions of single-family
properties, or may dispose of certain properties in our portfolio at inopportune times, in order to meet liquidity and other requirements.
Our revolving credit facility, securitization loan and any other debt we may incur in the future could expose us to additional risks, adversely affect our operating results, require us to sell properties, and 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 and securitization loan, 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:
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our cash flows from operations will be insufficient to make required payments of principal and interest;
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our debt may increase our vulnerability to adverse economic and industry conditions;
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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;
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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
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the terms of any refinancing may not be as favorable as the terms of the debt being refinanced.
If we are not able to generate sufficient cash flow to service our revolving credit facility, securitization loan and other current and future debt obligations, as well as satisfy the REIT distribution requirement, we may need to refinance our 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. For example, during the financial crisis, recent turmoil in the global markets and events in the real estate and securitization markets, as well as the debt markets and the economy generally, caused significant dislocations, illiquidity and volatility in the market for asset-backed securities and mortgage-backed securities, as well as a severe disruption in the wider global financial markets, including a significant reduction of investor demand for, and purchases of, asset-backed securities and structured financial products. Disruptions in the securitization market could preclude our ability to use securitization as a financing source or could render it an inefficient source of financing making us more dependent on alternative sourcing of financing that might not be as favorable as securitizations in otherwise favorable markets.
In addition, our revolving credit facility and securitization loan accrue 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.
Our current revolving credit facility and securitization loan require us to comply with various financial tests, including those relating to debt yield, debt service coverage ratios, 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 or are unable to meet repayment obligations relating to our current and any future debt, we will risk losing some or all of our properties that may be pledged to secure our obligations to foreclosure or we may be forced to sell properties at a loss. In addition, our current revolving credit facility and securitization loan 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.
Failure to hedge effectively against interest rate changes may adversely affect our results of operations and our ability to make distributions to stockholders.
In connection with our revolving credit facility and securitization loan, we have obtained interest rate cap agreements and swap agreements, 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 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.
The REIT provisions of the Code may also limit our ability to hedge effectively. Under current law, any income that we generate from derivatives or other transactions intended to hedge our interest rate risks, or any income from foreign currencies or other hedges, will generally be treated as nonqualifying income for purposes of the REIT 75% and 95% gross income tests unless specified requirements are met. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous, which could result in greater risks associated with interest rate or other changes that we would otherwise incur.
We face significant competition for acquisitions, which may limit our strategic opportunities and increase the cost to acquire those properties.
We face significant competition for attractive acquisition opportunities in our 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 deployed and continue to deploy, and others may 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 markets. This activity has adversely impacted our level of purchases in certain of our 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.
We intend to continue to expand our scale of operations and may make acquisitions even if the rental and housing markets are not as favorable as they have been in recent years, which could reduce our yield per share.
Our long-term growth depends on the availability of acquisition opportunities in our markets at attractive prices. We believe various factors and market conditions have made homes available for purchase at prices that are below replacement cost. Housing prices have been increasing over the past few years, and we expect that in the future they 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 past opportunities, including:
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improvements in the overall economy and job market;
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reductions in the supply of residential properties compared to demand;
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a resumption of consumer lending activity and greater availability of consumer credit;
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improvements in the pricing and terms of mortgage-backed securities;
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the emergence of increased competition for single-family assets from private investors and entities with similar investment objectives to ours; and
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tax or other government incentives that encourage homeownership.
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 property management platform 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.
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 plan to continue to refine our operations and make strategic acquisitions and dispositions of properties. Our future operating results depend upon our ability to effectively manage our growth, which is dependent, in part, upon our ability to:
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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;
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identify and supervise suitable vendors and employees to provide services to our properties;
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continue to improve our operational and financial controls and reporting procedures and systems; and
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scale our technology and other infrastructure platforms to adequately service new properties.
We cannot assure you that we 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.
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.
Our dependence upon vendors for key services may harm our operating results or reputation if the vendors fail to perform.
We rely on local vendors and service providers, including house renovation professionals, maintenance providers, leasing agents, and property management companies in situations where it is cost-effective to do so or if our internal staff is unable to perform these functions. For example, we currently use third-party property managers for approximately 5.5% of our current properties. We do not have exclusive or long-term contractual relationships with any of these providers, and we can provide no assurance that we will have uninterrupted or unlimited access to their services. Furthermore, selecting, managing, and supervising these service providers requires significant management resources and expertise. Poor performance by 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 we do not select, manage, and supervise appropriate 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 service providers, which could expose us to material liability or responsibility for associated damages, fines, or penalties.
In addition, any delay in identifying a service provider or removal or termination of existing service providers would require us to seek new vendors or providers, which would create delays and adversely affect our operating results.
Claims of deficiencies in the foreclosure process may result in rescission of our purchases or challenges to title.
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.
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. Courts and administrative agencies have been 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 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 or an increase in litigation costs incurred with respect to properties obtained through foreclosure.
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.
Furthermore, the properties we acquire may vary materially in terms of 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. Such changes affect the accuracy of our assumptions and, in turn, 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 39% of the properties we owned as of December 31, 2016 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, 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 were 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.
Approximately 40% of our properties owned as of December 31, 2016 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 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 portfolio acquisitions 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 may in the future acquire properties purchased as portfolios 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. When acquiring portfolios, we may not conduct interior inspections on each property and may fail to appropriately discover or predict defects associated with such properties, which may result in renovation and maintenance costs and time frames that exceed our estimates and negatively affect our financial results and earnings. 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 portfolio acquisitions 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.
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 we 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 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 portfolio 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.
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, South Carolina and Texas. As of December 31, 2016, approximately 61% of our properties were concentrated in only three markets - Phoenix, AZ, Atlanta, GA, and Tampa, FL. 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 these markets experience economic downturn in the future, 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 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.
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.
Tenant relief laws, including laws regulating evictions, rent control laws and other regulations that limit our ability to increase rental rates may negatively impact our rental income and profitability.
As the landlord of numerous properties, we are involved from time to time in evicting residents who are not paying their rent or who are otherwise in material violation of the terms of their lease. Eviction activities impose legal and managerial expenses that raise our costs and expose us to potential negative publicity. The eviction process is typically subject to legal barriers, mandatory “cure” policies, our internal policies and procedures and other sources of expense and delay, each of which may delay our ability to gain possession and stabilize the property. Additionally, state and local landlord-tenant laws may impose legal duties to assist residents in relocating to new housing, or restrict the landlord’s ability to remove the resident on a timely basis or to recover certain costs or charge residents for damage residents cause to the landlord’s premises. Because such laws vary by state and locality, we must be familiar with and take all appropriate steps to comply with all applicable landlord-tenant laws, and need to incur supervisory and legal expenses to ensure 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, in class actions or actions by state or local law enforcement and our reputation and financial results may suffer. We may be required to pay our adversaries’ litigation fees and expenses if judgment is entered against us in such litigation or if we settle such litigation.
Furthermore, state and local governmental agencies may introduce rent control laws or other regulations that limit our ability to increase rental rates, which may affect our rental income. Especially in times of recession and economic slowdown, rent control initiatives can acquire significant political support. If rent controls unexpectedly became applicable to certain of our properties, our revenue from and the value of such properties could be adversely affected.
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 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.
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 have in the past, and may again in the future, 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 we use 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.
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 intrinsic 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 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, and expect that we will continue to be 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. Our properties are subject to real estate taxes that may increase as tax rates change and as the real properties are assessed or reassessed by taxing authorities. As the owner of our properties, we are ultimately responsible for payment of the taxes to the applicable government authorities. If real estate taxes increase, our expenses will increase. If we fail to pay any such taxes, the applicable taxing authority may place a lien on the real property and the real property may be subject to a tax sale. 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.
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.
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. In addition, any remediation efforts may not enable us to avoid a material weakness in the future. 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.
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 (the "JOBS Act"), for so long as we take advantage of the exemptions contained in the JOBS Act. We will cease to be an “emerging growth company” as of December 31, 2017. Once we are no longer an emerging growth company, 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. Additionally, we will no longer be allowed to take advantage of the reduced disclosure and other requirements that are otherwise generally applicable to public companies that are not emerging growth companies.
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. In addition, the existence of a material weakness or significant deficiency could also result in errors in our financial statements that could require a restatement or cause us to fail to meet our public company reporting obligations. 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.
Risks Related to the Real Estate Industry
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:
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adverse changes in national or local real estate, economic, or demographic conditions;
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vacancies or our inability to rent our homes on favorable terms or at favorable rental rates;
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bankruptcies or adverse changes in the financial conditions of the residents of our properties;
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resident turnover or our inability to collect rent from residents;
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reduced demand for single-family home rentals and changes in the relative popularity of properties and neighborhoods;
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increased supply of single-family homes and availability of financing;
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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;
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changes in interest rates, availability, and terms of debt financing;
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the illiquidity of real estate investments generally;
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residents’ perceptions of the safety, convenience, and attractiveness of our properties and the neighborhoods where they are acquired;
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the ability or unwillingness of residents to pay rent increases;
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the effects of rent controls, stabilization laws and other laws or covenants regulating rental rates; and
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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.
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 Depository Insurance Corporation (FDIC), has implemented a number of programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures, including the Home Affordable Modification Program, which seeks to provide relief to homeowners 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 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 homeowners 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.
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 markets.
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.
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.
Additionally, as of the closing of the internalization of our management in September 2014, Pine River (as defined in Item 7) and Provident (as defined in Item 7) received an aggregate of 2,231,511 common units of our Operating Partnership, redeemable for cash or, at our election, common shares on a one-for-one basis. If we were to redeem such common units through the issuance of our common shares, and as long as the resale registration statement that we filed with the SEC covering these shares remains effective, these shares will be freely transferable without restriction if and when they are issued. The market price of our common stock may decline significantly if Pine River and Provident either or both were to sell a significant portion of their common stock within a short timeframe. Sales of substantial amounts of common stock or the perception that such sales could occur may adversely affect the prevailing market price for our common stock.
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;
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equity issuances by us, or share resales by our stockholders, or the perception that such issuances or resales may occur;
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actual or anticipated accounting problems;
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publication of research reports about us or the real estate industry;
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changes in market valuations of similar companies;
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adverse market reaction to any increased indebtedness we incur in the future;
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additions to or departures of our key personnel;
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speculation in the press or investment community;
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our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;
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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;
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failure to maintain our REIT qualification;
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price and volume fluctuations in the stock market generally, such as those experienced in the last half of 2015 and the beginning of 2016; and
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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 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.
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 Maryland General Corporation Law ("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), though our board of directors may vote to repeal the resolution at any time.
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 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 at regular corporate rates 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.
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 currently 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 investments in REITs to be less attractive than investments in non-REITs, 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 connection with our formation and initial public offering 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 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 we 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, to comply with certain statutory requirements of a prohibited transactions safe harbor, 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.
The ability of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.
Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interest to continue to qualify as a REIT. If we cease to be a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our taxable income to our stockholders, which may have adverse consequences on the total return to our stockholders.
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 Operating Partnership’s items of gain, loss, income, deductions, and credit. 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 any 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 any 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. For example, in December 2015, the Protecting Americans from Tax Hikes Act of 2015 (the "Act") was signed into law. The Act contains numerous changes to the U.S. federal income tax rules applicable to REITs. Such changes include modifications to various rules that apply to our ownership of, and business relationship with, our TRSs (including a reduction in the maximum allowable value of our assets attributable to TRSs from 25% to 20%) which could impact our ability to enter into future investments. The provisions enacted in by the Act could affect our tax positions or investments, and future legislative changes related to those rules described above could have a materially adverse impact on our results of operations and financial condition.
Potential changes to the U.S. tax laws could have a significant negative impact on our business operations, financial condition and earnings.
The incoming administration of President Trump has included as part of its agenda a potential reform of U.S. tax laws. The details of the potential reform have not yet emerged but during his presidential campaign, President Trump outlined several changes to business taxes. In addition, House Republicans and Congress have drafted an initial tax reform (“Tax Reform Blueprint”) to significantly amend the current income tax code. The convergence of the President’s plan and the Tax Reform Blueprint’s potential reforms has not yet taken place, however, key changes within the proposals include:
•
Elective replacement of current depreciation deductions with a cost recovery system for capital asset investments (excluding land investments),
•
Elimination of the deductibility of corporate interest expense, if a cost recovery system is elected,
•
Restriction or elimination of benefits of like-kind exchanges that defer capital gains for tax purposes,
•
Reduction of the maximum business tax rate from 35 percent to 15-20 percent,
•
Elimination of the corporate alternative minimum tax,
•
Implementation of a one-time deemed repatriation tax rate of 10 percent on corporate profits held offshore, and
•
Elimination of most corporate tax expenditures except for the Research and Development credit.
No details regarding the transition from the current tax code to potential new tax reforms have emerged. In addition, it is not yet known if the potential reform of the U.S. tax laws will include further changes that may impact existing REIT rules under the current Internal Revenue Code. If the tax reform is enacted with some or all of the changes outlined above, our taxable income and the amount of distributions to our stockholders required in order to maintain our REIT status may significantly increase. As a REIT, we are required to distribute at least 90% of our taxable income to our shareholders annually.
We cannot predict whether, when or to what extent new U.S. federal tax laws, regulations, interpretations or rulings will be issued, nor is the long-term impact of proposed tax reforms (including future reforms that may be part of any enacted tax reform) on the real estate industry clear. Furthermore, the proposed tax reform above may negatively impact our tenants operating results, financial condition and future business plans. Prospective investors are urged to consult their tax advisors regarding the effect of potential changes to the U.S. federal tax laws on an investment in our shares. A reform of the U.S. tax laws by the new administration may be enacted in a manner that negatively impacts our operating results, financial condition and business operations, and is adverse to our stockholders.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
The following table provides a summary of our portfolio of single-family properties as of December 31, 2016:
(1)
Properties reflected in this table exclude properties recorded as assets held for sale on our consolidated balance sheets.
(2)
Aggregate investment in real estate includes all capitalized costs, determined in accordance with U.S. generally accepted accounting policies ("GAAP"), incurred through December 31, 2016 for the acquisition, stabilization, and significant post-stabilization renovation of properties, including land, building, possession costs, and renovation costs. Aggregate investment in real estate includes $21.6 million in capital improvements incurred from our formation through December 31, 2016 made to properties that had been previously renovated but does not include accumulated depreciation.
(3)
As of December 31, 2016, approximately 2% of our properties were less than 10 years old, 39% were between 10 and 20 years old, 20% were between 20 and 30 years old, 19% were between 30 and 40 years old, 11% were between 40 and 50 years old, and 9% were more than 50 years old. Average age is an annual calculation.
(4)
Charlotte market includes properties in South Carolina due to their proximity to Charlotte, North Carolina.
(5)
Northern California market currently consists of Contra Costa, Napa, and Solano counties.
(6)
Southeast Florida market currently consists of Miami-Dade, Broward, and Palm Beach counties.
The following table summarizes the occupancy status of our properties as of December 31, 2016:
(1)
Average monthly rent for occupied properties was calculated as the average of the contracted monthly rent for all occupied properties as of December 31, 2016 and reflects rent concessions amortized over the life of the related lease.
(2)
Average remaining lease term assumes a remaining term of 30 days for leases in month-to-month status.
Item 3.
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.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock is listed on the NYSE under the symbol “SBY”. Below is a summary of the high and low prices for our common stock for each quarterly period during calendar years ended December 31, 2016 and 2015, as reported on the NYSE:
Holders
As of February 11, 2017, there were 174 registered holders of our common stock. This figure does not reflect the beneficial ownership of shares held in nominee name.
Dividends
The following table presents cash dividends declared on our common stock during calendar years ended December 31, 2016 and 2015:
We intend to continue making similar 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 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,” 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 2017 and thereafter.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2016 with respect to shares of our common stock that may be issued under our equity compensation plans.
(1)
Represents the maximum number of shares of common stock issuable upon vesting of outstanding performance stock units under our Restated 2012 Equity Incentive Plan (including applicable dividend equivalent rights).
Unregistered Sales of Equity Securities
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
On July 1, 2013, our board of directors authorized a share repurchase program, which allowed us to repurchase up to 2,500,000 shares of our common stock. On November 25, 2014, our board of directors authorized an increase of 2,500,000 shares to the previously authorized share repurchase program for a total of 5,000,000 shares. Following is repurchase activity for the fourth quarter of 2016:
(1)
Consists of shares withheld to settle tax withholding obligations related to the vesting of restricted stock awards.
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 US REIT Index.
Item 6.
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.
(1)
Our 2012 consolidated financial results include the results of our Predecessor (see Item 7.
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 Condition 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 internally-managed Maryland corporation that focuses 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, 2016, we owned 9,044 single-family properties for rental purposes in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, South Carolina and Texas, excluding properties reflected as assets held for sale on our consolidated balance sheets.
We are the continuation of the operations of Silver Bay Property Investment LLC (the "Predecessor"). At the time of its formation, the Predecessor was a wholly owned subsidiary of Two Harbors Investment Corp. ("Two Harbors"). The Predecessor began formal operations in February 2012, when it started acquiring single-family residential rental properties. In our current form, we were created on December 19, 2012, through a series of formation transactions (the "Formation Transactions"), which included an initial public offering (the "Offering"), the contribution of equity interests in the Predecessor by Two Harbors, and the acquisition of entities (the "Provident Entities") managed by Provident Real Estate Advisors LLC ("Provident").
We have elected to be treated as a real estate investment trust ("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 continue to 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 our taxable REIT subsidiaries ("TRSs") is subject to taxation at regular corporate rates.
Silver Bay Realty Trust Corp. was incorporated in Maryland in June 2012. Silver Bay Realty Trust Corp. conducts its business and owns all of its properties through Silver Bay Operating Partnership L.P. (the "Operating Partnership"), a Delaware limited partnership. Silver Bay Realty Trust Corp.’s wholly owned subsidiary, Silver Bay Management LLC (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, 2016, Silver Bay Realty Trust Corp. owned, through a combination of direct and indirect interests, 94.1% of the partnership interests in 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.
Through September 30, 2014, we were externally managed by PRCM Real Estate Advisers LLC (our "Former Manager"). During this time, we relied on our Former Manager to provide or obtain on our behalf the personnel and services necessary for us to conduct our business as we had no employees of our own. On September 30, 2014, we closed a transaction to internalize our management (the "Internalization") and now own all material assets and intellectual property rights of our Former Manager previously used in the conduct of its business. In connection with the Internalization, the officers and employees who worked for our Former Manager became our employees.
Recent Developments
On February 27, 2017, Silver Bay Realty Trust Corp. the General Partner, and the Operating Partnership (Silver Bay Realty Trust Corp., the Operating Partnership and the General Partner collectively referred to as the “Company Parties”), entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Tricon Capital Group, Inc., a company incorporated under the laws of the Province of Ontario (“Tricon Ultimate Parent”), TAH Acquisition Holdings LLC, a Delaware limited liability company (“Tricon Parent”) and TAH Acquisition LP, a Delaware limited partnership (“Tricon LP” and, together with Tricon Ultimate Parent and Tricon Parent, the “Tricon Parties”). Under the Merger Agreement, Silver Bay Realty Trust Corp. will merge
with and into Tricon Parent, with Tricon Parent being the surviving entity (the “Merger”). The board of directors of Silver Bay Realty Trust Corp. has unanimously approved the Merger Agreement, the Merger and the other transactions contemplated by the Merger Agreement.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger, each outstanding share of Silver Bay Realty Trust Corp. common stock, par value $0.01 per share (other than shares held by any Tricon Party or any subsidiary thereof or any wholly-owned subsidiary of the Company), will be converted into the right to receive an amount in cash equal to $21.50, without interest (as the same may be adjusted, the “Merger Consideration”), subject to any applicable withholding tax, and each outstanding share of Silver Bay Realty Trust Corp. 10% cumulative redeemable preferred stock, par value $0.01 per share, will be converted into the right to receive an amount in cash equal to $1,000 per share, plus an amount equal to all dividends accrued and unpaid on such share of preferred stock immediately prior to the Merger effective time, without interest, subject to applicable withholding tax. The Merger Agreement also provides for the merger of Tricon LP with and into the Operating Partnership, with the Operating Partnership being the surviving entity (the “Partnership Merger”).
The completion of the Merger and the Partnership Merger is subject to customary conditions, including, among others: (i) approval by a majority of Silver Bay Realty Trust Corp.’s stockholders; (ii) the absence of a material adverse effect on the Company; (iii) the receipt of a tax opinion relating to REIT status of the Company and (iv) the absence of any order, action or law by a governmental authority preventing, prohibiting, enjoining or making illegal the consummation of the Merger and the Partnership Merger.
The Company anticipates the Merger and Partnership Merger will close in the second quarter of 2017. For additional information regarding the Merger, Partnership Merger, or the Merger Agreement, see the Company’s Current Report on Form 8-K filed on February 27, 2017 and additional future filings and disclosures it will make with respect to the transaction.
Any discussion of future trends or business plans of the Company in this Item 7 ignores any impact of the Merger, the Partnership Merger, or the Merger Agreement.
Management Internalization Transaction
On September 30, 2014, we closed the Internalization after receiving the required stockholder approval for the transaction. The Internalization was completed under the terms of a contribution agreement (the “Contribution Agreement”) among Silver Bay, Pine River Domestic Management L.P. ("Pine River"), Provident, our Former Manager, and the Operating Partnership, pursuant to which we acquired our Former Manager in exchange for 2,231,511 common units of the Operating Partnership. These common units are redeemable for cash or, at our election, a number of our common shares on a one-for-one basis. We incurred $39.4 million of expenses during 2014 in connection with the Internalization. These costs primarily relate to the issuance of common units at $36.2 million, and to a lesser extent, certain transaction fees and expenses and the assumption of certain liabilities in connection with the transaction.
Prior to the Internalization, our Former Manager received management fees and expense reimbursement under the advisory management agreement and property management and acquisition services agreement. As a result of this transaction, as of September 30, 2014, we no longer pay fees or expense reimbursements to our Former Manager or our Former Manager's operating subsidiary.
Acquisition of The American Home Real Estate Investment Trust, Inc. Portfolio
During 2015, we acquired a portfolio of 2,461 properties (the "Acquired Properties") from The American Home Real Estate Investment Trust, Inc. ("TAH"). The acquisition was substantially completed on April 1, 2015 with an aggregate purchase price of $263.0 million (the "Portfolio Acquisition"). The Portfolio Acquisition was financed using proceeds obtained under our revolving credit facility, which was amended and restated on February 18, 2015 to increase the borrowing capacity to $400.0 million from $200.0 million. The properties acquired in the Portfolio Acquisition were primarily located in Atlanta, Charlotte, Tampa and Orlando.
Property Portfolio
Our investments in real estate consist of single-family properties located in select markets. As of December 31, 2016, we owned 9,044 single-family properties in the following markets:
(1)
Properties reflected in this table exclude properties recorded as assets held for sale on our consolidated balance sheets.
(2)
Aggregate investment in real estate includes all capitalized costs, determined in accordance with U.S. generally accepted accounting principles ("GAAP"), incurred through December 31, 2016 for the acquisition, stabilization, and significant post-stabilization renovation of properties, including land, building, possession costs and renovation costs. Aggregate investment in real estate includes $21.6 million in capital improvements, incurred from our formation through December 31, 2016, made to properties that had been previously renovated, but does not include accumulated depreciation.
(3)
As of December 31, 2016, approximately 2% of our properties were less than 10 years old, 39% were between 10 and 20 years old, 20% were between 20 and 30 years old, 19% were between 30 and 40 years old, 11% were between 40 and 50 years old, and 9% were more than 50 years old. Average age is an annual calculation.
(4)
Charlotte market includes properties in South Carolina due to its proximity to Charlotte, North Carolina.
(5)
Northern California market currently consists of Contra Costa, Napa and Solano counties.
(6)
Southeast Florida market currently consists of Miami-Dade, Broward and Palm Beach 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. Some of 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, seasonality, occupancy levels, rates of resident turnover, home price appreciation, changes in homeownership rates, changes in homeowners’ association fees and real estate taxes, changes in insurance costs, expenses incurred in the maintenance and turnover of our properties, resident defaults, our expense ratios and our capital structure. Certain of these factors are described in greater detail below.
Acquisitions and Dispositions
The following is a summary of our acquisition and disposition activity by quarter for the year ended December 31, 2016:
(1)
Our acquisitions in 2016 were sourced through portfolio transactions.
Our 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. 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. Availability of financing from such sources on acceptable terms will greatly impact our pace of acquisitions, as will any preference we may have for portfolio acquisitions, which are inherently less predictable than purchases through other channels.
We periodically sell properties after determining the property or related market no longer fit our portfolio and we may sell properties when we view market conditions as favorable given other potential uses of capital. As of December 31, 2016, we had 104 properties reflected as assets held for sale on our balance sheet. As of December 31, 2016, we had 30 properties under contract to sell with an aggregate contractual sales price of $6.1 million. There are no assurances we will close on the sales of these properties.
During the years ended December 31, 2016, 2015 and 2014, we sold 315, 230 and 60 properties, respectively, for total gross proceeds of $58.1 million, $29.2 million and $6.0 million, respectively, for a net gain on disposition of real estate of $10.7 million, $4.0 million and $0.2 million, respectively. The 2016 dispositions of real estate were primarily located in our Southeast Florida and Southern California markets. The 2015 dispositions of real estate were primarily located in our Houston, TX and Southern California markets.
Stabilization, Renovation, and Leasing
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. The time to stabilize a newly acquired property can vary significantly among properties for several reasons, including the property's acquisition channel, the age and condition of the property, whether the property was vacant when acquired, local demand for properties, our marketing techniques, and the size of our available inventory of rent ready properties.
The following table summarizes the occupancy status of our properties as of December 31, 2016:
(1)
Average monthly rent for occupied properties was calculated as the average of the contracted monthly rent for all occupied properties as of December 31, 2016 and reflects rent concessions amortized over the life of the related lease.
(2)
Average remaining lease term assumes a remaining term of 30 days for leases in month-to-month status.
Aggregate portfolio occupancy increased to 96.7% as of December 31, 2016 as compared to 95.8% as of December 31, 2015.
During the three months ended December 31, 2016, 594 properties turned over compared to 596 during the three months ended December 31, 2015. This turnover number includes move-outs, evictions and lease breaks on our stabilized portfolio. Quarterly turnover for the three months ended December 31, 2016 was 6.6%. Quarterly turnover represents the number of properties turned over in the period divided by the number of properties in stabilized status at period-end. The total number of properties with lease expirations in the three months ended December 31, 2016 was 1,948, including properties with month-to-month occupancy in the period. Of these properties, 407 properties turned over, resulting in a retention rate of 79.1% compared to a retention rate of 80.3% during the three months ended December 31, 2015.
The following is a summary of our turnover percentage by quarter for the years ended December 31, 2016 and 2015:
(1)
Quarterly turnover percentage represents the number of properties turned over in each respective period divided by the number of properties in stabilized status as of each respective period-end.
Same-Home Properties. We refer to our Same-Home properties as those properties (1) that we had stabilized and for
which we had completed the initial renovation as of January 1, 2015 and (2) that we held in operations throughout the full
periods presented in both 2015 and 2016. Same-Home properties exclude properties classified as held for sale and properties taken out of service as a result of a casualty loss.
As of December 31, 2016, we had 5,780 properties included in Same-Home properties in the following markets:
(1) Average monthly rent for occupied properties was calculated as the average of the contracted monthly rent for all occupied properties as of December 31, 2016 and 2015, respectively, and reflects rent concessions amortized over the life of the related lease.
Results of Operations
The following are our results of operations for the years ended December 31, 2016, 2015, and 2014:
(1) Net operating income ("NOI") is a non-GAAP financial measure we believe, when considered with the financial statements determined in accordance with GAAP, is helpful to investors in understanding our performance as a REIT. A reconciliation of NOI to net loss prepared in accordance with GAAP is found in this Item 7 under the heading "Non-GAAP Financial Performance Measures".
The following are the results of operations for our Same-Home portfolio for the years ended December 31, 2016 and 2015:
(1) Same-Home net operating income ("Same-Home NOI") is a non-GAAP financial measure we believe, when considered with the financial statements determined in accordance with GAAP, is helpful to investors in understanding our performance as a REIT. We believe Same-Home NOI is a useful measure of performance because the population of properties in this analysis is consistent from period to period, thereby eliminating the effects of changes in the composition of the portfolio. See "Same-Home Properties" section above for information as to how we define our Same-Home property portfolio. A reconciliation of Same-Home NOI to net loss prepared in accordance with GAAP is found in this Item 7 under the heading "Non-GAAP Financial Performance Measures".
Comparison of the Year Ended December 31, 2016 and the Year Ended December 31, 2015
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 $12.9 million, or 11.4%, in 2016 over the prior year. We owned 8,749 leased properties as of December 31, 2016 as compared to 8,645 as of December 31, 2015 with aggregate occupancy rates of 96.7% and 95.8%, respectively. We achieved an average monthly rent for leased properties in our portfolio of $1,205 as of December 31, 2016 as compared to $1,167 as of December 31, 2015. We calculate average monthly rent for a period as the average of the contracted monthly rent for all occupied properties as of the end of such period, net of the concessions amortized over the life of the related lease. The increase in revenue for the year ended December 31, 2016 over the prior year was primarily due to an increase in the number of occupied homes during the period driven by consummation of the Portfolio Acquisition on April 1, 2015 and to a lesser extent increases in our rental rates and occupancy rate.
Total revenue from Same-Home properties increased $4.5 million, or 5.6%, in the year ended December 31, 2016, compared to the prior year. This increase was due primarily to the increases in average monthly rent and aggregate occupancy. Average monthly rent for occupied properties in our Same-Home portfolio increased to $1,264 as of December 31, 2016 compared to $1,216 as of December 31, 2015. The average rent for the Same-Home portfolio is higher than our aggregate portfolio due to property mix as a result of the Portfolio Acquisition. Same-Home occupancy increased to 96.7% as of December 31, 2016 compared to 95.7% as of December 31, 2015.
Expenses
Property Operating Expenses. Property operating expenses include property operating and maintenance, real estate taxes, homeowners' association fees, and property management. Included in property operating and maintenance are repairs and maintenance, expenses associated with resident turnover, property insurance, bad debt and utilities and landscape maintenance on market ready properties not occupied. Real estate taxes are expensed once a property is placed in service. As of
December 31, 2016, we internally managed 94.5% of our portfolio, which represented all of our markets other than Las Vegas and Tucson, where we use third-party managers.
Property operating expenses for the entire portfolio increased $2.7 million, or 5.3% in the year ended December 31, 2016 over the prior year primarily as a result of the significant increase in the number of properties owned and in-service during the year ended December 31, 2016 due to the Portfolio Acquisition and the resulting increases in expenses for turnover, repairs and maintenance and real estate taxes. Property management decreased in the year ended December 31, 2016 over the prior year due to efficiencies realized from cost saving measures. As a percentage of revenue, property operating expenses decreased 2.5 percentage points in the year ended December 31, 2016 over the prior year primarily due to revenue growth as well as efficiencies of scale reflected in our property management expense calculated as a percentage of revenue.
Property operating expenses for the Same-Home properties increased $0.1 million, or 0.4% during the year ended December 31, 2016 primarily as a result of an increase in real estate taxes partially offset by a decrease in property management due to efficiencies realized from cost savings measures. As a percentage of total revenue, property operating expenses for the Same-Home properties decreased to 43.2% for the year ended December 31, 2016 from 45.4% for the year ended December 31, 2015.
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 $2.1 million, or 6.0%, in 2016 compared to the prior year, primarily as a result of the significant increase in the number of properties owned and in-service in 2016 compared to 2015 primarily due to the consummation of the Portfolio Acquisition on April 1, 2015.
Portfolio Acquisition Expense. Portfolio acquisition expense represents transaction costs incurred when acquiring
properties that meet the definition of a business under the guidance codified in Codification Topic, Business Combinations
("ASC 805"), which must be expensed when incurred rather than capitalized into the basis of each property.
We incurred $0.5 million in portfolio acquisition expense in the year ended December 31, 2016 as compared to $2.1 million during the year ended December 31, 2015. We purchased 343 properties during the year ended December 31, 2016 as compared to the 2,461 properties acquired in the Portfolio Acquisition during 2015. We anticipate this expense to fluctuate from year to year as our preference toward portfolio acquisitions is inherently less predictable than other forms of acquisitions.
General and Administrative. General and administrative includes those costs related to being a public company and other expenses associated with our corporate and administrative functions. General and administrative expense decreased $1.5 million in 2016 compared to the prior year primarily due to expense management.
Share-Based Compensation. Share-based compensation expense includes costs associated with our restricted stock awards to our board of directors and certain employees and our performance stock unit awards to certain members of
management which are described in Note 6 of the consolidated financial statements included with this Annual Report on Form 10-K.
Severance and other. Severance and other consists primarily of executive severance and related costs for certain
employees that have departed.
Interest Expense. Interest expense includes interest incurred on the outstanding balance of our debt, an unused line fee on the undrawn amount of the revolving credit facility, debt service costs, amortization of deferred financing fees, net of certain amounts capitalized for properties undergoing renovation activities, interest expense associated with the interest rate swap transactions and interest rate cap accretion. The following table presents total interest expense for the years ended December 31, 2016 and 2015:
(1) Includes the Securitization Loan's monthly servicing fees.
(2) For 2015, excludes deferred financing fees written-off in conjunction with the paydown of the Securitization Loan related to the sale of the Houston portfolio (see Note 5 of the consolidated financial statements included with this Annual Report on Form 10-K).
(3) Includes monitoring service fees and interest related to our designated derivative financial instruments (see Note 11 of the consolidated financial statements included with this Annual Report on Form 10-K).
(4) We capitalized interest for properties undergoing renovation activities and purchased subsequent to obtaining debt in May 2013.
Interest expense increased $4.8 million during the year ended December 31, 2016 as compared to the prior year primarily attributed to a higher average outstanding balance of debt in the revolving credit facility related to financing the Portfolio Acquisition in April 2015, as well as other acquisitions purchased during 2016, in addition to higher average interest rates and an increase in losses reclassified from accumulated other comprehensive income (loss) into earnings associated with our designated interest rate cap agreements.
Impairment of Real Estate. We evaluate long-lived assets for indicators of impairment periodically or whenever events or changes in circumstances indicate that an asset's carrying amount may not be recoverable. Upon identification as held for sale, a property is subject to an impairment test and an impairment is immediately recognized when the fair market value, less costs to sell, is less than the carrying amount of the asset. For the years ended December 31, 2016 and 2015, we recognized impairment charges of $1.1 million and $0.1 million, respectively, due to mix of properties identified for sale, predominantly in the Southeast Florida market.
Total Other Income (Expense). Total other income (expense) consists of activities related to our sales of investments in real estate as well as adjustments for derivative financial instruments, net. Total other income was $9.5 million and $3.7 million for the years ended December 31, 2016 and 2015, respectively. The increase in other income is primarily due to the net gain on disposition of real estate related to our Southeast Florida and Southern California markets along with certain other properties.
Income Tax (Expense) Benefit, Net. We intend to operate and to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code"), and intend to comply with the requirements of the Code relating to REITs. We have TRSs where certain investments may be made and activities conducted that may have otherwise been subject to the prohibited transactions tax and may not be favorably treated for purposes of complying with the various requirements for REIT qualification. The income and losses within the TRSs are subject to federal, state, and local income taxes. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis.
We recognized income tax expense of $1.0 million during the year ended December 31, 2016, which was primarily related to the income taxes on net gain on disposition of real estate in the TRS entities. We recognized a net income tax benefit of $0.8 million during the year ended December 31, 2015 which was primarily related to the reversal of a net deferred tax asset valuation allowance in 2015. Prior to 2015, our TRS had a history of losses and, as a result, had historically recognized a valuation allowance for net deferred tax assets. Each quarter, we evaluate the need to retain all or a portion of the valuation allowance on our net deferred tax assets. In the fourth quarter of 2015, we determined that it was more likely than not that the deferred tax assets, including any remaining net operating losses will be realized in certain TRS entities. In making this determination, we analyzed, among other things, our recent history of earnings, forecasts of future earnings from sales of depreciable property, and our cumulative earnings for the last year.
Comparison of the Year Ended December 31, 2015 and the Year Ended December 31, 2014
Revenue
Total revenue increased $35.8 million or 45.9% during 2015 over the prior year. This increase was primarily related to the Portfolio Acquisition and our increased aggregate occupancy, which increased to 95.8% as of December 31, 2015 from 85.7% as of December 31, 2014. We owned 8,645 leased properties as of December 31, 2015 as compared to 5,812 as of December 31, 2014. We achieved an average monthly rent for leased properties in our portfolio of $1,167 as compared to $1,194 as of December 31, 2014, primarily as a result of changes to portfolio mix. Excluding the Portfolio Acquisition, our average monthly rent increased 3.1% over the prior year period due to increases achieved on renewal and re-lease offset minimally by changes to portfolio mix.
Expenses
Property Operating Expenses. Property operating expenses increased $12.0 million or 30.7% in 2015 over the prior year. The increase in property operating expenses was attributable to the significant increase in the number of properties owned and in-service in 2015 as compared to 2014 and the resulting increases in resident turnover, repairs and maintenance, real estate taxes, homeowners' association fees and property management. Property operating expense as a percentage of revenue decreased to 44.8% in 2015 from 50.0% in 2014. This decrease as a percentage of revenue is primarily attributable to an increase in revenue due to the Portfolio Acquisition as well as changes in our property management as a result of the Internalization.
Prior to the Internalization, rather than compensating our Former Manager’s operating subsidiary with commissions or fees based on rental income, we reimbursed all costs and expenses of our Former Manager’s operating subsidiary incurred on our behalf. In addition to these costs, we paid a property management fee to our Former Manager’s operating subsidiary equal to 5% of certain compensation and overhead costs incurred as a result of providing services to us, which reduced the advisory management fee paid to our Former Manager by the same amount. Following the Internalization, we incur all property management costs directly. 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 increased $9.6 million, or 37.3%, in 2015 compared to the prior year, primarily as a result of the significant increase in the number of properties owned and in-service in 2015 compared to 2014.
Advisory Management Fee. Prior to the Internalization, we relied on our Former Manager to provide or obtain on our behalf the personnel and services necessary for us to conduct our business because we had no employees of our own. Under this previous arrangement, we paid our Former 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 the 5% property management fee paid to our Former Manager’s operating subsidiary. As a result of the Internalization, beginning in the fourth quarter of 2014, we ceased incurring the advisory management fee and, as described below, general and administrative expenses related to certain personnel expenses and certain other expenses previously borne by our Former Manager have increased. As a result, we incurred no advisory management fees in 2015 compared to $6.6 million in 2014.
Management Internalization. We did not incur any expenses during 2015 in connection with the Internalization as compared to $39.4 million during 2014. These costs primarily related to the issuance of 2,231,511 common units of the Operating Partnership at $36.2 million, and to a lesser extent, certain transaction fees and expenses and the assumption of certain liabilities in connection with the transaction.
Portfolio Acquisition Expense. We incurred $2.1 million of costs associated with the Portfolio Acquisition in the year ended December 31, 2015. We had no such costs for 2014.
General and Administrative. General and administrative include those costs related to being a public company, expense reimbursements under the advisory management agreement with our Former Manager through the date of Internalization on September 30, 2014, certain personnel costs we now incur directly following the Internalization and other expenses associated with our corporate and administrative functions. Under the advisory management agreement, we paid all costs and expenses of our Former Manager incurred in the operation of its business, other than the compensation of our Chief Executive Officer and personnel providing data analytics directly supporting the investment function. Beginning in the fourth quarter of 2014, general and administrative now includes these expenses previously borne by our Former Manager. General and
administrative now also includes certain personnel and operational costs classified as property management prior to Internalization. These changes primarily caused the year over year increase in general and administrative expense of $5.6 million.
Share-based Compensation. Share-based compensation expense increased $1.6 million in 2015 compared to the prior year, due to awards made in February and May 2015, which are described in Note 6 of the consolidated financial statements included within this Annual Report on Form 10-K.
Interest Expense. Interest expense included interest incurred on the outstanding balance of our debt, an unused line fee on the undrawn amount of the revolving credit facility, debt service costs, and amortization of deferred financing fees, net of certain amounts capitalized for properties undergoing renovation activities. Interest expense increased $9.7 million, or 83.6%, in 2015 compared to the prior year. The change is primarily attributable to a higher average outstanding balance of debt and amortization of additional financing fees incurred in the securitization transaction for the entire year of 2015 and the credit facility upsize.
Impairment of Real Estate. For the years ended December 31, 2015 and 2014, we recognized impairment charges of $0.1 million and $0.6 million. The change is primarily due to the mix of properties identified as held for sale. The majority of the properties sold during 2015 were either from our Houston, TX or Southern California markets or those acquired in the Portfolio Acquisition.
Total Other Income (Expense). Total other income (expense) was $3.7 million and $(0.5) million for the years ended December 31, 2015 and 2014, respectively. The increase in other income is primarily related to the net gain on disposition of real estate related to the sale of our Houston portfolio along with certain other properties. In addition, during 2014 we recorded $0.5 million in adjustments for derivative instruments, net pertaining to ineffectiveness on the revolving credit facility interest rate cap agreements upon entering into the securitization transaction in 2014.
Income Tax (Expense) Benefit, Net. We recognized an income tax benefit of $0.8 million during the year ended December 31, 2015. Prior to 2015, our TRS had a history of losses and, as a result, had historically recognized a valuation allowance for net deferred tax assets. Each quarter, we evaluate the need to retain all or a portion of the valuation allowance on our net deferred tax assets. In the fourth quarter of 2015, we determined that it was more likely than not that the deferred tax assets, including any remaining net operating losses will be realized in certain TRS entities. As such, we recorded a reversal of the net deferred tax asset valuation allowance in 2015. In making this determination, we analyzed, among other things, our recent history of earnings, forecasts of future earnings from sales of depreciable property, and our cumulative earnings for the last year.
Critical Accounting Policies
The preparation of financial statements in accordance with GAAP 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. Rental income, net of concessions and sales tax, is recognized on a straight-line basis over the term of the lease.
We periodically evaluate the collectability of our resident and other receivables and record an allowance for doubtful accounts for any estimated probable losses. This allowance is estimated based on payment history and probability of collection. We generally do not require collateral other than resident security deposits.
We recognize sales of real estate when the sale has closed, title has passed, adequate initial and continuing investment by the buyer is received, possession and other attributes of ownership have been transferred to the buyer, and we are not obligated to perform significant additional activities after closing. All these conditions are typically met at or shortly after closing.
Investments in Real Estate
Property acquisitions are evaluated to determine whether they meet the definition of a business combination or of an asset acquisition under GAAP. For asset acquisitions, we capitalize (1) pre-acquisition costs to the extent such costs would have been capitalized had we owned the asset when the cost was incurred, and (2) closing and other direct acquisition costs. We then allocate the total cost of the property including acquisition costs, between land and building based on their relative fair values, generally utilizing the relative allocation that was contained in the property tax assessment of the same or a similar property, adjusted as deemed necessary.
For acquisitions that do not qualify as an asset acquisition, we evaluate the acquisition to determine if it qualifies as a business combination. For acquired properties where we have determined that the property has a resident with an existing lease in place, we account for the acquisition as a business combination. For acquisitions that qualify as a business combination, we (1) expense the acquisition costs in the period in which the costs were incurred and (2) assign the cost of the property among land, building and in-place lease intangibles, if any, based on their fair value. The fair values of acquired in-place lease intangibles are typically less than one-year and are based on costs to execute similar leases including commissions and other related costs. The in-place lease intangible is amortized over the life of the remaining lease.
If, at acquisition, a property needs to be renovated before it is ready for its intended use, we commence the necessary stabilization and renovation activities. During this stabilization period, we capitalize all direct and indirect costs incurred in renovating the property. If we acquire a property with an existing lease, we capitalize the cost of the initial renovation of such property following lease expiration and resident move out.
Once a property is ready for its intended use, expenditures for ordinary maintenance and repairs thereafter are expensed to operations as incurred, and we capitalize expenditures that improve or extend the life of a home.
We begin depreciating properties to be held and used when they are ready for their intended use. We compute depreciation using the straight-line method over the estimated useful lives of the respective assets. We depreciate buildings and building improvements over 27.5 years, and we depreciate other land improvements over periods ranging from three to 15 years, with no salvage value. Land is not depreciated.
Properties are classified as assets held for sale when they meet the applicable GAAP criteria, including that the property is being listed for sale and that it is ready to be sold in its current condition. Held-for-sale properties are reported at the lower of their carrying amount or estimated fair value less costs to sell.
Impairment of Real Estate
We evaluate our long-lived assets for impairment periodically or whenever events or changes in circumstances indicate that their carrying amount may not be recoverable. Significant indicators of impairment may include declines in homes values, rental rate and occupancy and significant changes in the economy. If an impairment indicator exists, we compare the expected future undiscounted cash flows against the net carrying amount of a property. We make our assessment at the individual property level because it represents the lowest level of identifiable 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. Assets held for sale are not depreciated nor are they included in our operating metrics at period end.
Accounts Payable and Accrued Expenses
Accounts payable and accrued expenses consist primarily of trade payables, renovation and stabilization liabilities, real estate taxes and homeowners' association fees as of the end of the respective periods presented. We accrue for real estate taxes and homeowners' association fees based on amounts billed, and, in some circumstances, estimates and historical trends when bills or assessments are not available. If these estimates are not correct, the timing and amount of expenses recorded could be incorrect. Accounts payable and accrued expenses also consist of contingent loss accruals, if any, when they are both probable and estimable. When it is reasonably possible that a significant contingent loss has occurred, we disclose the nature of the potential loss and, if estimable, a range of exposure.
Income Taxes
We have elected to be taxed as a REIT under Section 856 to 860 of the Code which commenced with our taxable year ended December 31, 2012. We believe we have operated and intend to continue to operate in a manner that will allow us to satisfy requirements for qualification as a REIT. As long as we qualify as a REIT, we do not generally expect to pay U.S. federal corporate income taxes. Many of the REIT requirements, however, are highly technical and complex. If we were to fail to meet the REIT requirements, we would be subject to U.S. federal, state and local income taxes on REIT taxable income. Refer to Note 4 of the consolidated financial statements for further description of our income taxes.
Our financial results are generally not expected to reflect provisions for current or deferred income taxes, except for those taxable benefits or provisions recognized by our TRSs. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which these temporary differences are expected to be realized. A valuation allowance is provided if we believe it is more likely than not that all or some portion of our deferred tax assets will not be realized. Any increase or decrease in the valuation allowance that results from a change in circumstances, and that causes us to change judgment about the ability to realize the related deferred tax asset is included in the provision when such changes occur.
Derivative Instruments
We manage economic risks, including interest rate, liquidity, and credit risk, primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash receipts and our known or expected cash payments principally related to our borrowings. We do not use these derivatives for speculative purposes, but instead they are used to manage our exposure to interest rate changes.
As required by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815, Derivatives and Hedging, we record all derivatives in the consolidated balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether we have elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting. Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. We may enter into derivative contracts that are intended to economically hedge certain of our risk, even though hedge accounting does not apply or we elect not to apply hedge accounting. The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (loss) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. The
ineffective portion of the change in fair value is recorded directly in adjustments for derivative instruments, net in our consolidated statements of operations.
Recent Accounting Pronouncements
Under the Jumpstart Our Business Startups Act (the "JOBS Act"), we meet the definition of an “emerging growth company.” We have irrevocably elected to opt out of the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. We will cease to be an "emerging growth company" under the JOBS Act on December 31, 2017.
We consider the applicability and impact of all accounting standard updates ("ASUs"). ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on our consolidated financial position or results of operations.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance on revenue recognition and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, most industry-specific guidance and some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” The new standard specifically excludes lease revenue, but will apply to other revenue real estate sales. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. These judgments may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance will be effective for annual reporting periods beginning on January 1, 2018, and for interim periods within those annual periods. We can elect to adopt guidance using the full retrospective approach or the modified retrospective approach. Early adoption of this standard is only allowed as of the original effective date, annual periods beginning after December 15, 2016. We are currently evaluating the method of adoption and the impact on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, a new lease standard which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). Under ASU 2016-02, lessor accounting will be substantially similar to the current model, but aligned with certain changes to the lessee model and ASU 2014-09. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. Our rental revenue is primarily generated from short-term operating leases. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard is expected to impact our consolidated financial statements as we have operating office lease arrangements for which we are the lessee. The new standard will be effective beginning on January 1, 2019, with early adoption permitted. The new standard must be adopted using a modified retrospective transition, requiring application of the new guidance at the beginning of the earliest comparative period presented and provides for certain practical expedients. We are currently evaluating the impact the adoption will have on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The amendments in this ASU include multiple provisions intended to simplify various aspects of the accounting for share-based payments. The guidance will be effective for annual reporting periods beginning after December 15, 2016, and for interim reporting periods within those annual periods, with early adoption permitted. We do not anticipate the adoption of this ASU will have a material impact on our consolidated financial statements and we have adopted as of January 1, 2017.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, Measurement of Credit Losses on Financial Instruments, which changes how companies will measure credit losses for certain financial assets. This guidance requires an entity to estimate its expected credit losses and record an allowance based on this estimate so that it is presented at the net amount expected to be collected on the financial asset. The guidance will be effective for annual periods beginning after December 15, 2019 and interim periods within that reporting period with early adoption permitted beginning after December
15, 2018 and interim periods within that reporting period. We are currently evaluating the impact the adoption of this ASU will have on our consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows, Classification of Certain Cash Receipts and Cash Payments, which clarifies how certain cash receipts and cash payments should be presented and classified on the statement of cash flows. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within that reporting period. We are currently evaluating the impact the adoption of this ASU will have on our consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, Restricted Cash, which requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within that reporting period. We are currently evaluating the impact the adoption of this ASU will have on our consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations, Clarifying the Definition of a Business, which amends the guidance in ASC 805 to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within that reporting period. We are currently evaluating the impact the adoption of this ASU will have on our consolidated financial statements.
Liquidity and Capital Resources
Liquidity is a measure of our ability to meet potential cash requirements, fund and maintain our assets and operations, make interest payments and make distributions to our stockholders. Our liquidity, to a certain extent, is subject to general economic, financial, competitive and other factors that are beyond our control. Our near-term liquidity requirements consist primarily of acquiring and renovating certain properties, maintaining properties, funding our operations, and making interest payments and distributions to our stockholders.
Our liquidity and capital resources as of December 31, 2016 consisted of cash of $52.3 million and escrow deposits of $16.9 million, including cash held in reserve at financial institutions as required by our debt agreements of $14.8 million.
We believe our cash flows from operations together with current cash will be sufficient to fund the anticipated needs of our operations, including the acquisition and renovation of certain properties in 2017. We may also opportunistically utilize the capital markets to raise additional capital, including through the issuance of debt and equity securities (including the issuance of common units in the Operating Partnership) and securitizations in the future, but there can be no assurance that we will be able to access adequate liquidity sources on favorable terms or at all.
Securitization Loan
On August 12, 2014, we completed a securitization transaction (the "Securitization Transaction") in which a newly formed special purpose entity (the "Borrower") entered into a loan with a third-party lender for $312.7 million represented by a promissory note (the "Securitization Loan"). The Borrower is wholly owned by another special purpose entity (the "Equity Owner"), and the Equity Owner is wholly-owned by the Operating Partnership. The Borrower and Equity Owner are separate legal entities, but continue to be reported on our consolidated financial statements.
During the years ended December 31, 2016 and 2015, we paid down $1.5 million and $7.1 million, respectively, on the Securitization Loan to effect the release of certain properties from the first priority mortgages securing the Securitization Loan, including certain properties sold in the Southeast Florida and the Houston, TX markets.
The Securitization Loan had an initial term of two years with three, 12-month extension options, resulting in a fully extended maturity date of September 9, 2019 and provides for monthly payments at a blended rate equal to the one-month LIBOR plus 1.84% and a monthly servicing fee of 0.1355% (excluding the amortization of the original issue discount and deferred financing costs). The Securitization Loan has a blended effective rate of one-month LIBOR plus 1.95%, including the amortization of the original issue discount, plus monthly servicing fees of 0.1355%. The Securitization Loan was issued at a
discount of $1.5 million, which will be accreted and recognized to interest expense through the fully extended maturity date of September 9, 2019. During the year ended December 31, 2016, we executed the first 12-month extension option.
As part of the Securitization Transaction, the Securitization Loan (including the related promissory note) was
transferred by the third-party lender to one of our subsidiaries and subsequently deposited into a REMIC trust in exchange
for pass-through certificates. The pass-through certificates represent the entire beneficial interest in the trust and were sold to investors in a private offering through the placement agents retained for the transaction for gross proceeds of $311.2 million, net of the original issue discount of $1.5 million.
All amounts outstanding under the Securitization Loan are secured by first priority mortgages on the Securitization Properties, a pool of 2,975 properties excluding properties recorded as held for sale, in addition to the equity interests in, and certain assets of, the Borrower. The amounts outstanding under the Securitization Loan and certain obligations contained therein are guaranteed by the Operating Partnership only in the case of certain bad acts (including bankruptcy) as outlined in the transaction documents.
The Securitization Loan does not contractually restrict our ability to pay dividends but certain covenants contained therein may limit the amount of cash available for distribution. The Securitization Loan documents require us to maintain certain covenants, including a minimum debt yield on the Securitization Properties, and contain customary events of default for a facility of this type, including payment defaults, covenant defaults, breaches of representations and warranties, bankruptcy and insolvency, judgments, and cross-default with certain other indebtedness. We believe we were in compliance with all financial covenants under the Securitization Loan as of December 31, 2016.
We used proceeds of the Securitization Loan to pay down the full balance of our revolving credit facility at closing and the remaining proceeds were used for working capital and other corporate purposes, including the acquisition, financing and renovation of properties and the repurchase of common stock. Simultaneously, we reduced the size of our revolving credit facility from $350.0 million to $200.0 million (which has subsequently been amended as discussed below). As a result, we wrote off $1.1 million of deferred financing fees and reclassified $0.5 million from accumulated other comprehensive income (loss) to adjustments for derivative instruments, net due to hedge ineffectiveness in the associated credit facility interest rate cap agreements during the third quarter of 2014.
Revolving Credit Facility
Certain of our subsidiaries have a revolving credit facility with a syndicate of banks. On February 18, 2015, we amended and restated the revolving credit facility to increase the borrowing capacity to $400.0 million from $200.0 million and subsequently amended the revolving credit facility to address certain interest calculation mechanics. As amended, the revolving credit facility bears interest at a varying rate of three-month LIBOR plus 3.0% subject to a LIBOR floor of 0.0%, payable monthly. Prior to the amendment, the revolving credit facility bore interest at a varying rate of LIBOR plus 3.5% subject to a LIBOR floor of 0.5%. We are also required to pay a monthly fee on the unused portion of the revolving credit facility at a rate of 0.5% per annum, when the balance outstanding is less than $200.0 million or 0.3% per annum when the balance outstanding is equal or greater than $200.0 million. As part of the amendment, the term on the revolving credit facility was extended to February 18, 2018 and the advance rate for borrowings was increased to 65% from 55%. The advance rate is based on the aggregate value of the eligible properties which value is calculated as the lesser of (a) the third-party broker price opinion value or (b) the original purchase price plus certain renovation and other capitalized costs of the properties. We used the revolving credit facility to fund the Portfolio Acquisition in 2015 and other acquisitions of properties in 2016. The remaining proceeds were used for working capital and other corporate purposes, including the acquisition, financing and renovation of properties. At December 31, 2016, there was $352.8 million outstanding under the facility. The revolving period ended on February 18, 2017, and we are no longer able to draw additional amounts under the revolving credit facility.
All amounts outstanding under the revolving credit facility are collateralized by the equity interests and assets of certain of our subsidiaries ("Pledged Subsidiaries"), which exclude the owners of the Securitization Properties. The amounts outstanding under the revolving credit facility and certain obligations contained therein are guaranteed by Silver Bay Realty Trust Corp. and the Operating Partnership only in the case of certain bad acts (including bankruptcy) and up to $20.0 million for completion of certain property renovations, as outlined in the credit documents. As of December 31, 2016, there were approximately 5,840 properties pledged as collateral under the revolving credit facility, excluding properties recorded as held for sale.
The revolving credit facility does not contractually restrict our ability to pay dividends but certain covenants contained therein may limit the amount of cash available for distribution. For example, beginning on August 18, 2017, pursuant to a recent amendment, all net cash generated by the properties in the Pledged Subsidiaries (after paying associated property-level expenses) is directed towards principal repayment rather than being distributed to us. The revolving credit facility agreement requires us to meet certain quarterly financial tests pertaining to net worth, total liquidity, debt yield, and debt service coverage ratios and contain customary events of default for a facility of this type, including payment defaults, covenant defaults, breaches of representations and warranties, bankruptcy and insolvency, judgments, change of control and cross-default with certain other indebtedness. We must maintain total liquidity of $25.0 million and a net worth of at least $125.0 million, as determined in accordance with our revolving credit facility. We believe we were in compliance with all financial covenants under the revolving credit facility as of December 31, 2016.
Derivative Financial Instruments
Our objective in using derivative instruments is to manage our exposure to interest rate movements impacting interest expense on our borrowings. We use interest rate cap agreements and interest rate swap transactions to hedge the variable cash flows associated with our existing variable-rate loans and revolving credit facilities (see Note 5 and Note 11 to the accompanying consolidated financial statements for a detailed description of our hedging derivatives).
Operating Activities
Net cash provided by operating activities during 2016 was $32.2 million compared to net cash provided by operating activities of $31.1 million and $8.7 million during 2015 and 2014, respectively. Our operating cash flows during 2016 were primarily due to our experiencing the increased cash flow from the Portfolio Acquisition for the full year ended December 31, 2016 as compared to just nine months during the same period in 2015. Our increase in operating cash flows during 2015 over 2014 were driven by an increase in our portfolio of cash-generating properties and a decrease in cash on deposit with certain third-party property managers as we internalized property management across our portfolio.
Investing Activities
Our net cash related to investing activities is generally used to fund acquisitions and capital expenditures and is offset by proceeds from the disposition of real estate. Net cash used in investing activities during 2016 of $0.5 million was primarily driven by the acquisition and disposition of properties. We used $44.0 million for property acquisitions and another $14.5 million on capital improvements, of which $6.9 million was attributable to our initial renovation of properties, which includes properties purchased in a bulk purchase that have been renovated for the first time, and $7.6 million was attributable to capital improvements made to properties that had been previously renovated. In addition, we received $58.1 million in proceeds from the sale of real estate, primarily due to the sale of properties in Southeast Florida and Southern California.
The average renovation cost per property was approximately $26,200 or 23% of the average purchase price for all properties placed in service since our Predecessor commenced operations through December 31, 2016, including properties acquired with an in-place lease but excluding (i) properties acquired from entities managed by Provident, (ii) properties acquired in the Portfolio Acquisition and (iii) properties purchased in 2016 through portfolio transactions. These renovation costs included capitalized expenditures for renovations, property taxes, homeowners' association dues, interest, property insurance, costs required to gain possession of the property and other capitalized expenditures until the property is ready for its intended use.
Cash used in investing activities in 2015 was $268.8 million and was largely driven by the Portfolio Acquisition. We used $273.3 million for property acquisitions and another $25.7 million on capital improvements, of which $17.5 million was attributable to our initial renovation of properties, which includes properties purchased in a bulk purchase which have been renovated for the first time, and $8.2 million was attributable to capital improvements made to properties that had been previously renovated. In addition, we received $29.2 million in proceeds from the sale of real estate, primarily due to the sale of our Houston portfolio and certain other properties.
Cash used in investing activities in 2014 was $166.9 million and was primarily the result of us executing our acquisition and renovation strategies on newly acquired properties. In 2014, we used $136.0 million for property acquisitions and $37.8 million on capital improvements, of which $32.2 million was attributable to our initial renovation of properties, which includes properties purchased in a bulk purchase which have been renovated for the first time, and $5.6 million was attributable to capital improvements made to properties that had been previously renovated.
The acquisition of properties involves payments beyond the purchase price, including payments for property inspections, closing costs, title insurance, transfer taxes, recording fees, broker commissions, and property taxes or homeowners’ association dues in arrears, along with capitalized interest on properties purchased since we obtained debt in May 2013. Typically, these costs are capitalized as components of the purchase price of the acquired asset unless the property was purchased with an existing lease. We also make significant capital expenditures to renovate and maintain our properties to Silver Bay standards. Our ultimate success depends in part on our ability to make prudent, cost-effective decisions measured over the long term with respect to these expenditures.
Financing Activities
Our net cash related to financing activities is generally affected by any borrowings and capital activities net of any dividends and distributions paid to our common stockholders and non-controlling interests. Net cash used in financing activities during 2016 was $8.5 million and was attributable to payments on the revolving credit facility of $21.5 million, dividends paid of $19.7 million, repurchases and retirement of our common stock of $11.8 million and repayment of our Securitization Loan of $1.5 million, partially offset by draws on the revolving credit facility of $47.8 million, used mostly to fund the acquisition of properties. The repayments on both our revolving credit facility and our Securitization Loan were primarily to effect the release of certain properties which were sold.
Net cash provided by financing activities during 2015 was $216.8 million and was primarily attributable to a draw on the revolving credit facility of $282.0 million, used mostly to fund the Portfolio Acquisition, partially reduced by repayments of our revolving credit facility of $22.6 million, dividends paid of $15.0 million, repurchases and retirement of our common stock of $12.4 million, repayment of our Securitization Loan of $7.1 million and deferred financing costs of $5.8 million.
Cash provided by financing activities in 2014 was $164.3 million and was primarily attributable to the proceeds from the Securitization Loan of $311.2 million and $137.8 million in proceeds from our revolving credit facility, reduced by repayments on our revolving credit facility of $235.5 million, repurchases of our common stock of $31.5 million, deferred financing costs of $12.3 million and dividends paid of $4.3 million. We used the proceeds from our Securitization Transaction to pay down our revolving credit facility, repurchase common stock, invest in residential properties and for other general corporate purposes.
Payment Obligations
We have an obligation to pay dividends on our outstanding 10% cumulative redeemable preferred stock with a $1.0 million aggregate liquidation preference in preference to dividends paid on our common stock. We declared $0.1 million in preferred dividends during 2016.
We have elected to be treated as a REIT for U.S. federal income tax purposes. As a REIT, under U.S. federal income tax law we are required to distribute annually at least 90% of our REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and to pay tax at regular corporate rates to the extent that we annually distribute less than 100% of our REIT taxable income. Subject to the requirements of the Maryland General Corporation Law, we intend to pay quarterly dividends to our stockholders, if and to the extent authorized by our board of directors. On December 20, 2016, our board of directors declared $4.6 million in common stock dividends and $0.3 million in distributions on the common units, which were paid on January 13, 2017.
The 2,231,511 common units issued by the Operating Partnership in connection with the Internalization may be redeemed for cash or, at our election, a number of our common shares on a one-for-one basis. To the extent that we redeem the common units for cash, our liquidity will decrease. As of December 31, 2016, none of the common units had been redeemed.
Off-Balance Sheet Arrangements
We have no obligations, assets or liabilities which would be considered off-balance sheet arrangements. We have not participated in transactions that create relationships with unconsolidated entities or financial partnerships, often referred to as variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements.
Aggregate Contractual Obligations
The following table summarizes the effect on our liquidity and cash flows from certain contractual obligations, as of December 31, 2016:
(1)
Includes estimated interest payments on the respective debt and derivative agreements based on amounts outstanding as of December 31, 2016 and rates in effect as of such date. The revolving credit facility has a maturity date of February 18, 2018. The Securitization Loan had an initial maturity date of September 9, 2016 and three, 12-month extension options, of which the first 12-month extension has been exercised, resulting in a fully extended maturity date of September 9, 2019; this analysis assumes our exercise of the three extension options, which is management's intent.
(2)
Includes operating leases for corporate and market offices.
Non-GAAP Financial Performance Measures
In addition to our net loss which is presented in accordance with GAAP, we also present certain supplemental non- GAAP performance measures. These measures are not to be considered more relevant or accurate than the performance measures presented in accordance with GAAP. In compliance with applicable rules of the Securities and Exchange Commission ("SEC"), our non-GAAP measures are reconciled to net loss, the most directly comparable GAAP performance measure. As with other non-GAAP performance measures, neither the SEC nor any other regulatory body has passed judgment on these non-GAAP performance measures.
Net Operating Income and Same-Home Net Operating Income
We define net operating income ("NOI") as total revenue less property operating and maintenance, real estate taxes, homeowners’ association fees, and property management expenses. NOI excludes depreciation and amortization, the former advisory management fees, management internalization, portfolio acquisition expense, general and administrative expenses, share-based compensation, severance and other, interest expense, impairment of real estate, net gain on disposition of real estate, adjustments for derivative instruments, net, income tax expense (benefit), net and other non-comparable items as applicable. Additionally, NOI excludes certain property management add backs, such as the former 5% property management fee payable prior to the Internalization because it more closely represents additional advisory management fee, expensed acquisition fees and costs, and certain other property management costs.
We consider NOI to be a meaningful financial measure when considered with the financial statements determined in accordance with GAAP. We believe NOI is helpful to investors in understanding the core performance of our real estate operations without regard to items excluded from the calculation of such measure, which can vary substantially from company to company depending upon accounting methods, book value of assets, capital structure and the method by which assets were acquired, among other factors.
We believe Same-Home NOI is a useful measure of performance because the population of properties in this analysis is consistent from period to period, thereby eliminating the effects of changes in the composition of the portfolio.
The following is a reconciliation of our NOI and Same-Home NOI to net loss as determined in accordance with GAAP for the years indicated (amounts in thousands):
Neither NOI nor Same-Home NOI should be considered an alternative to net loss or net cash flows from operating activities, as determined in accordance with GAAP, as indications of our performance or as measures of liquidity. Although we use these non-GAAP measures for comparability in assessing our performance against other REITs, not all REITs compute these non-GAAP measures in the same manner. Accordingly, there can be no assurance that our basis for computing these non-GAAP measures is comparable with that of other REITs.
Funds From Operations and Core Funds From Operations
Funds From Operations ("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 ("NAREIT") defines FFO as net income (loss), computed in accordance with GAAP, excluding gains or losses 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. In addition, we have adjusted net income (loss) for the income tax expense (benefit) on disposition of real estate.
Core Funds From Operations ("Core FFO") is a non-GAAP financial measure that we use as a supplemental measure of our performance. We believe that Core FFO is further helpful to investors as it provides a more consistent measurement of our performance across reporting periods by removing the impact of certain items that are not comparable from period to period. We adjust FFO for expensed acquisition fees and costs, certain fees and expenses related to our Securitization Transaction, share-based compensation, severance and other, write-offs of expenses associated with changes in our debt structure, adjustments for derivative instruments, net, and certain other non-cash or non-comparable costs to arrive at Core FFO.
FFO and Core FFO should not be considered alternatives 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. These non-GAAP measures are not necessarily indicative of cash available to fund future cash needs. In addition, although we use these non-GAAP measures for comparability in assessing our performance against other REITs, not all REITs compute these non-GAAP measures in the same manner. Accordingly, there can be no assurance that our basis for computing these non-GAAP measures is comparable with that of other REITs. This is due in part to the differences in capitalization policies used by different companies and the significant effect these capitalization policies have on FFO and Core FFO. Real estate costs incurred in connection with real estate operations which are accounted for as capital improvements are added to the carrying value of the property and depreciated over time, whereas real estate costs that are expenses are accounted for as a current period expense. This impacts FFO and Core FFO because costs that are accounted for as expenses reduce FFO and Core FFO. Conversely, real estate costs associated with assets that are capitalized and then subsequently depreciated are excluded from the calculation of FFO and Core FFO.
FFO and Core FFO are calculated on a gross basis and as such, do not reflect adjustments for the non-controlling interests - Operating Partnership.
The following table sets forth a reconciliation of our net loss as determined in accordance with GAAP and our calculations of FFO and Core FFO for the years ended December 31, 2016, 2015, 2014, 2013 and 2012. Also presented is information regarding the weighted-average number of shares of our common stock and common units of the Operating Partnership outstanding and the effect of dilutive securities attributable to certain performance-based stock awards used for the computation of FFO and Core FFO per share (amounts in thousands, except share and per-share amounts):
(1)
Includes cost to internalize our Former Manager of $39.4 million, primarily related to issuance of common units of the Operating Partnership and to a lesser extent, certain transaction costs and assumption of certain liabilities during the year ended December 31, 2014.
(2)
Portfolio acquisition expense represents transaction costs incurred when acquiring properties that meet the definition of a business under the guidance codified in ASC 805, which must be expensed when incurred rather than capitalized into the basis of each property.
(3)
Includes a one-time expense reflected in general and administrative expense during the year ended December 31, 2014 to acquire the former Tampa third-party property manager.
(4)
Represents non-capitalizable costs related to our Securitization Transaction for personnel and other matters.
(5)
Non-comparable costs from prior periods.
(6)
Represents the weighted average of common shares and common units in the Operating Partnership outstanding for the periods presented.
(7)
Includes the effect of dilutive securities attributable to certain stock based awards meeting market conditions during the year ended December 31, 2016.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Our future revenue, cash flows and fair values relevant to certain financial instruments are dependent upon prevailing market interest rates. Our Securitization Loan and revolving credit facility have variable rates of interest. We are therefore most vulnerable to changes in short-term LIBOR interest rates, which may result from many factors, including government monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control. To mitigate this risk, we use derivative financial instruments such as interest rate swaps and interest rate caps in an effort to reduce the variability of earnings caused by changes in the interest rates we pay on our debt. We do not use derivatives for trading or speculative purposes.
These derivative transactions are entered into solely for risk management purposes, not for investment purposes. When undertaken, these derivative instruments likely will expose us to certain risks such as price and interest rate fluctuations, timing risk, volatility risk, credit/counterparty risk and changes in market liquidity. Therefore, although we expect to transact in these derivative instruments purely for risk management, they may not adequately protect us from fluctuations in our financing rate obligations.
We currently borrow funds at variable rates using secured financings. As of December 31, 2016, we had recorded $656.3 million of variable rate debt outstanding, of which $296.0 million was effectively converted to fixed rate through swap contracts and $360.3 million was protected by interest rate caps. Assuming no change in the outstanding balance of our existing variable debt, if the weighted-average interest rate on this variable rate debt had been one percentage point higher the annual interest expense would have increased by $3.6 million. If the weighted-average interest rate on this variable rate debt had been one percentage point lower the annual interest expense would have decreased by $3.6 million. These changes in interest expense would have a direct impact on our future earnings. These amounts were determined by considering the impact of hypothetical interest rates on our debt. This analysis does not consider the effects of the changes in overall economic activity that could exist in such an environment and assumes no changes in our financial structure.
The fair value of our financial instruments (including cash, escrow deposits, resident prepaid rent and security deposits, resident rent receivable, accounts payable and accrued expenses) approximate their carrying values because of their short-term nature. The fair value of our 10% cumulative redeemable preferred stock approximates its liquidation value. The fair values of our revolving credit facility and Securitization Loan approximate fair value as the rates are consistent with those demanded in the market for facilities with similar risks and maturities.
We cannot predict with certainty the effect of adverse changes in interest rates on our Securitization Loan and revolving credit facility and, therefore, our exposure to market risk, nor can we provide any assurance that long-term debt will be available at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
Item 8.
Item 8. Financial Statements and Supplementary Data.
SILVER BAY REALTY TRUST CORP.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Board of Directors and Stockholders
of Silver Bay Realty Trust Corp.
We have audited the accompanying consolidated balance sheets of Silver Bay Realty Trust Corp. (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations and comprehensive income (loss), changes in equity, and cash flows for each of the three years in the period ended December 31, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Silver Bay Realty Trust Corp. at December 31, 2016 and 2015, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
/s/ Ernst & Young LLP
February 28, 2017
Minneapolis, Minnesota
Silver Bay Realty Trust Corp.
Consolidated Balance Sheets
(amounts in thousands except share data)
See accompanying notes to the consolidated financial statements.
See accompanying notes to the consolidated financial statements.
Silver Bay Realty Trust Corp.
Consolidated Statements of Changes in Equity
For the Years Ended December 31, 2016, 2015 and 2014
(amounts in thousands except share data)
See accompanying notes to the consolidated financial statements.
See accompanying notes to the consolidated financial statements.
See accompanying notes to the consolidated financial statements.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Note 1. Organization and Operations
Silver Bay Realty Trust Corp. ("Silver Bay" or the "Company"), is a Maryland corporation that focuses on the acquisition, renovation, leasing, and management of single-family properties in select markets in the United States.
As of December 31, 2016, the Company owned 9,044 single-family properties for rental purposes in Arizona, California, Florida, Georgia, Nevada, North Carolina, Ohio, South Carolina and Texas, excluding properties reflected as assets held for sale on its consolidated balance sheets.
The Company is the continuation of the operations of Silver Bay Property Investment LLC (the "Predecessor"). At the time of its formation, the Predecessor was a wholly owned subsidiary of Two Harbors Investment Corp. ("Two Harbors"). The Predecessor began formal operations in February 2012, when it started acquiring single-family residential rental properties. The Company in its current form was created on December 19, 2012, through a series of formation transactions (the "Formation Transactions"), which included an initial public offering (the "Offering"), the contribution of equity interests in the Predecessor by Two Harbors, and the acquisition of entities (the "Provident Entities") managed by Provident Real Estate Advisors LLC ("Provident"), which owned 881 single-family properties.
In connection with the Offering, the Company restructured its ownership to conduct its business through a traditional umbrella partnership ("UPREIT structure") in which substantially all of its assets are held by, and its operations are conducted through, Silver Bay Operating Partnership L.P. (the "Operating Partnership"), a Delaware limited partnership. The Company's wholly owned subsidiary, Silver Bay Management LLC, is the sole general partner of the Operating Partnership. As of December 31, 2016, the Company owned, through a combination of direct and indirect interests, 94.1% of the partnership interests in the Operating Partnership.
The Company has elected to be treated as a real estate investment trust ("REIT") for U.S. federal tax purposes, commencing with, and in connection with the filing of its federal tax return for, its taxable year ended December 31, 2012. As a REIT, the Company will generally not be subject to federal income tax on the taxable income that it distributes to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax at regular corporate rates. Even if it qualifies for taxation as a REIT, the Company may be subject to some federal, state and local taxes on its income or property. In addition, the income of any taxable REIT subsidiary ("TRS") that the Company owns will be subject to taxation at regular corporate rates.
Through September 30, 2014, the Company was externally managed by PRCM Real Estate Advisers LLC (the "Former Manager"). During this time, the Company relied on the Former Manager to provide or obtain on its behalf the personnel and services necessary for it to conduct its business as the Company had no employees of its own. On September 30, 2014, the Company closed a transaction to internalize its management (the "Internalization") and now owns all material assets and intellectual property rights of the Former Manager previously used in the conduct of its business. In connection with the Internalization, the officers and employees who worked for the Former Manager became employees of the Company (see Note 10).
During the year ended December 31, 2015, the Company acquired a portfolio of 2,461 properties (the "Acquired Properties") from The American Home Real Estate Investment Trust ("TAH"). The acquisition was substantially completed on April 1, 2015 with an aggregate purchase price of $263,000 (the "Portfolio Acquisition"). The Portfolio Acquisition was financed using proceeds obtained under the Company's revolving credit facility, which was amended and restated on February 18, 2015 to increase the borrowing capacity to $400,000 from $200,000. The properties acquired in the Portfolio Acquisition are primarily located in Atlanta, GA, Charlotte, NC, Tampa, FL, and Orlando, FL.
Note 2. Basis of Presentation and Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company, the Operating Partnership and its consolidated subsidiaries and have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP"). All intercompany balances and transactions have been eliminated in consolidation. The Company consolidates real estate partnerships and other entities that are not variable interest entities ("VIE") when it owns, directly or indirectly, a
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
majority voting interest in the entity or is otherwise able to control the entity. The Company consolidates VIEs in accordance with Accounting Standards Codification ("ASC") 810, Consolidation, if the primary beneficiary of the VIE as determined by its power to direct the VIEs activities and the obligation to absorb its losses or the right to receive its benefits, which are potentially significant to the VIE. Ownership interests in certain consolidated subsidiaries of the Company held by outside parties are included in noncontrolling interest within the consolidated financial statements.
The Company adopted ASU 2015-02, Amendments to the Consolidation Analysis, during the quarter ended March 31, 2016. This guidance improved targeted areas of consolidation guidance by simplifying the consolidation evaluation process, and by placing more emphasis on risk of loss when determining a controlling financial interest. Based on its review and subsequent analysis of its legal entities structure, the Company concluded that the Operating Partnership is a VIE as the limited partners of the Operating Partnership do not have substantive kick-out rights. As the general partner and controlling owner of approximately 94.1% of the Operating Partnership with the power to direct its activities, the Company will continue to consolidate the Operating Partnership under this new guidance.
The Company may change its original assessment of a VIE upon subsequent events such as the modification of contractual arrangements that affects the characteristics or adequacy of the entity’s equity investments at risk and the disposition of all or a portion of an interest held by the primary beneficiary. The Company performs this analysis on an ongoing basis. As of both December 31, 2016 and 2015 the Company had one VIE.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions regarding future events that may affect the reported amounts and disclosures in the financial statements. The Company’s estimates are inherently subjective in nature and actual results could differ from these estimates.
Reclassifications
Certain reclassifications have been made to amounts in prior period financial statements to conform to current period presentation. These reclassifications have not changed the previously reported results of operations or equity.
Investments in Real Estate
Operating real estate assets are stated at cost and consist of land and improvements, buildings and improvements, including other capitalizable costs incurred during their possession, renovation and acquisition.
Single-family properties acquired that are not subject to an existing lease are treated as asset acquisitions and, as such, are recorded at their purchase price, including acquisition costs, which is allocated to land and building based upon their relative fair values at the date of acquisition. Fair value is determined under the guidance of Codification Topic, Fair Value Measurements (“ASC 820”), and is primarily based on unobservable data inputs which are categorized as Level 3 valuations. In making estimates of fair values for purposes of allocating the purchase price of individually acquired properties that are not subject to an existing lease, the Company utilizes its own market knowledge and published market data. In this regard, the Company also utilizes information obtained from county tax assessment records to assist in the determination of the fair value of the land and building.
Single-family properties that are acquired either subject to an existing lease or as part of a portfolio level transaction are treated as a business combination under the guidance of Codification Topic, Business Combinations (“ASC 805”), and, as such, are recorded at fair value, assigned to land, building and the existing lease, if applicable, based upon their fair values at the date of acquisition, with acquisition fees and other costs expensed as incurred. The Company engages a third party valuation specialist to assist management in the determination of fair value for purposes of assigning the purchase price of properties acquired as part of portfolio level transactions along with information obtained from county tax assessment records to assist in the determination of the fair value of the land and building. The value of acquired lease related intangibles, if any, is estimated based upon the costs the Company would have incurred to lease the property under similar terms. Such costs are capitalized and amortized over the remaining life of the lease.
The nature of the Company's business requires that in certain circumstances Silver Bay acquires single-family properties subject to existing liens. Liens that the Company expects to be extinguished in cash are estimated and accrued for on the date of acquisition and recorded as a cost of the property.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Building and improvements depreciation is computed on the straight-line basis over the estimated useful lives of the assets. The Company generally uses a 27.5-year estimated life with no salvage value. Depreciation on land improvements is computed on the straight-line basis over the estimated useful lives of the assets, generally 3 to 15 years with no salvage value. Land is not depreciated. The Company considers the value of acquired in-place leases in the allocation of purchase price and the amortization period reflects the average remaining term of each respective in-place acquired lease. The lease periods are generally short-term in nature (one or two years).
The Company incurs costs to prepare certain of its acquired properties to be placed in service. These costs are capitalized and allocated to building improvement costs or land improvement costs as part of such properties’ initial renovation. If the Company acquires a property with an existing lease, the Company capitalizes the cost of the initial renovation of such property following lease expiration and resident move out. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and expenditures for significant capital expenditures that improve the asset and extend the useful life of the asset are capitalized and depreciated over their remaining useful life.
The Company evaluates its long-lived assets for indicators of impairment periodically or whenever events or changes in circumstances indicate that an asset’s carrying amount may not be recoverable. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and the Company’s ability to hold, and its intent with regard to, each asset. If an impairment indicator exists, the Company compares the expected future undiscounted cash flows against the carrying amount of the asset. If the sum of the estimated undiscounted cash flows is less than the carrying amount of the asset, the Company records an impairment loss for the difference between the estimated fair value and the carrying amount of the asset.
Single-Family Properties Held for Sale and Discontinued Operations
Single-family properties are classified as held for sale when they meet the applicable GAAP criteria, including, but not limited to, being listed for sale and the home is in present condition for immediate sale, the existence of an active program to locate a buyer and the probable sale of the home within one year. Upon identification as held for sale, the property is subject to the Company’s impairment test and an impairment loss is immediately recognized when the estimated fair value, less costs to sell, is less than the carrying amount of the asset. The property is then marketed for sale and classified as held for sale in the consolidated financial statements. Depreciation ceases to be recorded upon designation of an asset as held for sale. As of December 31, 2016 and 2015, the Company had 104 and 98 single-family properties, respectively, classified as held for sale. These properties did not have material historical operating results under the Company's ownership. At December 31, 2016 and 2015, the Company had $16,543 and $11,184, respectively, of assets held for sale.
For the years ended December 31, 2016, 2015 and 2014, the Company recognized impairment charges of $1,105, $95 and $601, respectively, classified as impairment of real estate on the consolidated statements of operations and comprehensive income (loss). For the years ended December 31, 2016, 2015 and 2014, the Company recognized a net gain on sale of assets of $10,657, $4,044 and $174, respectively, classified as net gain on disposition of real estate on the consolidated statements of operations and comprehensive income (loss).
ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, defines a discontinued operation as: (1) a component of an entity or group of components that has been disposed of or classified as held for sale and represents a strategic shift that has or will have a major effect on an entity's operations and financial results; or (2) an acquired business that is classified as held for sale on the acquisition date. The application of this guidance is prospective from the date of adoption and applies only to disposals (or new classifications to held for sale) that have not been reported as discontinued operations or held for sale in previously issued financial statements. The Company adopted ASU 2014-08 during the quarter ended March 31, 2015 and did not have any discontinued operations during the years ended December 31, 2016, 2015 and 2014.
Cash
The Company maintains its cash and escrow deposits at financial institutions. The combined account balances at one or more institutions typically exceed the Federal Depository Insurance Corporation ("FDIC") insurance coverage, and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. The Company believes that the risk is not significant, as the Company does not anticipate the financial institutions’ non-performance.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Escrow Deposits
Escrow deposits primarily include cash held in reserve at financial institutions, as required by the Company's debt agreements described in Note 5. In addition, escrow deposits include money held at financial institutions for cash flow hedge collateral and refundable earnest money on deposit with certain third party property managers for property operating costs.
Deferred Lease Costs, Net
Direct and incremental costs incurred by the Company to lease properties are capitalized and amortized over the life of the lease and reflected as other assets on the consolidated balance sheets. Amortization of leasing costs is included in depreciation and amortization on the consolidated statements of operations and comprehensive income (loss).
Rent and Other Receivables, Net
The Company maintains an allowance for doubtful accounts for estimated losses that may result from the inability of residents to make required rent or other payments. This allowance is estimated based on payment history and current occupancy status. The Company generally does not require collateral or other security from its residents, other than security deposits. If estimates of collectability differ from the cash received, the timing and amount of the Company’s reported revenue could be impacted.
At December 31, 2016 and 2015, the Company had $738 and $978 in gross rent receivables, respectively, and $89 and $164 in allowances for doubtful accounts, respectively, classified as other assets on the consolidated balance sheets.
For the years ended December 31, 2016, 2015 and 2014, the Company recognized $1,002, $1,426 and $671 in bad debt expense, respectively, classified as property operating and maintenance on the consolidated statements of operations and comprehensive income (loss).
Fair Value of Financial Instruments, Including Derivative Instruments
The valuation of financial instruments requires the Company to make estimates and judgments that affect the fair value of the instruments. The Company, where possible, bases the fair values of its financial instruments, including its derivative instruments, on listed market prices and third party quotes. Where these are not available, the Company bases its estimates on current instruments with similar terms and maturities or on other factors relevant to the financial instruments.
In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company seeks to manage these risks through the use of derivatives to hedge interest rate risk on debt instruments.
The Company recognizes derivatives as either assets or liabilities on the consolidated balance sheets and measures those instruments at fair value. In addition, fair value adjustments will affect either accumulated other comprehensive income (loss) (a component of stockholders’ equity) or net income (loss) depending on whether the derivative instruments qualify as a hedge for accounting purposes and, if so, the nature of the hedging activity. The Company does not use derivatives for trading or speculative purposes.
Deferred Financing Costs, Net
Costs incurred in the placement of the Company’s debt are deferred and amortized, as a component of interest expense on the consolidated statements of operations and comprehensive income (loss), using the effective interest method, or alternative methods that approximate the effective interest method. The costs are amortized over the terms of the related debt, which, where applicable, reflect the intended exercise of renewal options. The Company adopted ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, as of January 1, 2016, which requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with the original issue discount, rather than as an asset. As a result of the retrospective adoption of this guidance, deferred financing costs, net of amortization of $5,884 and $8,139 at December 31, 2016 and 2015, respectively, are netted against the carrying values of the Securitization Loan (see Note 5). Previously, these costs were recorded as part of deferred financing costs, net on the consolidated balance sheets. Additionally, in accordance with ASU 2015-15, Interest-Imputation of Interest: Presentation
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, issued in August 2015, the Company presents debt issuance costs related to its revolving credit facility as an asset within other assets on the consolidated balance sheets and amortize them ratably over the term of the related facility.
Revenue Recognition
Rental income, net of concessions and sales tax, attributable to resident leases is recorded on a straight-line basis over the term of the lease. Leases entered into between residents and the Company for the rental of property units are generally year-to-year and renewable upon consent of both parties on an annual or monthly basis.
The Company recognizes other revenues such as pet fees, late fees, and application fee income when the related fees are earned and are realized or realizable.
The Company recognizes sales of real estate when the sale has closed, title has passed, adequate initial and continuing investment by the buyer is received, possession and other attributes of ownership have been transferred to the buyer, and the Company is not obligated to perform significant additional activities after closing. All of these conditions are typically met at or shortly after closing.
Noncontrolling Interests
The ownership interests in a consolidated subsidiary that are not held by the Company are noncontrolling interests and are reported on the consolidated balance sheets within equity, separately from the Company’s equity. However, securities that are redeemable for cash or other assets at the option of the holder, not solely within the control of the issuer, must be classified outside of permanent equity. This would result in certain outside ownership interests being included as redeemable noncontrolling interests outside of permanent equity in the consolidated balance sheets. The Company makes this determination based on terms in applicable agreements, specifically in relation to redemption provisions. Additionally, with respect to noncontrolling interests for which the Company has a choice to settle the contract by delivery of its own shares, the Company considered the guidance in the Codification Topic, Derivatives and Hedging -Contracts in Entity’s Own Equity (“ASC 815-40”) to evaluate whether it controls the actions or events necessary to issue the maximum number of shares that could be required to be delivered under share settlement of the contract. The Company presents the noncontrolling interest for common Operating Partnership units in the equity section of its consolidated balance sheets.
Net income (loss) is allocated to common Operating Partnership unit holders based on their respective ownership percentage of the Operating Partnership. Such ownership percentage is calculated by dividing the number of common Operating Partnership units held by the common Operating Partnership unit holders by the total Operating Partnership units held by the common Operating Partnership unit holders and the Company. Additional issuance or repurchase of shares of common stock or common Operating Partnership units changes the percentage ownership of both the noncontrolling interests - common Operating Partnership unit holders and the Company. Due in part to the exchange rights (which provide for the redemption of common Operating Partnership units into shares for common stock on a one-for-one basis), such transactions and the proceeds or costs therefrom are treated as capital transactions and result in an allocation between stockholders’ equity and noncontrolling interests to account for the change in the respective percentage ownership of the underlying equity of the Operating Partnership.
At both December 31, 2016 and 2015, the Company had 2,231,511 common Operating Partnership units classified as noncontrolling interests, respectively. As described in Note 10, the 2,231,511 common Operating Partnership units were issued on September 30, 2014 pursuant to the Internalization.
Preferred Stock
The Company accounts for its 10% cumulative redeemable preferred stock in accordance with the Codification Topic, Distinguishing Liabilities from Equity-SEC Materials (“ASC 480-10-S99”). Holders of the Company’s 10% cumulative redeemable preferred stock have certain preference rights with respect to the common stock. Based on the Company’s analysis, the preferred stock has been classified as redeemable interests outside of permanent equity in the mezzanine section of the Company’s consolidated balance sheets as a result of certain redemption requirements or other terms.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Earnings (Loss) Per Share
Basic and diluted earnings (loss) per share are computed by dividing net income (loss) attributable to common stockholders by the weighted average number of common shares and potential common shares outstanding during the years ended December 31, 2016, 2015 and 2014. For both basic and diluted per share calculations, potential common shares represent issued and unvested shares of restricted stock, which have full rights to the common stock dividend declarations of the Company. The common Operating Partnership units and any performance stock units whose market conditions have been met are excluded from the calculation of earnings (loss) per share as their inclusion would not be dilutive.
Equity Incentive Plan
The Company adopted an equity incentive plan which provides incentive compensation to attract and retain qualified directors, officers, advisors, consultants and other personnel of the Company. The plan permits the granting of stock options, restricted shares of common stock, restricted stock units, phantom shares, dividend equivalent rights, or other equity-based awards. The equity incentive plan is administered by the compensation committee of the Company’s board of directors.
The cost of restricted shares of common stock awarded to independent directors is based on the price of the Company’s stock as of the date of grant, in accordance with Codification Topic, Compensation - Stock Compensation (“ASC 718”). Prior to the Internalization, the cost of equity awards to employees of the Former Manager and the Former Manager’s operating subsidiary were measured at each reporting date based on the price of the Company’s stock as of period end, in accordance with Codification Topic, Equity (“ASC 505”). On the date of the Internalization, the employees of the Former Manager and the Former Manager's operating subsidiary became employees of the Company and the Company fixed the measurement of the awards to the respective employees to the stock price as of such date in accordance with ASC 718. The respective awards will not be subsequently remeasured and future awards to employees, subsequent to the Internalization, will be measured based on the price of the Company's stock as of the date of grant in accordance with ASC 718. All equity awards are amortized ratably over the applicable service period.
The Company recognizes compensation expense for performance stock units ("PSUs") based on the grant-date fair value and the service period of the respective awards. These units represent shares potentially issuable in the future based upon the Company's stock performance over a three-year performance period. Fair value of the PSUs are estimated using a Monte-Carlo simulation model.
Income Taxes
The Company intends to operate and to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Code") and intends to comply with the requirements of the Code relating to REITs. To qualify as a REIT, the Company must distribute at least 90% of its annual REIT taxable income to stockholders (not including taxable income retained in its TRS entities) within the time frame set forth in the Code and the Company must also meet certain other requirements. In addition, because certain activities, if performed by the Company, may cause the Company to earn income which is not qualifying for the REIT gross income tests, the Company formed or acquired TRS entities, as defined in the Code, to engage in such activities. These TRS activities are subject to federal, state, and local income taxes on any taxable income of such entities after consideration of any net operating losses, as well as any REIT taxable income not distributed to stockholders.
The Company assesses its tax positions for all open tax years and determines whether the Company has any material unrecognized liabilities in accordance with Codification Topic, Income Taxes (“ASC 740”). The Company records these liabilities to the extent the Company deems them more likely than not to be incurred. The Company classifies interest and penalties on material uncertain tax positions as income tax expense, on its consolidated statements of operations and comprehensive income (loss).
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Deferred Tax Assets and Liabilities
Income recognition for GAAP and tax differ in certain respects. These differences often reflect differing accounting treatments for tax and GAAP, such as differing basis on capitalized assets, differing treatment for certain acquired assets and real estate asset impairments and the timing of expense recognition for certain accrued liabilities and net operating losses. Some of these differences are temporary in nature and create timing mismatches between when taxable income is earned and the tax is paid versus when the GAAP income is recognized and the tax provision is recorded. Some of these differences are permanent since certain income (or expense) may be recorded for tax but not for GAAP (or vice-versa). One such significant permanent difference is the Company’s ability as a REIT to deduct dividends paid to stockholders as an expense for tax, but not for GAAP. The Company's deferred tax assets also include net operating losses generated or acquired.
As a result of these temporary differences, the Company’s TRS entities, may recognize taxable income in periods prior or subsequent to when it recognizes income for GAAP. When this occurs, the TRS will pay or defer the tax liability and establish deferred tax assets or deferred tax liabilities, respectively, for GAAP.
As income previously taxed is subsequently realized in future periods under GAAP, the deferred tax asset is reversed and a tax expense is recognized. Alternatively, as income previously recognized for GAAP is subsequently realized in future periods for tax, the deferred tax liability is reversed and a tax benefit is recognized. To date, the Company’s deferred tax assets and/or liabilities are generated solely by differences in GAAP and taxable income from the TRS entities. GAAP and tax differences in the REIT may create additional deferred tax assets to the extent the Company does not distribute all of its taxable income.
A valuation allowance is provided if the Company believes it is more likely than not that all or some portion of deferred tax assets will not be realized. Any increase or decrease in the valuation allowance that results from a change in circumstances and that causes the Company to change judgment about the realizability of the related deferred tax asset is included in the provision when such changes occur.
Segment reporting
In accordance with Codification Topic, Segment Reporting ("ASC 280"), the Company has determined that it has one reportable segment with activities related to leasing and operating single-family homes as rental properties. The Company's properties are geographically dispersed and management evaluates operating performance at the market level and while each market and its properties are unique, the aggregate market portfolios have similar economic interests and operating performance. The distribution of the properties throughout the United States reflects the Company's belief that geographic diversification helps insulate the portfolio from regional economic influences.
Recent Accounting Pronouncements
Under the Jumpstart Our Business Startups Act (the "JOBS Act") the Company meets the definition of an “emerging growth company.” The Company has irrevocably elected to opt out of the extended transition period for complying with new or revised U.S. accounting standards pursuant to Section 107(b) of the JOBS Act. As a result, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. The Company will cease to be an "emerging growth company" under the JOBS Act on December 31, 2017.
The Company considers the applicability and impact of all accounting standard updates ("ASUs"). ASUs not listed below were assessed and determined to be either not applicable or are expected to have minimal impact on the Company's consolidated financial position or results of operations.
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which provides guidance on revenue recognition and supersedes the revenue recognition requirements in Topic 605, Revenue Recognition, most industry-specific guidance and some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” The new standard specifically excludes lease revenue, but will apply to other revenue real estate sales. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. These judgments may include identifying performance obligations in the contract, estimating the amount of variable
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The guidance will be effective for the Company for annual reporting periods beginning on January 1, 2018, and for interim periods within those annual periods. The Company can elect to adopt guidance using the full retrospective approach or the modified retrospective approach. Early adoption of this standard is only allowed as of the original effective date, annual periods beginning after December 15, 2016. The Company is currently evaluating the method of adoption and the impact on the consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases, a new lease standard which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). Under ASU 2016-02, lessor accounting will be substantially similar to the current model, but aligned with certain changes to the lessee model and ASU 2014-09. The new standard requires lessors to account for leases using an approach that is substantially equivalent to existing guidance for sales-type leases, direct financing leases and operating leases. The Company’s rental revenue is primarily generated from short-term operating leases. The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating based on the principle of whether or not the lease is effectively a financed purchase of the leased asset by the lessee. This classification will determine whether the lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. The new standard is expected to impact the Company’s consolidated financial statements as the Company has operating office lease arrangements for which it is the lessee. The new standard will be effective for the Company beginning on January 1, 2019, with early adoption permitted. The new standard must be adopted using a modified retrospective transition, requiring application of the new guidance at the beginning of the earliest comparative period presented and provides for certain practical expedients. The Company is currently evaluating the impact on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting. The
amendments in this ASU include multiple provisions intended to simplify various aspects of the accounting for share-based
payments. The guidance will be effective for annual reporting periods beginning after December 15, 2016, and for interim
reporting periods within those annual periods, with early adoption permitted. The Company does not anticipate the adoption of this ASU will have a material impact on its consolidated financial statements and has adopted as of January 1, 2017.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses, Measurement of Credit Losses on
Financial Instruments, which changes how companies will measure credit losses for certain financial assets. This guidance
requires an entity to estimate its expected credit losses and record an allowance based on this estimate so that it is presented at
the net amount expected to be collected on the financial asset. The guidance will be effective for annual periods beginning after
December 15, 2019 and interim periods within that reporting period with early adoption permitted beginning after December
15, 2018 and interim periods within that reporting period. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows, Classification of Certain Cash Receipts
and Cash Payments, which clarifies how certain cash receipts and cash payments should be presented and classified on the
statement of cash flows. The guidance will be effective for annual periods beginning after December 15, 2017 and interim
periods within that reporting period. The Company is currently evaluating the impact the adoption of this ASU will have on its
consolidated financial statements.
In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows, Restricted Cash, which requires the statement of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. As a result, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments do not provide a definition of restricted cash or restricted cash equivalents. The guidance will be effective for annual periods beginning after December 15, 2017 and interim periods within that reporting period. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.
In January 2017, the FASB issued ASU 2017-01, Business Combinations, Clarifying the Definition of a Business, which amends the guidance in ASC 805 to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The guidance will be effective for annual periods beginning after December
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
15, 2017 and interim periods within that reporting period. The Company is currently evaluating the impact the adoption of this ASU will have on its consolidated financial statements.
Note 3. Investment in Real Estate
Acquisition of Properties
On October 1, 2016, the Company completed the acquisition of a portfolio of 322 homes located in its core markets. The aggregate purchase price for the acquisition was $41,455 which was primarily financed using proceeds obtained under the Company’s revolving credit facility. The homes are located in Atlanta, GA, Tampa, FL and Orlando, FL.
During the year ended December 31, 2015, the Company acquired a portfolio of 2,461 properties from TAH. The aggregate purchase price for the Portfolio Acquisition was $263,000 and was substantially completed on April 1, 2015. The Portfolio Acquisition was financed using proceeds obtained under the Company's revolving credit facility, which was amended and restated on February 18, 2015 to increase the borrowing capacity to $400,000 from $200,000 (see Note 5). The homes are primarily located in Atlanta, GA, Charlotte, NC, Tampa, FL, and Orlando, FL.
Transaction costs associated with portfolio acquisitions are expensed as incurred in accordance with ASC 805. During the years ended December 31, 2016 and 2015 the Company incurred $526 and $2,064, respectively, in transaction expenses associated with the acquisition of properties. These costs are included in portfolio acquisition expense in the consolidated statements of operations and comprehensive income (loss).
The following table summarizes the acquisition date fair values of the assets acquired as part of the Portfolio Acquisition:
Since the date of the Portfolio Acquisition, the Company has consolidated the 2,461 properties acquired as part of the transaction and the related results of these operations are reflected in the Company's consolidated financial statements.
Total revenue and net income (loss) attributable to the Portfolio Acquisition that was included in the Company's consolidated statements of operations and comprehensive income (loss) from the date of acquisition through December 31, 2015 were $19,919 and $(3,909), respectively.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
The following table illustrates the effect on net loss and loss per share - basic and diluted as if the Company had completed the Portfolio Acquisition on January 1, 2014 (unaudited):
(1) The unaudited pro forma information includes revenue and operating expenses based on the historical operations of TAH as well as the Company and does not purport to be indicative of what the Company's operating results would have been had the Portfolio Acquisition occurred on January 1, 2014.
(2) Assumes portfolio acquisition expense for the year ended December 31, 2015 had been incurred on January 1, 2014, and thus is included in the year ended December 31, 2014.
(3) Includes net gain on disposition of real estate as noted in the consolidated statements of operations and comprehensive income (loss).
Disposition of Real Estate Assets
During the year ended December 31, 2016, the Company sold certain properties, primarily in Southeast Florida and Southern California, for an aggregate sales price of $58,149, resulting in an aggregate net gain of $10,657, which has been classified as net gain on disposition of real estate in the consolidated statements of operations and comprehensive income (loss). In connection with these asset sales, certain debt repayments were made.
During the year ended December 31, 2015, the Company sold certain properties, primarily in Houston, TX, for an aggregate sales price of $29,223 resulting in an aggregate net gain of $4,044. During the year ended December 31 2014, the Company sold certain properties for an aggregate sales price of $5,979, resulting in an aggregate net gain of $174.
In accordance with ASC 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, the disposals were not considered a discontinued operation. Any holding costs associated with homes being sold are reflected within held for sale expenses and are classified as other expense in the consolidated statements of operations and comprehensive income (loss).
Note 4. Income Taxes
For the years ended December 31, 2016, 2015 and 2014, the Company believes that it qualified to be taxed as a REIT under the Code for U.S. federal income tax purposes. As long as the Company qualifies as a REIT, the Company generally will not be subject to U.S. federal income taxes on its taxable income to the extent it annually distributes its net taxable income to stockholders, does not engage in prohibited transactions, and maintains its intended qualification as a REIT. The majority of states also recognize the Company’s REIT status, and as such, the Company has generally only incurred certain state franchise taxes. The TRS entities are subject to all applicable federal, state and local income, excise and franchise taxes. The Company’s TRS entities file separate tax returns and are fully taxed as standalone U.S. corporations. Certain activities the Company performs may produce income which will not be qualifying income for REIT purposes. The Company has designated the TRS entities to engage in these activities to mitigate any negative impact on the Company’s REIT status.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
The following table summarizes the tax expense (benefit) recorded at the taxable subsidiary level for the years ended December 31, 2016, 2015 and 2014.
(1)
In addition to the deferred tax benefit generated for the year ended December 31, 2014, the Company acquired $486 of deferred tax assets in connection with the Internalization transaction.
The following is a reconciliation of the Company’s statutory federal and state rates to the effective rates, for the years ended December 31, 2016, 2015 and 2014.
The Company’s consolidated balance sheets as of December 31, 2016 and 2015 contained the following current and deferred tax assets and liabilities, which are included in other assets and are recorded at the taxable subsidiary level.
The cost basis of land and depreciable property, net of accumulated depreciation, for federal income tax purposes as of December 31, 2016 and 2015 was $1,109,152 and $1,141,531, respectively (unaudited).
Deferred tax assets and liabilities applicable to the TRS entities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. These assets and liabilities are measured using enacted tax rates for which the temporary differences are expected to be
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
recovered or settled. The effects of changes in tax rates on deferred tax assets and liabilities are recognized in earnings in the period enacted. Similarly, deferred income tax assets and liabilities are recorded at the date of contribution to the TRS entities to reflect the tax benefit/detriment on the movement of assets from the non-taxed REIT to the taxable TRS entities. The TRS entities deferred tax assets and liabilities are generally the result of real estate asset impairments, differing basis on capitalized assets, the timing of expense recognition for certain accrued liabilities, and net operating losses. In addition, during calendar year 2014, the Company recognized deferred tax assets assumed in the Internalization, which relate to net operating losses and differences in GAAP and tax treatment of assets acquired from the third-party property manager in Tampa (refer to Note 10 for descriptions of these transactions). As of December 31, 2016 and 2015, the TRS entities have recorded net deferred tax assets of $1,084 and $1,797, respectively. Certain TRS entities have a history of operating losses and as a result, historically resulted in a full valuation allowance for their deferred tax assets. As of December 31, 2015, the Company determined it was more likely than not that certain deferred tax assets, including certain net operating loss carryforwards, would be realized. In making this determination, the Company analyzed, among other things, its recent history of earnings from certain sales of depreciable property and forecasts of future taxable earnings. The reversal of the deferred tax asset valuation resulted in an income tax benefit of $964 during the year ended December 31, 2015 which is reported as income tax (expense) benefit, net on the consolidated statements of operations and comprehensive income (loss) and an offsetting asset of the same amount is included in other assets on the consolidated balance sheets.
The Company’s TRS entities have approximately $1,598 and $3,900, respectively, of net operating loss carry-forwards available as of December 31, 2016 and 2015 that will expire between December 31, 2032 and December 31, 2035.
Based on the Company’s evaluation, it has concluded that there are no significant uncertain tax positions requiring recognition in the Company’s financial statements of a contingent tax liability for uncertain tax positions. None of the Company’s consolidated entities are currently under federal or state audit for the years ended December 31, 2016, 2015 and 2014, but these years remain subject to examination by the applicable tax jurisdictions. Additionally, there were no amounts accrued for penalties or interest as of or during the periods presented in the consolidated financial statements.
During the years ended December 31, 2016, 2015 and 2014 the Company’s tax treatment of dividends and distributions per share were as follows:
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Note 5. Debt
The following table presents the Company's debt as of December 31, 2016 and 2015:
(1)
The securitization loan provides for monthly payments at a blended rate equal to the one-month LIBOR plus 1.84% and a monthly servicing fee of 0.1355% (excluding the amortization of the original issue discount and deferred financing costs).
(2)
The securitization loan had an initial term of two years, with three, 12-month extension options, which management intends to exercise, resulting in a fully extended maturity date of September 9, 2019. The extension options may be executed provided there is no event of default under the securitization loan, a replacement interest rate cap agreement is obtained in a form reasonably acceptable to the lender and the borrower complies with other terms set forth in the loan agreement. During the twelve months ended December 31, 2016, the Company executed the first 12-month extension option.
(3)
The original issue discount will be accreted and recognized to interest expense through the fully extended maturity date of September 9, 2019.
(4)
As amended, the revolving credit facility bears interest at a varying rate of three-month LIBOR plus 3.0%, subject to a LIBOR floor of 0.0% and includes an unused fee as further described below.
(5)
The revolving credit facility had a borrowing capacity of up to $400,000 and a maturity date of February 18, 2018. The revolving period ended on February 18, 2017 and the Company is no longer able to draw additional amounts under the revolving credit facility. Beginning August 18, 2017, pursuant to a recent amendment, all net cash generated by the properties in the Pledged Subsidiaries (as defined below) (after paying associated property-level expenses) is directed towards principal repayment rather than being distributed to the Company.
Securitization Loan
On August 12, 2014, the Company completed a securitization transaction (the "Securitization Transaction") in which a newly-formed special purpose entity (the "Borrower") entered into a loan with a third-party lender for $312,667 represented by a promissory note (the "Securitization Loan"). The Borrower is wholly-owned by another special purpose entity (the "Equity Owner"), and the Equity Owner is wholly-owned by the Operating Partnership. The Borrower and Equity Owner are separate legal entities, but continue to be reported in the Company’s consolidated financial statements.
The Securitization Loan provides for monthly payments comprised of six floating rate components computed based on one-month LIBOR for each interest period plus a fixed component spread for each of the six components, resulting in a blended rate equal to the one-month LIBOR plus 1.84% and a monthly servicing fee of 0.1355% (excluding the amortization of the original issue discount and deferred financing costs). The Securitization Loan has a blended effective rate of one-month LIBOR plus 1.95%, including the amortization of the original issue discount, plus monthly servicing fees of 0.1355%. The Securitization Loan was issued at a discount of $1,503, which will be accreted and recognized to interest expense through the fully extended maturity date of September 9, 2019. The principal amount of each component of the loan corresponds to the respective class of certificates which were issued in connection with the Securitization Transaction.
In the years ended December 31, 2016, 2015 and 2014, the Company incurred gross interest expense of $7,584, $6,791 and $2,594, respectively, excluding amortization of the discount, deferred financing costs, other fees, the effect of any hedging derivatives and before the effect of capitalizing interest related to property renovations. As of December 31, 2016 and 2015, the loan had a weighted-average interest rate of 2.68% and 2.30% respectively, which is inclusive of the monthly servicing fees, but excludes amortization of the original issue discount, deferred financing costs and interest rate cap accretion.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
During the years ended December 31, 2016 and 2015, the Company paid down $1,514 and $7,085, respectively, on the Securitization Loan to effect the release of certain properties from the first priority mortgages securing the Securitization Loan, including certain properties sold from the Southeast Florida and Houston, TX markets as described in Note 3.
The Securitization Loan has an initial term of two years, with three, 12-month extension options, resulting in a fully extended maturity date of September 9, 2019. The Borrower may execute the extension options provided there is no event of default under the Securitization Loan, the Borrower obtains a replacement interest rate cap agreement in a form reasonably acceptable to the lender and the Borrower complies with the other terms set forth in the loan agreement. During the twelve months ended December 31, 2016, the Company executed the first 12-month extension option.
As part of the Securitization Transaction, the Securitization Loan (including the related promissory note) was transferred by the third-party lender to one of the Company's subsidiaries and subsequently deposited into a REMIC trust in exchange for pass-through certificates. The pass-through certificates represent the entire beneficial interest in the trust and were sold to investors in a private offering through the placement agents retained for the transaction for gross proceeds of $311,164, net of the original issue discount of $1,503.
At closing, the Company transferred the Securitization Properties (as defined below) to the Borrower. The Securitization Properties are substantially similar to the other properties owned by the Company and were leased to residents underwritten on substantially the same basis as the Company's other properties. During the duration of the Securitization Loan, the Company can substitute properties only if a property owned by the Borrower becomes a disqualified property under the terms of the Securitization Loan. The lender immediately transferred the Securitization Loan, upon closing, to a subsidiary of the Company and then to a trust in exchange for the certificates. The Company accounted for the transfer of the Securitization Loan from its subsidiary to the trust as a sale under Codification Topic, Transfers and Servicing ("ASC 860"), with no resulting gain or loss as the Securitization Loan was both originated by the lender and immediately transferred at the same fair market value. The Company has also evaluated and not identified any variable interests in the trust.
All amounts outstanding under the Securitization Loan are secured by first priority mortgages on the securitization properties (the "Securitization Properties"), a pool of 2,975 properties excluding properties recorded as assets held for sale, in addition to the equity interests in, and certain assets of, the Borrower. The amounts outstanding under the Securitization Loan and certain obligations contained therein are guaranteed by the Operating Partnership only in the case of certain bad acts (including bankruptcy) as outlined in the transaction documents. The Borrower and Equity Owner are separate legal entities, but continue to be reported in the Company’s consolidated financial statements. As long as the Securitization Loan is outstanding, the assets of the Borrower and Equity Owner are not available to satisfy the debts and obligations of the Company or its other consolidated subsidiaries and the liabilities of the Borrower and Equity Owner are not liabilities of the Company (excluding, for this purpose, the Borrower and Equity Owner) or its other consolidated subsidiaries. The Company is permitted to receive distributions from the Borrower out of unrestricted cash as long as the Borrower is current with all payments and in compliance with all other obligations under the Securitization Loan.
The Company used $235,160 of the Securitization Loan proceeds in 2014 to pay down the full balance of the Company's revolving credit facility at closing and the remaining proceeds were used for working capital and other corporate purposes, including the acquisition, financing and renovation of properties and the repurchase of common stock. Simultaneously, the Company reduced the size of the revolving credit facility from $350,000 to $200,000. As a result, the Company wrote off $1,058 of deferred financing fees and reclassified $480 from accumulated other comprehensive income (loss) to earnings due to hedge ineffectiveness in the associated interest rate cap agreements for the year ended December 31, 2014.
The Securitization Loan provides for the restriction of cash whereby the Company must set aside funds for payment of real estate taxes, capital expenditures and other reserves associated with the Securitization Properties. There is also a cash management account controlled by the lender for the collection of all rents and cash generated by the Borrower's properties. In the event of default, the lender may apply funds, as the lender elects, from the cash management account, foreclose on its security interests, appoint a new property manager, and in limited circumstances, enforce the Company's guaranty. As of December 31, 2016 and 2015, the Company had $3,715 and $5,139, respectively, included in escrow deposits associated with the required reserves on the consolidated balance sheets.
The Securitization Loan does not contractually restrict the Company's ability to pay dividends but certain covenants contained therein may limit the amount of cash available for distribution. The Securitization Loan documents require the
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Company to maintain certain covenants, including a minimum debt yield on the Securitization Properties, and contain customary events of default for a loan of this type, including payment defaults, covenant defaults, breaches of representations and warranties, bankruptcy and insolvency, judgments and cross-default with certain other indebtedness. As of December 31, 2016 and 2015, the Company believes it was in compliance with all financial covenants.
Revolving Credit Facility
Certain of the Company's subsidiaries have a revolving credit facility (the "revolving credit facility") with a syndicate of banks. On February 18, 2015, the Company amended and restated the revolving credit facility to increase the borrowing capacity to $400,000 from $200,000 and subsequently amended the revolving credit facility to address certain interest calculation mechanics. The revolving period ended February 18, 2017 and the Company is no longer able to draw additional amounts under the revolving credit facility. As amended, the revolving credit facility bears interest at a varying rate of three-month LIBOR plus 3.0%, subject to a LIBOR floor of 0.0%. Prior to the amendment, the revolving credit facility bore interest at varying rates of LIBOR plus 3.5% subject to a LIBOR floor of 0.5%, payable monthly. The Company is also required to pay a monthly fee on the unused portion of the revolving credit facility at a rate of 0.5% per annum, when the balance outstanding is less than $200,000, or 0.3% per annum when the balance outstanding is equal to or greater than $200,000. As part of the amendment, the term of the revolving credit facility was extended to February 18, 2018 and the advance rate for borrowings was increased to 65% from 55%. The advance rate is based on the aggregate value of the eligible properties which value is calculated as the lesser of (a) the third-party broker price opinion value or (b) the original purchase price plus certain renovation and other capitalized costs of the properties. The Company used proceeds from the revolving credit facility to fund the Portfolio Acquisition and other acquisitions of properties as referenced in Note 3. The remaining proceeds were used for working capital and other corporate purposes, including the acquisition, financing and renovation of properties.
As of December 31, 2016 and 2015, $352,799 and $326,472, respectively, was outstanding under the revolving credit facility. As of December 31, 2016 and 2015, the interest rate on the revolving credit facility was 4.04% and 3.68%, respectively, inclusive of the unused fee. In the years ended December 31, 2016, 2015 and 2014, the Company incurred $13,020, $9,843 and $6,073, respectively, in gross interest expense on the revolving credit facility, excluding amortization of deferred financing costs, interest rate cap accretion and before the effect of capitalizing interest related to property renovations.
All amounts outstanding under the revolving credit facility are collateralized by the equity interests and assets of certain of the Company’s subsidiaries ("Pledged Subsidiaries"), which exclude the owners of the Securitization Properties. The amounts outstanding under the revolving credit facility and certain obligations contained therein are guaranteed by the Company and the Operating Partnership only in the case of certain bad acts (including bankruptcy) and up to $20,000 for completion of certain property renovations, as outlined in the credit documents. As of December 31, 2016, there were approximately 5,840 properties pledged as collateral under the revolving credit facility, excluding properties recorded as held for sale.
The revolving credit facility provides for the restriction of cash whereby the Company must set aside funds for payment of insurance, real estate taxes and certain property operating and maintenance expenses associated with properties in the Pledged Subsidiaries' portfolios. As of December 31, 2016 and 2015, the Company had $11,037 and $10,101, respectively, included in escrow deposits associated with the required reserves.
The Pledged Subsidiaries are separate legal entities, but continue to be reported in the Company’s consolidated financial statements. As long as the revolving credit facility is outstanding, the assets of the Pledged Subsidiaries are not available to satisfy the other debts and obligations of the other Pledged Subsidiaries or the Company. The revolving credit facility does not contractually restrict the Company’s ability to pay dividends. The Company is permitted to receive distributions from the Pledged Subsidiaries as long as the Company and the Pledged Subsidiaries are current with all payments and in compliance with all other obligations under the revolving credit facility, however certain covenants contained therein may limit the amount of cash available for distribution. For example, beginning on August 18, 2017, pursuant to a recent amendment, all net cash generated by the properties in the Pledged Subsidiaries (after paying associated property-level expenses) is directed towards principal repayment rather than being distributed to the Company.
The revolving credit facility agreement requires the Company to meet certain quarterly financial tests pertaining to net worth, total liquidity, debt yield and debt service coverage ratios. The Company must maintain total liquidity of $25,000 and a net worth of at least $125,000, as determined in accordance with the revolving credit facility agreement. The revolving credit facility also contains customary events of default for a facility of this type, including payment defaults, covenant defaults,
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
breaches of representations and warranties, bankruptcy and insolvency, judgments, change of control and cross-default with certain other indebtedness. The Company believes it was in compliance with all financial covenants under the revolving credit facility as of December 31, 2016 and 2015.
Total Borrowings
As of December 31, 2016, the Company had total outstanding borrowings of $656,251, of which borrowings under the Securitization Loan were $303,452 and borrowings under the revolving credit facility were $352,799.
The following table summarizes the Company's contractual maturities of debt as of December 31, 2016 (in thousands):
The revolving credit facility was amended and restated on February 18, 2015 and has a maturity date of February 18, 2018. The Securitization Loan has an initial maturity date of September 9, 2016 and three, 12-month extension options resulting in a fully extended maturity date of September 9, 2019; this table assumes the exercise of the three extension options, which is the Company's intent. During the twelve months ended December 31, 2016, the Company executed the first 12-month extension option.
Deferred Financing Costs
Costs incurred in the placement of the Company’s debt are being amortized using the straight-line method, which approximates the effective interest method, over the terms of the related debt. Amortization of deferred financing costs is recorded as interest expense in the accompanying consolidated statements of operations and comprehensive income (loss).
In connection with its Securitization Loan, the Company incurred deferred financing costs of $19, $460 and $11,040 for the years ended December 31, 2016, 2015 and 2014, respectively. The costs are being amortized through September 9, 2019, the fully extended maturity date of the Securitization Loan. Amortization of the deferred financing costs was $2,260, $2,321 and $865 for the years ended December 31, 2016, 2015 and 2014, respectively. In conjunction with the paydown of the Securitization Loan related to the sale of the Houston portfolio, the Company wrote off $174 in deferred financing costs for the year ended December 31, 2015, which has been included in net gain on disposition of real estate in the consolidated statements of operations and comprehensive income (loss).
In connection with its revolving credit facility, the Company incurred deferred financing costs of $29, $5,323 and $1,852, respectively, for the years ended December 31, 2016, 2015 and 2014. Amortization of the deferred financing costs was $2,337, $2,141 and $1,691, respectively, for the years ended December 31, 2016, 2015 and 2014.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Interest Expense
The following table presents the Company's total interest expense for the years ended December 31, 2016, 2015 and 2014:
(1)
Includes the Securitization Loan's monthly servicing fees.
(2)
For 2015, excludes deferred financing fees written-off in conjunction with the paydown of the Securitization Loan related to the sale of the Houston portfolio.
(3)
Includes monitoring service fees and interest related to the Company's designated derivative financial instruments (see Note 11).
(4)
The Company capitalizes interest for properties undergoing renovation activities and purchased subsequent to the Company obtaining debt in May 2013.
Derivative Financial Instruments
The variable rate of interest on the Company's debt exposes the Company to interest rate risk. Currently, the Company uses interest rate cap agreements and interest rate swap transactions (collectively "Hedging Derivatives") to manage this interest rate risk. These instruments are carried at fair value in the Company’s financial statements (see Note 11). Changes in the fair value of the designated portion of the Company's Hedging Derivatives that qualify for hedge accounting are recognized through other comprehensive income (loss) (see Note 11).
Non-designated hedges are derivatives that do not meet the criteria for hedge accounting or for which the Company did not elect to designate as accounting hedges. The Company does not enter into derivative transactions for speculative or trading purposes, but may enter into derivatives to manage the economic risk of changes in interest rates.
The following table summarizes the consolidated derivative positions at December 31, 2016:
(1)
The full notional balance is hedged through September 15, 2017 after which $200,000 is hedged through September 15, 2019.
(2)
For interest rate caps, represents the weighted average interest rate on the hedged debt as of December 31, 2016.
(3)
For interest rate caps, represents the capped interest rate, which is inclusive of the monthly servicing fees, but excludes amortization of the original issue discount, deferred financing costs and interest rate cap accretion.
(4)
The swap transactions are structured with a fixed rate that steps up over the three-year term locking in the forward LIBOR curve at the time of execution. This structure resulted in an average effective rate of 2.77% over the three-year term.
As of December 31, 2015, the Company held four interest rate cap agreements, which included two interest rate cap agreements with an aggregate notional amount of $349,100, LIBOR caps of 3.00%, and termination dates of February 17, 2018
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
and February 18, 2018 associated with the revolving credit facility, one interest rate cap agreement with a notional amount of $312,667, a LIBOR cap of 3.1085%, and a termination date of September 15, 2016 associated with the Securitization Loan and one forward-starting interest rate cap agreement with a notional amount of $200,000, a LIBOR cap of 3.1085%, and a termination date of September 15, 2019.
The two interest rate cap agreements associated with the revolving credit facility with an aggregate notional amount of $349,100, were purchased in the first quarter of 2015, at an aggregate purchase price of $867. In August 2014, the Company entered into the first interest rate cap agreement associated with the Securitization Loan with a notional amount of $312,667 at a purchase price of $293. In January 2015, the Company entered into a forward-starting interest rate cap agreement associated with the Securitization Loan at a purchase price of $1,383. Portions of the purchase prices of the interest rate cap agreements, representing the premiums paid to enter into the contracts, were capitalized as deferred financing costs and are being amortized using the straight-line method over the terms of the related agreements. The Company determined that the interest rate caps qualified for hedge accounting and, therefore, were designated as cash flow hedges with future changes in fair value recognized through other comprehensive income (loss) (see Note 11). Ineffectiveness was calculated as the amount by which the change in fair value of the derivatives exceeds the change in the fair value of the anticipated cash flows related to the corresponding debt and is recorded in adjustments for derivative instruments, net in the consolidated statements of operations and comprehensive income (loss).
In July 2016, the Company entered into one interest rate cap agreement at LIBOR of 3.1085% with a notional amount of $104,367 and a termination date of September 15, 2017 to hedge interest rate risk associated with its Securitization Loan. The Company determined that the interest rate cap agreement qualified for hedge accounting and, therefore, designated the derivative as a cash flow hedge. The interest rate cap agreement was subsequently de-designated as noted below.
In August 2016, the Company, through its Operating Partnership, entered into interest rate swap transactions with two counterparties (the “Swaps”). The Company entered into the Swaps to effectively fix the interest rate on $296,000 of the Company’s floating rate indebtedness under the Securitization Loan for three years. The Swaps have an effective date and maturity date as reflected in the table below. From each respective effective date through the corresponding maturity date, the Company will be required to make monthly fixed rate payments at the fixed swap rate and on the notional amounts reflected in the table below, while the counterparty will be obligated to make monthly floating rate payments to the Company based on one-month LIBOR and referencing the same notional amount. In connection with the Swaps, the Company is required to maintain cash reserves of at least $15,000. The Company determined that the Swaps qualified for hedge accounting and designated the derivatives as cash flow hedges. Concurrently, the Company de-designated three interest rate cap agreements also associated with the Securitization Loan and will reclassify the balance of deferred losses of $1,255 in accumulated other comprehensive income (loss) to earnings over the remaining life of the associated interest rate cap agreements.
In connection with the financing of the October 1, 2016 acquisition (see Note 3), effective September 29, 2016, the Company modified an existing interest rate cap agreement originally entered into on March 31, 2015 to increase the notional amount from $266,100 to $287,100 to hedge interest rate risk associated with its revolving credit facility. The Company determined that the interest rate cap agreement qualified for hedge accounting and, therefore, continued its designation of the derivative as a cash flow hedge. Ineffectiveness was calculated as the amount by which the change in fair value of the derivatives exceeds the change in the fair value of the anticipated cash flows related to the corresponding debt.
During the years ended December 31, 2016 and 2015, the Company paid $30 and $2,250, respectively, in connection with the purchase of interest rate cap agreements which are included in other assets on the consolidated balance sheets and recorded at fair value (see Note 11).
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Capitalized Interest
The Company capitalizes interest for properties undergoing renovation activities and purchased subsequent to the Company obtaining debt in May 2013. Capitalized interest totaled $0, $311 and $858, respectively, for the years ended December 31, 2016, 2015 and 2014.
Note 6. Equity Incentive Plan
Restated 2012 Equity Incentive Plan
On December 4, 2012, the Company adopted an equity incentive plan (the "2012 Plan") which provides incentive compensation to attract and retain qualified directors, officers, advisors, consultants and other personnel of the Company. The 2012 Plan provides for grants of restricted common stock, phantom shares, dividend equivalent rights and other equity-based awards, originally subject to a ceiling of 921,053 shares available for issuance. The 2012 Plan allows for the Company’s board of directors to expand the types of awards available to include long-term incentive plan units in the future. If an award granted under the 2012 Plan expires or terminates, the shares subject to any portion of the award that expires or terminates without having been exercised or paid, as the case may be, will again become available for the issuance of future awards. No award may be granted under the equity incentive plan to any person who, assuming payment of all awards held by such person, would own or be deemed to own more than 9.8% of the outstanding shares of the Company’s common stock.
On February 9, 2016 the Company's board of directors approved the amendment and restatement of the 2012 Plan (the "Restated 2012 Plan"), which was approved by stockholders on May 17, 2016. The amendment and restatement of the 2012 Plan increased the number of shares available for issuance by 1,500,000 shares and made certain other changes. Unless previously terminated by the Company's board of directors, no new award may be granted under the Restated 2012 Plan after February 9, 2026.
The compensation committee of the Company’s board of directors has the full authority to administer and interpret the plan, to authorize the granting of awards, to determine the eligibility of directors, officers, advisors, consultants and other personnel of the Company to receive an award, to determine the number of shares of common stock to be covered by each award, to determine the terms, provisions and conditions of each award, to prescribe the form of instruments evidencing awards and to take any other actions and make all other determinations that it deems necessary or appropriate in connection with the equity incentive plan or the administration or interpretation thereof. In connection with this authority, the compensation committee may, among other things, establish performance goals that must be met in order for awards to be granted or to vest, or for the restrictions on any such awards to lapse.
Restricted Stock Awards
Restricted shares that have been awarded to certain personnel of the Company through December 31, 2015 vest in three annual installments commencing on the date of the grant, as long as such individual is an employee on the vesting date. Restricted shares that have been awarded to personnel and certain officers of the Company during the year ended December 31, 2016 vest in one year commencing on the date of the grant, as long as the individual is an employee on the vesting date. Restricted share awards to independent directors generally vest on the earlier of (i) the one year anniversary of the date of grant and (ii) the date immediately preceding the date of the annual meeting of the Company’s stockholders for the year following the year of grant for the award, as long as such director is serving as a board member on the vesting date.
The Company’s unvested restricted stockholders have the same voting rights as any other common stockholder. During the period of restriction, the Company’s unvested restricted stockholders receive quarterly dividend payments on their shares at the same rate and on the same date as any other common stockholder. For the years ended December 31, 2016, 2015 and 2014 inclusive of the impact of cash dividends, the Company recognized $2,489, $2,274 and $1,022, respectively, of stock compensation expense related to the restricted stock awards.
On February 9, 2016, the Company issued, in aggregate, 127,648 shares of restricted common stock to certain officers and employees of the Company. The estimated fair value of these awards was $12.97 per share, based upon the closing price of the Company’s stock on the date prior to the grant. These grants will vest in one year commencing on the date of the grant, as long as such individual is an employee on the vesting date, unless earlier accelerated pursuant to its terms.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
On May 17, 2016, the Company awarded each of its four independent directors an equity retainer in the form of an award of 3,432 shares of restricted stock at a grant date fair value of $14.57 per share. On August 2, 2016 the Company appointed a new independent director to the Company's Board of Directors who received 2,179 shares of restricted stock at a grant date fair value of $18.11 per share. On August 31, 2016 the Company accepted the resignation from one independent director on the Company's Board of Directors effective August 31, 2016. In connection with this resignation, the Board of Directors accelerated the vesting of 997 shares of restricted stock held by such director.
As of December 31, 2016, the total compensation cost related to nonvested awards not yet recognized was $508 and the weighted-average period over which such amount is expected to be recognized is 0.61 years.
The table below summarizes the award activity of the restricted stock awards for 2016, 2015 and 2014:
On January 4, 2017, the Company appointed a new independent director to the Company's Board of Directors who received 1,055 shares at a grant date fair value of $17.27 per share.
On January 27, 2017, the Company issued, in aggregate, 121,067 shares of restricted common stock to certain officers and employees of the Company. The estimated fair value of these awards was $16.82 per share, based upon the closing price of the Company’s stock on the date prior to the grant. These grants will vest in one year commencing on the date of the grant, as long as such individual is an employee on the vesting date, unless earlier accelerated pursuant to its terms.
Performance Stock Units
The table below summarizes the award activity of the PSUs for 2016 and 2015. There were no PSUs granted prior to 2015.
As of December 31, 2016, the Company had 140,000 performance stock units (“PSUs”) granted to certain members of executive management under its equity incentive plan. Each PSU represents the potential to receive Silver Bay common stock based on the extent to which specified performance targets are met during the 36-month performance period, which begins on the grant date and is subject to continued employment until the end of the performance period. The number of shares of Silver Bay common stock to be earned as of the vesting date for each PSU increases and decreases based on Silver Bay's total stockholder return (stock price appreciation plus dividends) ("TSR").
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
On February 12, 2015, the Company granted 165,000 PSUs which would vest based on the Company’s annualized TSR during the performance period on an absolute (i.e., non-relative) basis (the “Absolute TSR PSUs”). On June 21, 2016, the Company granted an additional 30,000 Absolute TSR PSUs to the Chief Executive Officer. On January 27, 2017, the Company granted an additional 30,000 Absolute TSR PSUs. The number of common stock is determined by multiplying the target number of PSUs by the TSR multiplier, determined in accordance with the following table:
(1)
To the extent the Company's annualized TSR falls between two discrete points, linear interpolation shall be used to determine the TSR multiplier. Additionally, each PSU contains one dividend equivalent right, which is equal to the cash dividend that would have been paid on the PSU had the PSU been an issued and outstanding common share on the record date for the dividend and is payable in additional shares if the market and service conditions are met.
On each of June 21, 2016 and January 27, 2017, the Company granted an additional 30,000 PSUs to its Chief Executive Officer which will vest based on the Company’s TSR during the performance period relative to a peer group index (the “Relative TSR PSUs”) comprised initially of those companies in the Apartment and Single Family Home subsectors of the FTSE NAREIT All REIT Index (the “Index”) with equal weighting provided to each subsector in constructing the peer group index. The number of shares of common stock eligible to be received will be determined by multiplying the target number of PSUs by the TSR Multiplier determined in accordance with the following table:
(2)
To the extent the Company's TSR performance compared to the Index TSR falls between two discrete points, linear interpolation will be used to determine the TSR Multiplier.
Notwithstanding the foregoing, the payout of any Relative TSR PSU will be capped at 110% if the Absolute PSU TSR during the performance period is negative. Additionally, each PSU contains one dividend equivalent right, which is equal to the cash dividend that would have been paid on the PSU had the PSU been an issued and outstanding common share on the record date for the dividend and is payable in additional shares if the market and service conditions are met.
The Company utilized a Monte-Carlo simulation to calculate the weighted-average grant date fair value for all outstanding PSUs. The grant date fair value of the Absolute TSR PSUs granted in 2016 and 2015 were $12.84 and $7.00, respectively. The grant date fair value of the Relative TSR PSUs granted in 2016 was $18.68. The grant date fair value of the Absolute TSR PSUs and Relative TSR PSUs granted on January 27, 2017 was $7.78 and $13.67, respectively.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
The following table summarizes the Monte-Carlo simulation inputs used to calculate the weighted-average grant date fair value of PSUs issued during the years ended December 31, 2016 and 2015:
(1)
For the 2016 grants, expected volatility is based on the Company's historical stock price volatility over the last three years using daily data points. For the 2015 grants, expected volatility is calculated as a 50.0% relative weighting of the Company's historical volatility of 15.54% (over the period from August 1, 2013 through the date of grant of the PSUs) and a 50.0% relative weighting on the implied volatility of 19.55%.
(2)
An assumed dividend yield of 0% is the mathematical equivalent to the reinvestment of dividends, which is consistent with the TSR definition described above.
(3)
Based on the closing price of the Company's common stock on the date of the grant.
(4)
For the 2016 grants, based on the average closing price over the period from January 19, 2016 to June 21, 2016. For the 2015 grants, based on the 30 trading days ended on February 12, 2015.
During the year ended December 31, 2016 and 2015, the Company recognized non-cash performance-based stock unit expense of $178 and $339, respectively, which is included within share-based compensation in the consolidated statements of operations and comprehensive income (loss). Unrecognized compensation expense at December 31, 2016 was $988, and the weighted-average period over which such amount is expected to be recognized is 1.70 years.
On January 27, 2017, certain executives were awarded 39,610 PSUs which would vest based on the Company's annualized TSR during the performance period based on an absolute period (the "Outperformance TSR PSUs") with a grant date fair value of $5.37. The number of shares of common stock is determined by multiplying the number of PSUs by the TSR multiplier, determined in accordance with the following table:
(1)
To the extent the Company's annualized TSR falls between two discrete points, linear interpolation shall be used to determine the TSR multiplier. Additionally, each PSU contains one dividend equivalent right, which is equal to the cash dividend that would have been paid on the PSU had the PSU been an issued and outstanding common share on the record date for the dividend and is payable in additional shares if the market and service conditions are met.
Note 7. Preferred Stock
During the Company's formation, it issued 1,000 shares of its 10% cumulative redeemable preferred stock to a subsidiary of Two Harbors, which subsequently sold the shares. This preferred stock ranks, with respect to dividend rights and rights upon the Company's liquidation, dissolution or winding up, senior to the rights of holders of the Company’s common stock. The Company may issue other classes or series of capital stock in the future, including classes or series of preferred stock, and expressly designate such classes or series as ranking junior to, on parity with or senior to the 10% cumulative redeemable preferred stock. The Company may not, however, issue capital stock ranking as to dividends or rights upon the
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Company's liquidation, dissolution or winding up, senior to the 10% cumulative redeemable preferred stock, without the affirmative vote or consent of two-thirds of the issued and outstanding shares of 10% cumulative redeemable preferred stock. Dividends shall accrue on a daily basis and be cumulative from the initial issue date. Dividends, if authorized by the board of directors, will be payable annually in arrears on June 30 of each year, or more frequently as determined by the board of directors. The Company has the option at any time after five years from the initial issue date of December 18, 2012 to redeem the 10% cumulative redeemable preferred stock at a redemption price of $1 per share, plus all accrued and unpaid dividends. At any time, beginning on the sixth anniversary of the initial issue date, a preferred stockholder, with adequate notice, may put their shares back to the Company, at a redemption price of $1 per share, plus all accrued and unpaid dividends.
As of both December 31, 2016 and 2015, there was $21 in preferred stock dividends included in accounts payable and accrued expenses on the consolidated balance sheets.
Note 8. Stockholders’ Equity
Common stock
As of December 31, 2016, the Company had 35,380,034 shares of common stock outstanding. The following table presents the changes in the Company’s issued and outstanding common shares for the years ended December 31, 2016, 2015 and 2014:
On July 1, 2013, the Company’s board of directors authorized the Company to repurchase up to 2,500,000 shares of its common stock through a share repurchase program. On November 25, 2014, the Company's board of directors authorized an increase of 2,500,000 shares to the previously authorized share repurchase program for a total of 5,000,000 shares. Shares may be repurchased from time to time through privately negotiated transactions or open market transactions, pursuant to a trading plan in accordance with Rules 10b5-1 and 10b-18 under the Securities Exchange Act of 1934, as amended, or by any combination of such methods. The manner, price, number and timing of share repurchases will be subject to a variety of factors, including market conditions and applicable U.S. Securities and Exchange Commission rules.
In the years ended December 31, 2016, 2015 and 2014, the Company repurchased and retired 776,202, 770,417 and 1,912,139 common shares, respectively, under the program for a total cost of $11,281, $12,260 and $31,396, respectively, at an average purchase price of $14.53, $15.91 and $16.42, respectively, inclusive of commission.
In the years ended December 31, 2016, 2015 and 2014, respectively, the Company repurchased and retired 39,040, 11,022 and 5,697 common shares, respectively, outside of the repurchase program for a total cost of $512, $174 and $93, respectively, at an average purchase price of $13.13, $15.74 and $16.28, respectively. The shares were repurchased from certain employees, officers, directors, advisors and certain personnel of the Former Manager and the Former Manager's operating subsidiary to cover the minimum statutory tax withholding obligations related to the vesting of restricted common stock.
On September 30, 2014, the Company issued 2,231,511 common units of the Operating Partnership to acquire the Former Manager (see Note 10).
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Common Stock Dividends
The following table presents cash dividends declared by the Company on its common stock for the three years ended December 31, 2016:
On February 27, 2017, our board of directors declared a quarterly dividend of $0.13 per share payable on April 14, 2017, to shareholders of record on April 3, 2017.
Preferred Stock Dividends
The following table presents cash dividends declared by the Company on its 10% cumulative redeemable preferred stock for the three years ended December 31, 2016:
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Note 9. Earnings (Loss) Per Share
The following table presents a reconciliation of net loss attributable to common stockholders and shares used in calculating basic and diluted earnings (loss) per share ("EPS") for the years ended December 31, 2016, 2015 and 2014:
A total of 2,231,511 common units were outstanding from September 30, 2014 through December 31, 2016 which have been excluded from the calculations of diluted EPS as their inclusion would not be dilutive. In addition, 102,458 performance stock units, inclusive of applicable dividend equivalent rights, have been excluded from the calculation of diluted EPS for the year ended December 31, 2016 as their inclusion would not be dilutive, even though their market conditions had been met. During the year ended December 31, 2015, 165,000 performance stock units have been excluded from the calculation of diluted EPS as their market conditions had not been met. There were no PSUs granted prior to February 12, 2015.
Note 10. Related Party Transactions
Management Internalization Transaction
On September 30, 2014, the Company closed the Internalization after receiving the required stockholder approval for the transaction. The Internalization was completed under the terms of a contribution agreement (the "Contribution Agreement") among the Company, Pine River Domestic Management L.P., Provident, the Former Manager, and the Operating Partnership, pursuant to which the Company acquired the Former Manager in exchange for 2,231,511 common units of the Operating Partnership. These common units are redeemable for cash or, at the Company's election, the Company's common shares on a one-for-one basis.
The Contribution Agreement included a net worth adjustment, payable in cash, in the event that the closing net worth of the Former Manager was greater or less than $0 after making an adjustment to exclude any liabilities for accrued bonus compensation payable to the Chief Executive Officer and personnel providing data analytics directly supporting the investment function of the Company. The Company settled the net worth adjustment on September 30, 2014 based on estimated amounts. The Company finalized the net worth adjustment in the fourth quarter of 2014 and the settlement was de minimis. As a result of this transaction, as of September 30, 2014, the Company no longer pays fees or expense reimbursements to the Former Manager or the Former Manager's operating subsidiary.
The Company recognized $39,373 in the third and fourth quarters of 2014 in connection with the Internalization, which is recorded as management internalization expense in the accompanying consolidated statements of operations and comprehensive income (loss). The Internalization expense primarily consists of the issuance of the 2,231,511 common units of the Operating Partnership with a fair value of $36,173, based on the stock price on the date of closing of $16.21. The issuance of the common units was recognized as an expense as it represented the cost of terminating the advisory management fee agreement. The remaining amounts in management internalization were attributable to transaction fees and expenses, and the assumption of certain liabilities in connection with the transaction. The Company acquired cash of $2,069 and other net liabilities of $2,067 in the transaction.
Upon Internalization, the Company assumed net operating losses and a deferred tax asset of the Former Manager's operating subsidiary. The Company has elected to have this new entity be treated for tax purposes as a TRS. See Note 4 for further detail on income taxes.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Advisory Management Agreement
Prior to the Internalization, the Company and the Former Manager maintained an advisory management agreement whereby the Former Manager designed and implemented the Company’s business strategy and administered its business activities and day-to-day operations, subject to oversight by the Company’s board of directors. In exchange for these services, the Former Manager earned a fee equal to 1.5% per annum, or 0.375% per quarter, of the Company’s daily average fully diluted market capitalization, as defined by the agreement, calculated and payable quarterly in arrears. The fee was reduced for the 5% property management fee (described below) received by the Former Manager’s operating subsidiary or its affiliates under the property management and acquisition services agreement. The Company also reimbursed the Former Manager for all expenses incurred on its behalf or otherwise in connection with the operation of its business, other than compensation for the Chief Executive Officer and personnel providing data analytics directly supporting the investment function.
During the year ended December 31, 2014, the Company expensed $6,621 in advisory management fees, net of the reduction for the 5% property management fee described below. As of December 31, 2014, the Company had settled the final advisory management fee payable and had $0 outstanding related to the advisory management fee.
The Company also reimbursed the Former Manager for certain general and administrative expenses, primarily related to employee compensation and certain office costs. Direct and allocated costs incurred by the Former Manager on behalf of the Company totaled $0 for both the years ended December 31, 2016 and 2015 and totaled $5,476 for the year ended December 31, 2014. As of December 31, 2016 and 2015, the Company did not have an outstanding balance due to the Former Manager and affiliates on the consolidated balance sheets.
Property Management and Acquisition Services Agreement
Prior to the Internalization, the Company and the Former Manager's operating subsidiary maintained a property management and acquisition services agreement pursuant to which the Former Manager's operating subsidiary acquired and managed single-family properties on the Company's behalf. For these services, the Company reimbursed the Former Manager’s operating subsidiary for all direct expenses incurred in the operation of its business, including the compensation of its employees. The Former Manager’s operating subsidiary also received a property management fee equal to 5% of certain costs and expenses incurred by it in the operation of its business that were reimbursed by the Company. Prior to the Internalization, this 5% property management fee reduced the advisory management fee paid to the Former Manager on a dollar-for-dollar basis. Upon Internalization, the Former Manager's operating subsidiary performing these services was acquired.
Prior to the Internalization, through the nine months ended September 30, 2014, the Company incurred property management expense of $7,569, which included direct expense reimbursements of $5,120 and the 5% property management fee of $288. The remaining $2,161 of property management fees incurred prior to the Internalization was incurred to reimburse the Former Manager's operating subsidiary for direct property management type expenses and payments due directly to third-party property managers. In addition, the Company incurred charges with the Former Manager's operating subsidiary of $608 in acquisitions and renovation fees, which the Company capitalized as part of property acquisition and renovation costs and $11 for leasing services, which are reflected as other assets and are being amortized over the life of the leases (typically one year or less). Following the Internalization, the Company incurred property management expense of $1,832 for total 2014 expense of $9,401.
As of December 31, 2016 and 2015, the Company did not have an outstanding balance due to the Former Manager and affiliates on the consolidated balance sheets for property management and acquisition services.
In June 2014, the Former Manager's operating subsidiary acquired the Company's third-party property manager in Tampa, who provided services exclusively to the Company, for $775. No significant assets or liabilities were acquired or assumed as part of the transaction and the payment was recorded as a one-time general and administrative expense.
Note 11. Derivative and Other Fair Value Instruments
ASC 820 established a three level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Level 1 - Inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - Inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 - Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
Recurring Fair Value
The Company uses Hedging Derivatives to manage its exposure to interest rate risk (refer to Note 5) and in conjunction with certain variable rate secured debt to satisfy lender requirements. The Hedging Derivatives are valued using models developed by the respective counterparty that use as their basis readily observable market parameters (such as forward yield curves).
The following table provides a summary of the aggregate fair value measurements for the Hedging Derivatives and the location within the consolidated balance sheets at December 31, 2016 and 2015, respectively:
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
The following table provides a summary of the effect of Hedging Derivatives on the Company’s consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2016:
The following table provides a summary of the effect of Hedging Derivatives on the Company’s consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2015:
The following table provides a summary of the effect of Hedging Derivatives on the Company’s consolidated statements of operations and comprehensive income (loss) for the year ended December 31, 2014:
As of December 31, 2016 and 2015, there were approximately $2,841 and $(1,613), respectively, in deferred gains (losses) in accumulated other comprehensive income (loss) related to Hedging Derivatives. The Company expects to recognize approximately $593 in interest expense during the year ending December 31, 2017, pertaining to the interest rate cap agreements, which will be reclassified out of accumulated other comprehensive income (loss), in accordance with the amortization schedules established upon designation of the interest rate caps as cash flow hedges. In addition, the Company expects to recognize approximately $207 into earnings during the year ended December 31, 2017, pertaining to the de-designated interest rate cap agreements (as discussed below), which will be reclassified out of accumulated other
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
comprehensive income (loss) into adjustments for derivative instruments, net, in accordance with the amortization schedules established upon designation of the interest rate cap agreements as cash flow hedges.
In association with the pay down of the revolving credit facility in the third quarter of 2014, the Company de-designated the three interest rate cap agreements associated with the revolving credit facility and concurrently reclassified $480 in deferred losses from accumulated other comprehensive income (loss) to income which is recorded as adjustments for derivative instruments, net on the consolidated statements of operations and comprehensive income (loss). All future gains and losses associated with these interest rate cap agreements were recorded in earnings. During the year ended December 31, 2014, the Company recorded a loss of $49 related to the change in fair value following the de-designation of the three interest rate cap agreements associated with the revolving credit facility (see Note 5).
In conjunction with the paydown of the revolving credit facility in the fourth quarter of 2015, the Company recorded a portion of the $266,100 interest rate cap agreement as ineffective. Current and future gains and losses associated with the ineffective portion of this interest rate cap agreement will be recorded as adjustments for derivative instruments, net on the consolidated statements of operations and comprehensive income (loss). During the year ended December 31, 2015, the Company recorded $51 in losses as ineffectiveness in interest rate cap agreements associated with the revolving credit facility.
In August 2016, the Company entered into a series of interest rate swaps (see Note 5) and determined they qualified for hedge accounting and designated the derivatives as cash flow hedges. In connection with entering into these interest rate swaps, the Company de-designated three interest rate cap agreements associated with the Securitization Loan. As the Company still holds a balance on the Securitization Loan, it will reclassify the balance at December 31, 2016 of $1,255 in deferred losses in accumulated other comprehensive income (loss) to earnings over the remaining life of the associated interest rate cap agreements. During the year ended December 31, 2016, the Company realized $180 in gains related to the change in fair value on the de-designated interest rate cap agreements which is recorded in adjustments for derivative instruments, net.
Nonrecurring Fair Value
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 the Company has determined to sell the asset. Assets held for sale are valued based on comparable sales data, less estimates of third-party broker commissions, which are gathered from the markets (see Note 2). These impairment measurements constitute nonrecurring fair value measures under ASC 820 and the inputs are characterized as Level 2.
Fair Value of Other Financial Instruments
In accordance with ASC 820, the Company is required to disclose the fair value of financial instruments, both assets and liabilities recognized and not recognized in the consolidated balance sheets, for which fair value can be estimated. The following describes the Company’s methods for estimating the fair value for financial instruments. Descriptions are not provided for those items that have zero balances as of December 31, 2016 and 2015.
•
Cash, escrow deposits, resident prepaid rent and security deposits, resident rent receivable (included in other assets), accounts payable, and accrued expenses have carrying values which approximate fair value because of the short-term nature of these instruments. The Company categorizes the fair value measurement of these assets and liabilities as Level 1.
•
The Company’s revolving credit facility has a floating interest rate based on an index plus a spread and the credit spread is consistent with those demanded in the market for facilities with similar risk and maturities. Accordingly, the interest rate on this borrowing is at market and thus the carrying value of the debt approximated fair value as of December 31, 2016 and 2015. The Company categorizes the fair value measurement of this liability as Level 2.
•
The fair value of the Company's Securitization Loan was $301,582 and $293,536 as of December 31, 2016 and 2015, respectively, based on an average of market quotations. The Company categorizes the fair value measurement of this liability as Level 2.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
•
The Company’s 10% cumulative redeemable preferred stock had a fair value which approximates its liquidation value at December 31, 2016 and 2015. The Company categorizes the fair value measurement of this instrument as Level 2.
Note 12. Commitments and Contingencies
Concentrations
As of December 31, 2016, approximately 61% of the Company’s properties were located in Phoenix, AZ, Tampa, FL, and Atlanta, GA, which exposes the Company to greater economic risks than if the Company owned a more geographically dispersed portfolio.
Resident security deposits
As of December 31, 2016, the Company had $12,992 in resident security deposits. Security deposits are refundable, net of any outstanding charges and fees, upon expiration of the underlying lease.
Operating leases
Upon Internalization, the Company assumed certain commitments that were previously those of the Former Manager or the Former Manager’s operating subsidiary. The Company leases certain office facilities under operating leases, some of which include rent payment escalation clauses, with lease terms ranging from one to five years. In addition to minimum lease payments, some of the Company's office facility leases require payment of a proportionate share of fees and taxes and building operating expenses.
In the years ended December 31, 2016, 2015 and 2014 the Company incurred $890, $837 and $104, respectively, in rental expense on operating leases.
A schedule of future minimum lease payments under non-cancelable operating leases for the following years is as follows:
Legal and regulatory
From time to time, the Company is subject to potential liability under laws and government regulations and various claims and legal actions arising in the ordinary course of the Company’s business. Liabilities are established for legal claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts established for those claims. Based on information currently available, management is not aware of any legal or regulatory claims that would have a material adverse effect on the Company’s consolidated financial statements and, therefore, no accrual has been recorded as of December 31, 2016.
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
Note 13. Quarterly Financial Data (Unaudited)
Following is quarterly financial data for 2016 and 2015:
During the quarter ended December 31, 2016, the Company recorded net income attributable to common stockholders of $2,667, as such, the Company has reported diluted EPS of $0.07 for the quarter. The diluted weighted average shares outstanding during the quarter included 2,231,511 common units and 147,176 performance stock units, inclusive of applicable dividend equivalent rights, as their market conditions had been met.
During the fourth quarter of 2015, the Company recorded a tax benefit of $964 related to the reversal of a deferred tax valuation allowance for the portion of the Company’s deferred tax assets that the Company believes meets the “more-likely than not” realizability test as described in Note 4.
Note 14. Subsequent Events
On February 27, 2017, Silver Bay Realty Trust Corp. the General Partner, and the Operating Partnership (Silver Bay Realty Trust Corp., the Operating Partnership and the General Partner collectively referred to as the “Company Parties”), entered into a definitive Agreement and Plan of Merger (the “Merger Agreement”) with Tricon Capital Group, Inc., a company incorporated under the laws of the Province of Ontario (“Tricon Ultimate Parent”), TAH Acquisition Holdings LLC, a Delaware limited liability company (“Tricon Parent”) and TAH Acquisition LP, a Delaware limited partnership (“Tricon LP” and, together with Tricon Ultimate Parent and Tricon Parent, the “Tricon Parties”). Under the Merger Agreement, Silver Bay Realty Trust Corp. will merge with and into Tricon Parent, with Tricon Parent being the surviving entity (the “Merger”). The board of directors of Silver Bay Realty Trust Corp. has unanimously approved the Merger Agreement, the Merger and the other transactions contemplated by the Merger Agreement.
Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger, each outstanding share of Silver Bay Realty Trust Corp. common stock, par value $0.01 per share (other than shares held by any Tricon Party or any subsidiary thereof or any wholly-owned subsidiary of the Company), will be converted into the right to receive an amount in cash equal to $21.50, without interest (as the same may be adjusted, the “Merger Consideration”), subject to any applicable withholding tax, and each outstanding share of Silver Bay Realty Trust Corp. 10% cumulative redeemable preferred stock, par value $0.01 per share, will be converted into the right to receive an amount in cash equal to $1,000 per share, plus an amount equal to all dividends accrued and unpaid on such share of preferred stock immediately prior to the Merger effective time, without interest (the “Preferred Merger Consideration”), subject to applicable withholding tax. The Merger Agreement also provides for the merger of Tricon LP with and into the Operating Partnership, with the Operating Partnership being the surviving entity (the “Partnership Merger”).
SILVER BAY REALTY TRUST CORP.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(amounts in thousands, except share and per share data and property counts)
The completion of the Merger and the Partnership Merger is subject to customary conditions, including, among others: (i) approval by a majority of Silver Bay Realty Trust Corp.’s stockholders; (ii) the absence of a material adverse effect on the Company; (iii) the receipt of a tax opinion relating to REIT status of the Company and (iv) the absence of any order, action or law by a governmental authority preventing, prohibiting, enjoining or making illegal the consummation of the Merger and the Partnership Merger.
The Company anticipates the Merger and Partnership Merger will close in the second quarter of 2017.
Silver Bay Realty Trust Corp.
Schedule III - Real Estate and Accumulated Depreciation
As of December 31, 2016
(dollars in thousands)
(1)
Encumbrances include the number of properties pledged under the revolving credit facility and the number of properties secured by first priority mortgages under the Securitization Loan, as well as the aggregate value of outstanding debt attributable to such properties, excluding the original issue discount. There are 87 properties in various markets classified as assets held for sale as of December 31, 2016 that are encumbered under the Company's revolving credit facility and Securitization Loan for an aggregate total of $9.0 million that have been excluded from Schedule III.
(2)
The gross aggregate cost of total real estate for federal income tax purposes was approximately $1,217,745 at December 31, 2016 (unaudited).
(3)
Depreciation of building and improvements is computed on the straight-line basis over the estimated useful life of 3 to 27.5 years, with no salvage value.
The changes in investments in real estate for the years ended December 31, 2016, 2015 and 2014 are as follows:
The changes in accumulated depreciation for the years ended December 31, 2016, 2015 and 2014 are as follows:
(1)
Includes assets transferred to held for sale.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Accounting Officer, has evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2016. Based on such evaluation, our Chief Executive Officer and Chief Accounting Officer have concluded that, as of the end of such period, our disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We continue to review and document our disclosure controls and procedures, including our internal controls over financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company. Internal control over financial reporting is a process to provide reasonable assurance regarding the reliability of our financial reporting for external purposes in accordance with accounting principles generally accepted in the United States of America. Internal control over financial reporting includes maintaining records that in reasonable detail accurately and fairly reflect our transactions; providing reasonable assurance that transactions are recorded as necessary for preparation of our financial statements; providing reasonable assurance that receipts and expenditures of Company assets are made in accordance with management authorization; and providing reasonable assurance that unauthorized acquisition, use or disposition of Company assets that could have a material effect on our financial statements would be prevented or detected on a timely basis. Because of its inherent limitations, internal control over financial reporting is not intended to provide absolute assurance that a misstatement of our financial statements would be prevented or detected.
Management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the 2013 Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2016.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended December 31, 2016 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information called for by this Item is incorporated herein by reference from the Company’s definitive Proxy Statement for its 2016 Annual Meeting of Stockholders under the captions "Election of Directors," "Corporate Governance and Board Matters," "Section 16(a) Beneficial Ownership Reporting Compliance" and "Executive Officers," which will be filed with the SEC pursuant to Regulation 14A not later than 120 days after December 31, 2016.
Item 11.
Item 11. Executive Compensation.
The information called for by this Item is incorporated herein by reference from the Company’s definitive Proxy Statement for its 2017 Annual Meeting of Stockholders under the captions "Executive Officers - Executive Compensation," "Director Compensation" and "Corporate Governance and Board Matters," which will be filed with the SEC pursuant to Regulation 14A not later than 120 days after December 31, 2016.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
For information regarding securities authorized for issuance under our equity compensation plan, see Part II, Item 5 of this report. Other than such information, the information called for by this Item is incorporated herein by reference from the Company’s definitive Proxy Statement for its 2017 Annual Meeting of Stockholders under the caption "Security Ownership of Management and Certain Beneficial Owners," which will be filed with the SEC pursuant to Regulation 14A not later than 120 days after December 31, 2016.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information called for by this Item is incorporated herein by reference from the Company’s definitive Proxy Statement for its 2017 Annual Meeting of Stockholders under the captions "Corporate Governance and Board Matters" and "Related Party Transactions," which will be filed with the SEC pursuant to Regulation 14A not later than 120 days after December 31, 2016.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information called for by this Item is incorporated herein by reference from the Company’s definitive Proxy Statement for its 2017 Annual Meeting of Stockholders under the caption "Ratification of Selection of Independent Registered Public Accounting Firm - Auditor Fees," which will be filed with the SEC pursuant to Regulation 14A not later than 120 days after December 31, 2016.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)(1) Financial Statements: The following financial statements are included in Item 8 herein:
(a)(2) Financial Statement Schedules: The following financial statement schedule is included in Item 8 herein:
Schedule III-Real Estate and Accumulated Depreciation
All other schedules are omitted because they are either not required, are not applicable, or the information is included in the consolidated financial statements and notes thereto.
(a)(3) Exhibits:
The exhibits listed on the accompanying Exhibit Index are filed or incorporated by reference as part of this Annual Report on Form 10-K.
Item 16. Form 10-K Summary.
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
EXHIBIT INDEX
_______________
*
The schedules and exhibits to this agreement have been omitted from this filing. The Company will furnish supplementally a copy of any such omitted schedules or exhibits to the SEC upon request.
**
Indicates a management contract or compensatory plan.