Tricon: A smart way to play the U.S. housing recovery

Posted on 01-27-2014 07:01
Summary: For Canadian investors, there’s a back door into the U.S. housing recovery, one that might bypass some of the risk.

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For Canadian investors, there’s a back door into the U.S. housing recovery, one that might bypass some of the risk.

Tricon Capital Group Inc. is a Toronto-based investing company that pounced on the U.S. housing crisis, scooping up distressed properties and homes in the markets most afflicted by the crash. So long as the rebound continues, Tricon will profit, as it has for several months. But what set the company apart are its multiple sources of exposure to residential activity, which help to smooth out the risk in what remains an erratic sector.

“I would put this out as a less volatile way to play that trend,” said Jeff Young, chief investment officer at NexGen Financial Ltd. “Typically, you’re going to get a lot more volatility in a pure home builder.”

For the biggest U.S. home builders, last year was a fickle one. D.R. Horton Inc., PulteGroup Inc., Lennar Corp., Ryland Group Inc., Meritage Homes Corp., KB Home – they all followed the same pattern – riding market gains to multi-year highs, before crashing in May.

It was the U.S. Federal Reserve that played spoiler to the sector. When chairman Ben Bernanke hinted in the spring at taking the first step of withdrawing monetary stimulus, those most directly exposed to the U.S. housing resurgence were punished amid fear that the Fed’s move would push borrowing rates up and reduce the demand for new homes.

Between May and August, home-builder stocks fell more than 40 per cent. But Tricon was relatively resilient. Its stock was hit by the same concerns, but the effect was muted, with shares falling 16 per cent. Also, while none of the big U.S. home builders have returned to their pre-loss peaks, Tricon hit a new all-time high closing price of $8.24 on Jan. 10.

The majority of the company’s stock value comes from its co-investments with other investors in U.S. residential developments. The company also has directly built up a portfolio of more than 3,000 single-family homes, which it expects to increase to 4,000 units by the end of this year.

“Tricon’s taken a much more measured approach with their local partners. It’s not just dumb Canadian money coming down and just buying things without really knowing,” Mr. Young said.

Tricon also receives fees for managing a portfolio of assets on behalf of other investors.

“There are three different ways they get exposure to residential real estate. That’s unique,” said Trevor Johnson, an analyst at National Bank Financial, who initiated coverage on the stock last week with a target share price of $10. “The revenues and cash flows are coming from different sources. And the asset-management fees are a little less volatile. They’re not as directly tied to home-price appreciation.”

With a certain degree of diversification within U.S. real estate, the company is not quite as susceptible to market concerns as are the pure-play home builders, Mr. Johnson said.

The same goes for real estate investment trusts. REITs were also hammered last year over the expectation that interest rates would rise. “We believe Canadian REITs are at the end of a 20-year era of exceptional returns driven by declining interest rates,” CIBC World Markets declared in a recent report.

Fundamentally, the U.S. market looks to be the safer place. “Due to the depths of the crash and what that’s done to housing starts, these things tend to overshoot to the downside,” Mr. Young said. “We’re in a rebuilding phase, and I think there’s still a few years of that left.”

Mr. Johnson said he sees Tricon’s assets “growing pretty aggressively” over that period, building up exposure to a healing market, while maintaining a risk profile just a little different from that of the big players.

Geoffrey Kwan, a RBC Dominion Securities analyst, who has a $9.50 target, calls Tricon “the best way to play a recovery in U.S. housing within our coverage universe.”


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