How To Make A Garden In Front Yard

Tough economic times generally spell trouble for merger activity, especially in the financial sector. For instance, we saw the merger between Simon Property Group and Taubman Centers run aground in June as a result of the COVID-19 crisis.

Front Yard Residential's ( RESI ) potential acquisition by Amherst Residential LLC was another merger that fell apart as the COVID-19 crisis unfolded in the spring. Credit markets had somewhat seized up, financing became hard to get, and uncertainty about the state of the economy was the final nail in the merger's coffin.

Front Yard is now making its way as an independent single-family residential real estate investment trust (REIT). Is it safe to buy stock in the company yet?

Another REIT merger falls apart

In February, after a long sales process, Front Yard Residential announced a deal where the company would be sold to Amherst for $12.50 per share. The COVID-19 crisis hit soon thereafter, and the deal was terminated in May. Amherst agreed to pay Front Yard a cash termination fee of $25 million, to purchase 4.4 million shares at $12.50 per share, and to extend a $20 million loan.

A "for rent" sign in the front lawn of a house.

Image source: Getty Images.

The fundamentals of single-family rentals are strong

Front Yard operates in one of the more attractive spaces in the REIT sector right now: single-family rentals. The COVID-19 crisis has accelerated the move of a growing segment of the population from dense urban cities out to the suburbs, and single-family residences are much more attractive than they had been. With more families in apartments now finding themselves working from home, the extra space in a single-family residence has become a huge selling point. Demand for suburban property is high, and Front Yard is in the middle of this trend.

A serial underperformer

That said, Front Yard has been a serial underperformer. Below is a three-year relative performance chart of Front Yard versus single-family REITs American Homes 4 Rent ( AMH 2.77% ) and Invitation Homes ( INVH 3.84% ). Over the past three years, stock prices for American Homes 4 Rent and Invitation are up 24% and 23% respectively, while Front Yard stock is down 21%.

RESI Chart

RESI data by YCharts

Front Yard's board of directors agreed to pursue strategic alternatives in 2019, which is something struggling companies typically do. The company looked for a buyer, examined terminating its management relationship with Altisource Asset Management ( AAMC -8.21% ), and looked for other ways to increase shareholder value. That process ended with the merger with Amherst. Recently, Front Yard terminated its asset management agreement with Altisource, which will require Front Yard to pay a termination fee of $46 million.

Fundamentals are headed in the right direction

In the second quarter, Front Yard reported rental revenue of $55 million. Revenue rose 1.5% from the first quarter and 6.9% from a year ago. Core funds from operations (FFO) were $10 million, or $0.18 per share. This was up $0.06 from the first quarter of 2020 and $0.13 from a year ago. Funds from operations are a better approximation of a REIT's cash flows than earnings per share. This is because depreciation (a non-cash charge) is a significant expense. Average monthly rent per property was $1,326, and the average change in rent charged was 4.1%. The second quarter was a record for the company, so it is heading in the right direction.

The next year will be stressful

That said, Front Yard has a lot of uncertainty dealing with life after the Altisource agreement and the longer-term trends in unemployment. Given Front Yard's price point, stimulus checks really matter to its tenants. The company suspended late fees (as did most residential REITs) as the crisis unfolded, which depressed revenue. The dividend is suspended and the company has $128 million in debt coming due in the next 12 months, along with the $46 million it owes Altisource. The company holds $109 million in cash. Given all the uncertainty about the company going forward, investors interested in the single-family REIT space should perhaps consider American Homes 4 Rent or Invitation Homes instead.

This article represents the opinion of the writer, who may disagree with the "official" recommendation position of a Motley Fool premium advisory service. We're motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.