January 28, 2014

Tricon Capital Group Inc.

Re-affirm Top Pick post SFR update and U.S. home

price release



First impression:

We maintain our Top Pick rating following discussions with management

regarding the U.S. single family rental (SFR) strategy. We came away

with greater comfort regarding our expectations for growth and outlook

regarding Tricon’s SFR business and that if anything, we believe our

forecasts are more likely to err on the conservative side.

Securitization of SFR cash flows in 2014 remains a possibility with

potential upside to our forecasts coming from: (1) lower funding costs,

as the first ever securitization of SFR cash flows done by a competitor was

completed at almost 200bps lower than TCN’s current debt facility costs;

and (2) potentially freeing up of capital invested in TCN’s SFR strategy that

could be re-deployed elsewhere should Tricon be able to securitize at loanto-

cost that is higher than the existing portfolio.

Usage of free cash flow. We estimate ~$100MM in annual FCF from

the Tricon 9 investment over the next few years (almost $1/share)

and while potential usages of FCF include co-investments in future

separate accounts, private equity fund commitments, dividends and

special dividends, TCN may look to expand into new product offerings such

as manufactured housing, multi-unit residential development and other

opportunities (e.g., student housing).

Other key takeaways: (1) potentially almost 8.5MM homes that could be

acquired in the future for the SFR industry; (2) the automated valuation

model used to value Tricon’s SFR portfolio does have limitations and

likely undervalues the portfolio as it is based on home sales data that is

3-6 months old [U.S. home prices continue to rise] and does not reflect

renovations and/or the physical appearance of a home; and (3) TCN is

looking to acquire 660 to almost 1,000 homes during H1/14 and could

potentially reach 5,000 total homes in the portfolio during 2015.

November 2013 S&P/Case-Shiller data continued to show strong home

price appreciation in almost all of Tricon’s key U.S. housing markets. The

national 20-city index showed home prices were +13.7 % Y/Y but relatively

flat M/M, at -0.1% (see Exhibits 3 and 4 on page 4 for details on Tricon's

key cities). The degree of home price increases should support strong NAV

growth at least in the near-term.

Key takeaways from discussion on Tricon’s single family rental strategy

Sizing the opportunity. There are approximately 130MM homes in the U.S. Tricon estimates

(using data from John Burns Real Estate Consulting) that there are almost 8.5MM homes that

could be potential future supply for the SFR market:

3MM owner-occupied homes that are delinquent and/or in foreclosure;

2MM owner-occupied homes that are 30-90 days in arrears with negative equity;

2MM owner-occupied homes where mortgages are current but have negative equity;


1.3MM vacant homes. Currently there are 14MM vacant homes in the U.S., with 1.3MM

representing the excess amount over the historical average vacant stock.

Tricon’s SFR portfolio overview:

Almost 3,000 homes as of Q3/13;

C$315MM invested (including debt);

80% occupancy rate based on all homes; and

92% occupancy rate based on homes owned 6+ months. This would be slightly higher

but Tricon is renovating a 550 home portfolio acquired in Charlotte on a rolling basis

(renovating ~50 homes at a time with the remaining 500 rented out).

Key points regarding Tricon’s SFR strategy:

In our view, Tricon differs from several other SFR operators as TCN has sought to focus

on achieving attractive cap rates as soon as possible which has resulted in buying homes

much more slowly vs. peers. This allows Tricon to renovate quickly and rent out to new

tenants in short order. As a result, TCN’s SFR business is generating positive net income.

Target buying homes for $100,000 to $150,000, partnering with experienced local


Target 12-13% gross rental yield (annual rent divided by the all-in cost which includes

renovations) and 7-8% cap rates (after vacancy, maintenance and capex reserves) (see

Exhibit 1 below for an example of profitability of a single property);

Alignment of interests with local partners through 3-10% co-investment by local

partners; and carried interest/performance fee potential; and

Acquire 1-2 homes/day (~$3-5MM/month) per city.

Target markets (see Exhibit 2 below):

Tricon has typically looked to operate its SFR business in markets that were particularly

hard hit by the U.S. housing downturn, many of which today have above-average

employment growth. Tricon has also expanded into a market for other reasons, such as

San Antonio (attractive rental yields, positive employment fundamentals with close

proximity to both U.S. military bases and energy plays).

How TCN values its SFR portfolio for its financial statements

Tricon primarily uses an automated valuation model (AVM) to value each home in its

portfolio. While this approach is economical and timely, the main shortcoming in our

view is that it is based on home price data that can be 3-6 months old (i.e., not current).

As well, an AVM model does not take into account the physical condition of a home and

any additional renovations completed (pricing is based on factors such as square

footage, number of bedrooms/bathrooms, etc.).

2014 outlook:

Tricon is looking to acquire 660 to almost 1,000 homes in H1/14, with Atlanta and to a

lesser extent Las Vegas, San Antonio, Tampa Bay and Charlotte being focus markets.

Tricon does not expect to buy homes in San Francisco, Sacramento, Phoenix and LAInland