May 2015

12  May 2015                                                                                                                                                                                PDF version available here1st quarter 2015

Dear Investor, 

US Residential Fund (ASX: USR) is pleased to release its first quarterly update to investors since listing on the ASX on 12 February 2015.  

US Residential Fund (USR) provides investors with an opportunity to gain exposure to the US residential property market.  The fund currently has a portfolio of 161 established rental houses in three states (Texas, Georgia and Ohio).  The investment objectives of the Fund were set out in the Offer Document and include expanding and diversifying in the US residential market through direct and indirect property investments, utilising both debt and equity instruments to facilitate the transactions.

Portfolio efficiencies  

During the Initial Public Offering, it was flagged that we would seek to improve the operational efficiency of the property’s management, through the merging of three portfolios’.   As part of the streamlining of processes, the Fund has agreed to have the majority of single family home maintenance and renovation requirements undertaken by HomeStar Field Services LLC, as preferred contractor.  

HomeStar Field Services LLC (HomeStar) www.homestarllc.com is a member of the HomeStar Family of Companies, which as part of their comprehensive suite of offerings provide property preservation, rehab, maintenance, inspection, environmental remediation, code compliance and hazard insurance claims on a national basis.  HomeStar’s clients have included listed single family REITs, Government Sponsored Enterprises (ie Fannie Mae, Freddie Mac), banks, realtors and investors.

HomeStar, will renovate properties and make properties ready for rent in between tenants, execute tenant maintenance requests, and provide a capital works plan for the single family homes held by the Fund. 

In the coming months we expect that the Fund’s single family home asset manager will co-locate with HomeStar in their Dallas offices. This co-location should further improve communication between the asset manager and the field maintenance teams, thereby improving asset efficiency. 
Single family home strategic repositioning

We believe the US residential property market’s recovery continues to presents opportunities to make capital gains by engaging in strategic single family home repositioning for the US rental market.  Typically this consists of properties that may have been neglected or foreclosed houses in sought after neighbourhoods.  Once repositioned, these properties have increased home buyer appeal. 

The Fund is pleased to announce that it has co invested in a Joint Venture Special Purpose Vehicle (SPV) designed to take advantage of single family residential repositioning opportunities.  The SPV will be a Joint Venture with a subsidiary of the HomeStar Family of Companies.

The SPV will have the direct involvement of the HomeStar Family of Companies, who provide significant experience and industry networks. HomeStar  understands the requirements of private and institutional investors having amassed over twelve years’ experience in the housing and construction industries and with a  general contractors’ license. HomeStar  brings an extensive background in real estate acquisition, building and renovating and environmental hazard remediation.  This places the SPV at a competitive advantage when it comes to acquiring, renovating and selling to home owners.

The Fund will contribute two thirds of the equity required by the SPV with the HomeStar subsidiary contributing the other third. The SPV will raise debt in order to supplement the committed equity and enhance returns. 

The projects will be managed by the Fund through its established management arrangements and target a return on equity after costs greater than 12%.  

The project management team will be specifically incentivised by the Fund to identify and manage the repositioning strategy and process. The Fund’s project management team has effectively managed the repositioning of many of the Fund’s current assets over the last four years. They have developed systems and processes to efficiently and effectively undertake these transactions from identification of assets through to sale. Part of this process has required the development of strong networks of service providers such as title agents, attorneys, insurers, and realtors.

The Fund through its management arrangements will control all aspects of the financial transaction and project management.
The SPV is currently reviewing a range of possible assets for acquisition and we expect to be in a position to make an announcement about specific assets. 
Sector commentary

US Economy Watch: When Will Interest Rates Rise?

Residential property fundamentals in the main are in good shape across the United States, businesses are in the main stable, the unemployment trend is down, lenders are returning to property markets and foreclosures rates are falling. There is a growing expectation that interest rates will not go up this northern summer. Our expectation based on current data and our time spent in our key markets is that US interest rates will not significantly increase over the 2 years.  We also expect that when increases in official rates eventually occur that they will not significantly impact on the growth occurring in the US property market which is being driven by the increasing volume of cash available for investment by corporates and individuals seeking returns above those offered by US official interest rates. 

Inflation remains stubbornly low, and whilst this isn’t a positive for the economy or the health of real estate markets; the low interest rates are the continuing overriding driver providing opportunities for real estate deals. 

Recent severe weather conditions, which are not unusual in the first quarter, have had the usual short term impact on the economy reflected in the low wage and GDP growth. The home adjacent is an asset of the Fund in Cleveland, photo was taken in March.

Rental markets

In general, rental markets have been strong for several years. Even though new construction of apartments has been running at a robust pace over the past two years, the provision of rental accommodation has not kept pace with accelerating demand. 

Accelerating demand, falling unemployment, and rising rents are rising in key markets has been exacerbated by no significant rebound in home ownership. 

Indeed in many places single-unit properties are being converted into rental complexes. Rental vacancy rates are at the lowest levels since 1994. With robust job growth new household formations are accelerating, showing strong gains in the renter households.
Our markets

The Fund invests in four metropolitan markets in Texas, Georgia and Ohio. During our time in these key markets we made the following observations.

Dallas-Fort Worth, Texas 

In Dallas-Fort Worth the drop in oil price has tempered momentum, even though  the greater Dallas-Fort Worth Metroplex’s diversified economy will still record strong job growth in 2015, which is expected to continue to drive renter demand and keep vacancy at historically low levels.
Financial services firms including State Farm, TD Ameritrade and Liberty Mutual are growing in northwest Dallas and plan to add thousands of jobs over the next few years, helping to drive these residential markets.  

Strong economic growth will persist throughout 2015, feeding optimistic outlooks for the Metroplex. 

Houston, Texas

The Houston economy has diversified significantly away from its dependency on the energy market in recent years. On our recent visit to Houston, it was apparent that there is significant infrastructure and construction underway. 

The sheer geographical size of Houston and its increasingly congested freeways are driving urban consolidation.   While downstream industries such as petrochemicals and refining will benefit from lower oil prices, the growth in this segment of the energy market might not be enough to rising unemployment in the energy sector and job growth is expected to moderate over the year. 

That said the general consensus is that Houston’s job market will slow from being one of the fastest-growing in the nation, to one that achieves just national average growth rates. Moody’s Analytics is forecasting that Houston’s 2015 job growth will be about half of what was previously expected, but still viable enough to produce an estimated 63,000 new jobs in 2015.

Atlanta, Georgia 

Accelerating rental demand in Atlanta is being driven by employment growth which shows no signs of slowing as the metro continues to enjoy a strong influx of corporate relocations and expansions led by Comcast and Mercedes-Benz. Rental vacancy remains below 7 percent. 
This demand has pushed up rents, where shopping and employment hubs are within a short commute. Motivated by generationally low borrowing costs and rent increases more than triple the rate of inflation, investor activity is heating up all over the metro. 

Average effective rents continue to rise in the Atlanta metro area because of strong population growth, and demand is set to outpace supply even with new construction activity remaining robust.

Strong property fundamentals and vigorous investor interest in Atlanta will continue this year, causing transactions volumes to rise. Demand outweighs available supply in most urban markets, and low interest rates are providing cheap leverage for well-capitalised investors and this may provide some opportunities for the Fund.

Cleveland, Ohio

For many years a butt of jokes, Cleveland, is experiencing a thriving rental demand and a renewed focus on development.

This year the metro gears up for the 2016 Republican National Convention. Employment expanded every quarter over the past year as development activity and corporate growth underscored strong job creation in construction and professional fields as a result rent has increased at a rate above inflation while vacancy levels remain just below 4% metro wide.

While political conventions come and go, Cleveland is on the comeback through a technology led recovery. As young people sick of high prices in the big city look for more manageable places to live and cities capitalise on attracting a new generation of employers with the internet allowing companies to locate in lower cost regions.

Cleveland is accordingly well positioned with its new strengths rooted in medical device companies, largely because of the Cleveland Clinic, which started doing heart research and married manufacturing and health sciences. Cleveland is beginning to return to population growth and is attracting highly educated residents. Cleveland added 40,000 people with college degrees from 2006 to 2012, with 41% of those gains in the 25 to 34 year old age group. 

Hiring activity remains robust in Cleveland as employers added 14,500 jobs over the past year. Job creation in the first quarter totalled 2,500 new positions which is a 1.3% increase year over year.

Growth was especially pronounced in the professional and business services sector, which posted 7,300 additional workers this past year. This is assisting in producing robust development activity and boosted hiring in construction, with more than 2,000 jobs. 

All of this builds upon the ongoing development of the Cleveland Clinic and medical precinct. Health care in and around Cleveland which has attracted some 700 biomedical firms, including, Philips Healthcare, Steris and Invacare. 

Prime renter cohorts are focusing on areas of urban redevelopment where the population can live-work-play  This is  driving vacancy lowest in core downtown submarkets and leading developers to repurpose office buildings into much needed rental apartments. 

Investors are showing strong  interest in Cleveland residential property.  Investor demand will continue unabated in 2015 as operations remain strong and underlying market trends show improvement.

Summary

Our period since listing has been very active for your fund, with our joint venture and strategic relationship with the Homestar Family of Companies anticipated to provide the fund with attractive new opportunities. We remain positive on the US property market which we believe will continue to provide us with strong residential market opportunities.

We look forward to keeping the market updated with the progress and initiatives being undertaken to deliver attractive shareholder returns as our activities progress in the coming months.