Insiders are selling, and that could spell trouble for one of the most important markets in America.
The logic goes like this: Nobody knows the future of their business better than the corporate insiders.
Corporate insiders are the CEOs, CFOs, board members, and officers of a company. They know what’s happening to their business.
When the business cycle looks like it’s getting better, they will buy their company’s stock. When business is looking bad, they will dump shares like there’s no tomorrow.
Maybe you remember the ImClone insider selling scandal from 2001, the one that sent Martha Stewart to jail…
In this case, ImClone insiders knew that their blockbuster drug, Erbitux, was going to get rejected by the FDA. They also knew the announcement would crush the stock price. So, in the days before the FDA’s decision was announced, insiders dumped over $15 million worth of stock.
It was discovered that the CEO told Martha Stewart she should sell her stock, too. She went to jail for insider trading.
ImClone was an egregious example of illegal insider trading. The insiders were acting on specific information that wasn’t yet public.
But most insider selling isn’t illegal, even if the insiders know more than the average investor.
That’s why it’s a good idea to pay attention to what they are doing.
Insiders and the Financial Crisis
The housing crash in 2007/2008 and ensuing financial crisis is a great example of insider selling.
Think about it…
Banks were using incredibly lax standards to issue hundreds of billions’ worth of loans to risky borrowers.
They then packaged those loans as high-yielding mortgage bonds (mortgage-backed securities) and sold them to hedge funds, pension funds, and other banks.
The sellers knew those mortgage bonds were highly risky, just as they knew the loans they had made were risky. That’s why they sold them.
Now, this may seem like a pretty extreme example, but it’s not. Remember, Wall Street’s goal is to buy low and sell high.
So any time Wall Street starts selling, it’s a good indication that the price is high, and the insiders want to take their money off the table.
Right now, Wall Street is getting its money out of one particular asset class: housing.
What These IPOs Mean
You may recall back in the financial crisis days, several funds sprung up for the purpose of buying foreclosed real estate on the cheap, anticipating that those homes could be resold later for a profit.
Well, those home are now being sold — though not in the way you might expect…
On July 31, 2013, a company called American Homes 4 Rent (NYSE: AMH) held an initial public offering of shares at $16 a share. The company had hoped to raise $1.25 billion at its IPO. But demand for the shares wasn’t strong enough, so it had to “settle” for $706 million.
Now, American Homes 4 Rent was the brainchild of billionaire B. Wayne Hughes. He made his fortune with Public Storage (NYSE: PSA). Hughes still personally owns around 65,000 shares worth close to $10 million. And an entity called “B. Wayne Hughes Et Al” that I assume is a trust fund has sold around $48 million worth of Public Storage shares in the last 18 months.
Anyway, over the last few years, American Homes 4 Rent spent $3.4 billion to buy 19,825 single-family homes. Its plan is to rent the homes to generate revenues.
As of its latest earnings report, June 30, 56% of its houses were under lease. It lost $14 million in that quarter. Analysts hope the company can make $144 million in 2014.
By virtue of the IPO, American Homes 4 Rent recouped $706 million of its investment by selling stock to the public. Of course, before the IPO, the company sold $1.2 billion worth of shares to institutional investors.
So, of the $3.4 invested in single-family homes, it’s already gotten $2 billion back. And more is on the way…
On Monday, September 30, insiders will be eligible to sell shares on the open market for the first time. Three months after that, another lock-up period will expire, and insiders will dump shares again.
And AMH isn’t the only business like this. There’s Silver Bay Realty Trust (NYSE: SBY), which ran as high as $22 after its IPO, yet currently trades for $15.50. And there’s American Residential Properties (NYSE: ARPI), which went public at $21 and has fallen to $17. And Blackstone (NYSE: BKX) spent $5 billion on 32,000 homes, and is planning to cash out with an IPO sometime soon.
The Housing Recovery that Wasn’t
Obviously, investors haven’t done too well with these home rental stocks.
And there’s a good reason why…
The housing recovery we’ve seen in the U.S. isn’t all its cracked up to be.
For one, Bernanke’s low interest rates have helped fuel demand. And two, investors like the Blackstone and others make up as much of 25% of the recent homebuyers.
But now that interest rates have started to rise, fewer people are buying. And Wall Street is getting out.
If you’re thinking about buying a house, wait a few months. Prices are going to come down.
And don’t buy what Wall Street is selling.
Until next time,
Until next time,
Briton Ryle
@BritonRyle on Twitter
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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
