An Unusual Way to Profit From the Rental Market Boom

One way to earn large profits in the stock market is by discovering and playing the macro trends in the economy. Think of the Internet revolution and the billions that were made by investors who correctly followed the macro-trend from its inception. Another example is the subprime mortgage crisis of 2008. Hedge-fund manager John Paulson, for example, made billions of dollars by correctly betting against mortgages, spotting the meltdown that was to come. 

In retrospect, the beginning of these examples is easy to spot. It’s much more difficult — but far from impossible — to do in real time. 

#-ad_banner-#The way I spot the macro trends is by paying close attention to the financial and economic news. Notice what subjects are mentioned again and again, and then identify issues that need to be solved within these subjects. Next, find niche companies that are poised to solve the issues inherent within the macro trend. This is exactly how I discovered a gem of a niche insurance product — one from which I think investors can profit greatly. 

The housing crisis has changed many Americans’ opinion on home ownership. Prior to 2008, home ownership was truly the sacred cow of the upwardly mobile. Owning a home was considered priority numero uno for almost everyone. With the great value appreciation and tax benefits, home ownership simply made sense. 

However, this all changed in a few short years. 

Home prices have plummeted in many areas, leaving vast numbers of homeowners upside-down on their mortgages. The homeownership rate has declined from 69.2% in the fourth quarter of 2004 to 65.9% today, according to the Harvard Joint Center for Housing Studies. In addition, 77% of consumers say they think there are advantages to renting compared with owning a home given the current state of the real estate market, independent research firm Harris Interactive has reported. This represents the third straight yearly rise in rental confidence among consumers. 

Talk about the very possible start of a macro trend from home ownership to renting… It’s very clear to me that this shift has started and is still in its infancy, meaning there’s still time for investors to get in early on the trend. 

Once I identified this likely birth of a macro trend from home ownership to renting, I asked myself what issues renters have when it comes to renting a place to live. Personal experience made it clear that qualifying for a lease can be very difficult, even for those with solid credit and decent income. This is particularly true in high-rent cities such as New York. 

In New York City, landlords generally require that a prospective tenant’s annual income be 40 to 50 times the monthly rent, in addition to having great credit. If the tenant doesn’t meet these requirements, then they are forced to either find a co-signer who meets the criteria or look for a less attractive place to live. This is a real problem for countless good tenants who either don’t quite make the income requirements, don’t have U.S.-based credit records, are self-employed or professionals fresh out of school, among many other examples. 

Acting on this critical need of prospective tenants and landlords, Argo Group (Nasdaq: AGII) created a niche insurance product called Insurent Lease Guarantee. Basically, the product provides an institutional guarantee that a tenant will pay their yearly rent. This opens up an entirely new rental audience to landlords and allows many more prospective tenants to obtain their ideal rental housing. 

The way it works is the tenant who does not qualify by the landlord‘s traditional metric pays 80-110% of one month’s rent to obtain the Insurent Lease Guarantee. Insurent then guarantees the year’s rent to the landlord should the tenant default. Obviously, the tenant needs to qualify under the Insurent guidelines, but it is much easier than qualifying by the standard landlord requirements. The service has become a vital part of the New York City rental market and is now accepted by more than 150,000 apartments in the city. 

What an incredible idea! I wish it existed when I was looking for my first NYC apartment. Although the Insurent product is currently only available in New York City, I can easily see it catching on throughout the country as the macro-trend shift from owners to renters continues to expand. 

The company behind this unique niche product, Argo Group, is an international underwriter of specialty insurance and reinsurance products in the property and casualty market. Argo’s U.S. insurance subsidiaries are rated by Standard and Poor’s as an “A-” (Strong) with a stable outlook. 

The company posted strong first-quarter 2012 numbers, with a $48.5 million increase in gross premiums underwritten and tax income of $28.1 million compared with a loss of $96.7 million in the first quarter of 2011. Last but far from least, its debt-to-equity ratio is very low at 0.25 and is currently below the industry average. This reflects the company’s success at managing its debt. Although the Insurent product is presently a small portion of Argo’s success, it has the potential to become the big revenue growth driver in the future.

The company just declared a quarterly cash dividend of $0.12 and offers an annualized yield of about 1.7%. Although this dividend is quite small, I expect to see it increase over the next several years as the Insurent product catches on with a wider audience.

Risks to Consider: Although I think Insurent is a revolutionary product, it’s critical to keep in mind that one product does not make an insurance company. Like any company in the insurance sector, catastrophic risk factors come into play and must be considered prior to investing.

Action to Take –> Argo Group shares have been channelling between $27 and $31. The price has just hit the lower channel line, setting up a solid technical “buy” signal right now for a bounce back to the upper channel line. Should the upper channel line at $31 be broken, I would add to the position. Buying here with stops at $25 makes technical sense.