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By Ramsey Su

Wall Street Enters the Scene

A headline from Reuters last week: "Blackstone eyes first-ever REO-to-rental securitization". I believe this marks the official arrival of Wall Street in the single family real estate market.

To recap, lets go back to June of 2012 when I thought about The New and Improved Real Estate Investment Model.

The new and improved model is simple. Just like a subprime pool of loans, buy up as many properties as possible, put some lipstick on the pig (aka glossy brochures) and let Wall Street sell it as REITs. They can also securitize the income and voilà, a new round of derivatives is born. Once the fees are made and the syndicators collect their share of the profits, Wall Street can now prosper off the derivatives with no regards to the underlying properties.

This bubble is only in its infancy. The first part has been completed, by that I mean the pipeline has been set up to purchase as many properties as possible. It involves only a little capital from a few fat cats and a few of their back-pocket clients. Blackstone (NYSE:BX) has been receiving the most attention. I understand they are now buying properties for $100 million per month and their property count is close to 20,000.

Next comes putting lipstick on the pig. What does this lipstick-on-the-pig look like? Take a look at this short two minutes promotional video on the Blackstone real estate website. The video is for amateur real estate investors, strictly for promotional purposes. Pros would be wondering what the costs are for all that sod, the fancy kitchens and the thousands of workers which they are hiring. Behind the scenes, a gaggle of MBAs are busy putting on the finishing touches with creative pro forma calculations on how much these portfolios will yield, readying the upcoming offerings. The pig is just about ready for the prom.

The second step is getting the Wall Street machine directly involved. According to the article linked above:

Blackstone is the largest asset manager in the sector, and demand for a securitization is thought to be so strong that any deal could go forward without needing credit ratings.

The new Deutsche Bank loan, upsized to US$2.1bn, includes an original US$600m warehouse facility in addition to investments from eight other banks and securities investors.

The $2.1 billion is nothing, it is just the start of an unlimited pool of revolving funds. More important is that Deutsche Bank, and the eight other unidentified banks and securities investors will be setting up the conduit to pass these products on to the masses. The powerful Wall Street machine has been set in motion. There is now a product that they can spin and sell for years to come. Here is how it works:

1. Buy a product that is not marketable on Wall Street.

2. Assemble and convert the product into something that Wall Street recognizes, such as a bond fund or some income fund. In this case, it can be debt secured by the rentals or debt secured by the income from the rentals.

3. Have the rating agencies stamp their AAAAAAs on the product.

4. Now they become qualified investment products that the suckers such as pension plans and fixed income funds are allowed to hold in their portfolios.

Doesn't this sound a lot like the sub-prime bubble? The only step left is to create the derivatives such as the old CDOs, CDS, then square and cube them to maximize leverage. Can they escape the scrutiny required under the Dodd-Frank regulations? I am sure Wall Street can figure something out in due time.

Why do I call this a bubble? It is mainly because purchase prices are no longer relevant. Wall Street will pay whatever price is needed as long as they can securitize, make fees and sell on for a higher price. In the Southern California market, investors are gobbling up over 30% of all sales, and this is approaching 40% in Phoenix and over 50% in Las Vegas. Over one third of the properties in Southern California are selling for cash, over 40% in Phoenix and over 50% in Las Vegas. In these three markets, investors have been buying roughly 10,000 single family homes per month over the last six months (all data sourced from DQ News).

The Conundrum

The market is artificially supported by bulk investors using OPM (other peoples' money). Interest rates meanwhile are artificially subsidized by the Fed's QE operations. How significant are these forces? In Southern California, investors and the FHA (Federal Housing Administration, ed.) combined account for over 50% of sales, for over 60% in Phoenix and for over 80% in Las Vegas. If I had data separating coastal Southern California versus inland, my guess would be that for areas like Riverside or San Bernardino, the majority of sales are FHA financed or sales to investors. In other words, these two forces are the market.

Here is the conundrum. With these two large forces active in the market, how can real estate values not go up and up? On the other hand, what would happen if these two forces were to disappear, or simply lose their inflationary powers?

The sub-prime bubble needed Joe Six-Pack as the borrower and buyer, regardless of whether Joe could afford it. This new "yet-to-be-named" bubble needs Joe Six-Pack to participate as a rent slave, which is easy to arrange because Joe is already stretched to the limit anyway. One little bump in prices will knock him out from being able to buy a house and he will become one of the Blackstone renters forever. In fact, if Joe cannot even compete at current prices and with incredibly cheap financing, how is the Six-Packs' income going to be sufficient to buy these Blackstone houses in the future at a higher price and higher interest rates? Furthermore, household incomes show no signs of increasing. Regardless of whether he's renting or owning, Joe Six-Pack cannot afford to pay higher housing expenses.

If the two main forces in the market are successful in driving home prices up further, the cap rate is going to come down for investors unless rents increase proportionally. If home prices keep going up, how is Bernanke going to justify the continuation of QE3/4, especially if the housing component begins driving up the inflation rate? We shall soon find out how successful Wall Street is in introducing and maintaining the new and improved bubble.

In closing, I offer this entertaining interview with Stuart Miller, CEO of Lennar (NYSE:LEN). If you believe even a fraction of what he says, then I have a bridge to sell you.

Addendum: A Couple of Timely Follow-up Links

Bloomberg: House Price Gains Signal U.S. Rental Bonanza Ending

“Rents for single-family homes are rising slower than property prices as firms such as Blackstone Group LP flood the market with homes for lease, posing risks to investors betting billions on the burgeoning market.

Monthly payments for properties in Phoenix rose 1.3 percent in February from a year earlier, compared with a 25 percent jump in for-sale asking prices, according to Trulia Inc. (TRLA), which operates an online listing service. In Atlanta, asking prices climbed 14 percent as single family rents gained 0.5 percent, and in Las Vegas rents dropped 1.7 percent even as asking prices soared 18 percent.”

While private-equity firms are helping real estate values recover from the worst slump since the 1930s by cutting the supply of foreclosures for sale, they’re also crowding the market with rentals. Leases for U.S. apartments rose 3.9 percent in February from a year earlier, more than quadruple the 0.9 percent increase for single-family homes, Trulia said.

“Investors are buying homes, in part, to rent them out, and that has added a lot of rental supply, and that’s preventing rents from rising,” Jed Kolko, San Francisco-based Trulia’s chief economist, said in a telephone interview. “It means some investors will start to think about selling those single-family rentals.”

(emphasis added)

[comment by PT: see also our recent comment on the sheep shearing preparations that have been set into motion; someone's going to end up stuck with all these properties ...]

In the meantime, it appears Silver Bay has quite a few houses for rent in Phoenix and Atlanta:

(click to enlarge)

Silver Bay houses for rent in Phoenix

(click to enlarge)

Silver Bay houses for rent in Atlanta

Source: Silverbay Management, Phoenix homes and Atlanta homes, Images via google maps/silverbay.