The Newest Trick In The Book: Rent-Backed Securities

 |  Includes: BX
by: Daniel Huang


Financiers have created a new real-estate derivative.

The rent-backed security is an investment vehicle that bundles together rental payments with mortgages on the underlying properties as collateral.

Since its inception by Blackstone last fall, it has quickly become one of the hottest new products on Wall Street.

However, old pitfalls have not been addressed and new dangers pose additional risk.

Poor Charlie Brown. Every year, Lucy convinces him to kick the football, and every year, she pulls it back at the last moment, sending him flying. The American finance industry, it seems, suffers from the same myopia.

A decade ago, the surge in popularity of mortgage-backed securities, in which hundreds of mortgages are packaged together and sold to yield-starved investors, fueled the collapse of the housing market and triggered a global financial crisis.

Wall Street is now back at it again, unveiling its latest product: the rent-backed security. Last fall, Blackstone (NYSE:BX), a private equity firm, bundled rental payments from 3,207 single-family homes to create a $479 million bond, the first of its kind. Offering mortgages on the underlying houses as collateral, it drummed up six times as much investor demand as it could accept. Roused by this success, competitors have already announced they are developing similar products. Bankers estimate such deals will eventually grow to $20 billion a year. A whole new industry may be on the rise.

First-time renters have grown ten times as fast as homeowners since 2005. Indeed, many Americans are still spooked by plummeting house prices from the subprime mortgage crisis. Others find it increasingly difficult to meet new loan requirements. Last summer, the median rent for vacant units reached an all-time high of $735 per month.

Firms have leapt at the opportunity, snatching up more than 200,000 cheap, foreclosed homes in the past two years. Last April, Blackstone bought 1,400 houses in Atlanta in one day. The buyout firm is now the largest landowner in the country.

Proponents of rent-backed securities argue that the billions spent on property have boosted recovery and raised housing prices. Securitization adds further liquidity by enabling investors to limit risk and access cheaper financing.

However, these assurances sound suspiciously familiar. In 2005, then Fed Chairman Ben Bernanke made the regrettable blunder of calling the housing bubble "a pretty unlikely possibility." Similar expectations dominate the market today. Unable to resist the lure of high returns, greedy buyers willing to gobble up untested housing exposure risk replaying the chain of events that caused the crisis last time.

Then, there is the issue of managing the properties itself. In 2012, Blackstone formed a subsidiary, Invitation Homes, to fill this role. According to numerous tenant-filed grievances, it is anything but. Reports complain of cockroaches, unaddressed maintenance requests, and even larger structural issues. Meanwhile, an even larger problem looms. Poor management is the primary cause of vacancies, and empty units eat away at an investor's promised return. If Blackstone, or any other property owner, is ever pushed to default, thousands of families may get evicted, even if they have never missed a month's rent.

Like Charlie Brown, the Wall Streeters behind these rent-backed securities are blind, both to their failures in the past and the warning signs in the present. Enamored by the slim prospect of success, they are convinced that this will be the year they finally kick the ball out of the stadium.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.