Over the past few months, I have written about mREITs [Two Harbors (TWO)]and private equity [Blackstone (BX)] getting into the own to rent market (example here and here) which is a compelling, if economically challenging, market.
Saturday night I was reading International Financing Review (http://www.ifre.com - and yes, this is what my life has come to) when I happened upon a story regarding securitizing own to rent properties (i.e. making bonds out of the asset pool).
From the story (available here):
The first so-called real estate owned-to-rental securitisations in the US may be moving forward without credit ratings, as ratings agencies continue to assess how to assign grades to such new and potentially risky products.
In the planned deals, real estate investors would buy up blocks of foreclosed properties and rent them out to borrowers who were displaced by their inability to pay their mortgages. The rental payment streams - and possibly the proceeds from eventually selling the properties - would provide payments to bond investors.
The implications of this type of securitization are both significant and compelling. Think of the following:
- Securitizing bank inventory. With all the properties held on bank balance sheets, renting them instead of selling them and being able to securitize the transaction is compelling. This type of transaction could reduce the other real estate owned (OREO) and free up capital. If the bank then retains the servicing, the fee income is also compelling.
- Investment firms such as Blackstone and KKR (KKR) could buy up property packages from the GSEs, tranche the securitization and retain the slices (equity and subordinate) that have higher returns and could be retained or included in collateralized debt obligation (CDO) product.
Fitch has done an initial report on the sector. Included in their report are:
SFRs (single family rental) May Narrow Inventory Gap: Fitch estimates that, just in the non-agency sector alone, distressed inventory (loans 60 days or more delinquent) totaled 1.13 million in June 2012, while government-sponsored entity (GSE) delinquencies of 60 days or more plus real estate owned (REO) inventory as of the end of first-quarter 2012 totaled roughly 1.3 million units. Given current house price conditions, tight underwriting guidelines, and elevated unemployment levels, inventory absorption by potential homebuyers is likely to be insufficient. SFRs can narrow the gap until conditions improve while providing displaced families with a comparable alternative.
Rating Caps Likely: Fitch has identified several performance/data issues that are likely to result in the imposition of a rating cap for SFR transactions. Chief among these is limited performance data for the sector and individual property management firms. Historical data for market rents, rent roll histories, vacancy rates, and supply and demand are also limited. Although some firms have a few years' operating history, most do not have a proven track record managing in a down cycle, outside their footprint, or on a large-scale basis. This concern is further heightened by ambitious growth strategies by regional operators looking to expand their portfolios rapidly over the near term, which will make it unlikely that Fitch will consider high investment-grade ratings for initial SFR transactions.
Bottom Line: Securitizations in the own to rent market could help attract investors into distressed real-estate and single family home package sales by the GSEs. As bonds, assuming that they are suitably over-collateralized and debt service coverage stays well above 1:1 in stressed situations, these could have multiple end markets. These would be somewhat of a hybrid between RMBS and CMBS and the pricing could be very attractive (due to the higher risk and the limited history). This is a development that has to be monitored as its implications are widespread.
Additional disclosure: This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.