How would you feel about having the homes in your neighborhood securitized? We have all probably heard the news that the housing market is finally turning the corner, and we could well be on our way to a housing recovery and out of one of the greatest economic crisis of our time. We have also probably heard that, thanks to a select group of investors who are buying up foreclosures that were expected to flood the market and further drive down home prices, home prices have begun an upward trend.
In the last few years there has been a shift in the real estate market as many properties went into foreclosure following the recent housing bubble burst. Scores of home owners who lost their homes did not only leave a huge supply of unoccupied housing, but many suffered a financial blow that left them unable to afford or even qualify for credit to buy other homes. With no place to turn, but still needing shelter, the current rental boom was born.
Given the huge supply of single family homes available in the market, historically small scale investors would buy and rent these properties, but recently there is a new player in the field. The single family rental market has drawn big name hedge funds and private equity firms. The promise of yields as high as 8% compared to a savings rate yield of less than 1%, coupled with programs like REO to rental, introduced by The Federal Housing Finance Agency (FHFA), sent investors hungry for the next big thing scouring for single family rentals. FHFA was looking for ways to reduce the high inventory of foreclosures in the hands of government sponsored entities (GSE’s) like Fannie Mae and Freddie Mac.
In recent months there has been chatter that these big investors were considering the securitization of Single Family Rentals. Securitization as defined by Investopedia is, “The process through which an issuer creates a financial instrument by combining other financial assets and then marketing different tiers of the repackaged instruments to investors. The process can encompass any type of financial asset and promotes liquidity in the marketplace.” (In this case cash flows from rental income would be the asset.)
Wait, have we not heard of this concept before? Leading to the U.S subprime mortgage crisisthere was a rise in subprime mortgage delinquencies and foreclosures, that caused the decline of Mortgage backed securities (MBS) resulting in a global financial crisis. As part of the housing and credit booms, Mortgage backed securities which derive their value from mortgage payments and housing prices, greatly increased. This enabled institutions and investors around the world to invest in the U.S. housing market. When housing prices declined, major global financial institutions that had borrowed and invested heavily in MBS reported significant losses and as the crisis expanded from the housing market to other parts of the economy, there were defaults in other loans and consequently a global financial crisis ensued with total losses estimated in the trillions of U.S. dollars.
According to a report on July 19th in the Wall Street Journal, Potential issuers like Colony Capital LLC and Waypoint Real Estate Group, two major players in the industry, were seeking to create and sell securitized SFR’s to tap outside investors for capital that they in turn could use to expand their businesses. In a follow up article on September 16th the Wall Street Journal reported that Waypoint Real Estate Group had secured a $65 million loans from Citigroup Inc., to help add to its portfolio of homes. The paper also wrote, “The Waypoint deal underlines banks' confidence in the investment strategy and may serve as a precursor to another development in the market: Bankers said they have been hammering out details on how to create the first security backed by home-rental payments.” It is believed that banks would merge the rents of thousands of tenants living in the formerly foreclosed properties and sell to investors a promised return based on the incomes from these rentals.
There are reports that big banks have reached out to the major credit-rating firms about potential securitizations. A report published in August by Fitch, one of these firms, made it clear that its rating will be based on the underlying value of a security’s assets, which will be determined by location, quality of management and the availability of data, and not on price or yield. While it would be easy to establish the viability of a location through data collected by firms like CoreLogic, and management quality could be assured by certification from creditable third party organization, it is not clear just how much data there is to support this operation. The mass investment on single family homes has only recently burgeoned and a firm like Colony Capital LLC has been in operation for less than one year.
In an essay, The Paradox of Securitization, Policy Innovations, an online magazine, outlines how securitization in the early 1980’s served as a vehicle for growth, but how the same model could bring the global economy to its knees when implemented while ignoring the risk of fraud inherent in it. While the risks involved with this seem apparent to many, there are those who seem to think that this will be good business. The question is: should we be concerned that there are some who seem to have quickly forgotten the lesson from the recent global financial crisis? Or should we take comfort that there are those is the credit-rating firms that seem apprehensive to embrace wholly the idea of securitized SFR’s without scrutiny?
Michael Hobbs, SRA, LEED GA, PahRoo Appraisal & Consultancy