REO-To-Rental Securitizations: Wacky Idea Or Sound Investment?

As former homeowners become renters in droves, corporate landlords and large investors are finding a new way to cash in on the trend. While most entities are generating revenues the old-fashioned way, by buying foreclosed homes and then renting them to tenants, some companies are creating new investment vehicles.

In late October, New York City-based Blackstone Group announced it had launched the first-ever real estate owned (REO)-to-rental securitization and was seeking investors for these instruments. The investment firm created a subsidiary, Invitation Homes, which reportedly purchased more than 40,000 foreclosed homes, which are now rental properties. Blackstone packages the rental income as a security, similar to a mortgage-backed security.
The creation of this investment vehicle makes sense now because of two factors, says Robert C. Hockett, professor of law at Cornell Law School in Ithaca, N.Y. ‘Wealthy individuals are looking for exotic new investment vehicles – something less boring than treasury bills,’ he says. ‘One theory is that demand on the part of the ultra-wealthy is one of the drivers of new financial products.’

Meanwhile, Hockett says, on the other end of the demographic spectrum are consumers who are having difficulty maintaining their standard of living – and are looking for new ways to borrow. Some are not able to obtain credit to buy a home, so they rent, which Hockett explains is similar to a loan because if the consumers do not maintain payments, they lose their ability to live in the property.

‘Economists call this demand coincidence,’ Hockett says. ‘There is demand for new ways to invest, and demand for new borrowing opportunities. A securitized rental product satisfies the top with a newfangled investment and satisfies the bottom, who cannot buy a home.’

Blackstone Group's newfangled investment received a AAA rating from the credit ratings agency Moody's, the investment research firm Morningstar and the risk consulting firm Kroll, according to the Financial Times. Other companies are reportedly developing their own REO-to-rental securitization products.
Hockett adds that one reason why these securitizations are possible is that the country is at an unnaturally low homeownership rate. For years, the homeownership rate was 67% or 68% of households, and during the boom, it was closer to 70%, a level that famously proved to be unsustainable. According to the U.S. Department of Commerce's Census Bureau, in the third quarter of 2013, the homeownership rate was 65.3%, which was slightly higher than the second quarter of 2013 rate of 65.0%.

‘I do think securitized rentals will probably stick around,’ Hockett says. ‘I hope they won't stay big because I hope we will get back to healthy homeownership rates.’

Ron D'Vari, CEO and co-founder of NewOak Capital in New York City, says it's too early to tell whether these securitizations are a fad or are here to stay. ‘It strongly hinges on if REO-to-rental funds successfully transition to permanent single-family-rental operating companies,’ D'Vari says.

D'Vari adds that in addition to buying foreclosed properties and turning them into rentals, the funds can potentially develop properties to rent. ‘Ultimately, they will move from bulk REO purchases to potentially community development or strategic geographic acquisitions,’ he says. ‘Leverage needs to stay modest until longer historical operational data and experience have been accumulated.’
There are risks, D'Vari says. This is not a liquid investment, and investors have to think long term. ‘Securitization and average life cannot be based on short-term exits or flips,’ he says.

Still, the investment looks attractive to certain investors. ‘The equity tranches are clearly held by the issuer/sponsor/operator single-family rental company,’ D'Vari says. ‘The rated senior tranches could be held by held-to-maturity accounts with some knowledge of multifamily securitization. Underwriting banks also could be also interested in holding them in lieu of holding the bank loans to REO-to-rent, especially to the ones backed by well-established private equity firms.’

Nora Caley is a Denver-based freelance writer.


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