Second REO-to-rental deal to raise millions, and questions
Lots and lots of questions
With Bloomberg breaking news Tuesday night that American Homes 4 Rent, the nation’s second-largest single-family landlord, has tapped Goldman Sachs (GS) to arrange a bond backed by house rental payments, it looks like REO-to-rental as an asset class is here to stay a while.
The deal announcement comes just a few months after Blackstone Group (BX) spent the past two years building an expansive portfolio of single-family rental homes via subsidiary, Invitation Homes, spending $7.5 billion to acquire 40,000 houses. Blackstone then packaged rental income from single-family homes into a pass-through security, which is functionally not unlike a mortgaged-backed security.
Moody's Investors Service(MCO) provided a credit analysis for Invitation Homes 2013-SFR1, an REO-to-Rental securitization, awarding $278.7 million in triple-A ratings.
Goldman Sachs started coverage on American Homes 4 Rent at a neutral rating and a price target of $18, reports say. American Homes 4 Rent has spent some $3.5 billion to acquire more than 21,000 rental homes.
With millions of homeowners who lost homes to foreclosure and millions more unable to meet new lending requirements, the home rental market is seeing a lot of demand, and investors see a lot of potential for growth in REO-to-Rental if it can be made viable.
News of the American Homes 4 Rent deal has prompted skepticism for a number of reasons.
Rick Sharga, executive vice president at Auction.com, said as an operation, REO-to-rental is solid.
"I think the death of the REO to rental movement has been greatly exaggerated. There will be an unusually high demand for rental properties in the next few years, and investors playing in the space are meeting a need," Sharga said. "A lot of people either don’t have cash for down payment or can’t meet lending requirements or are not comfortable buying now. REO-to-rental is not exactly a new idea. Individual investors have been doing it forever. It’s just we’ve never seen it on a national scale."
Private equity firms and real estate investment trusts have purchased nearly 200,000 homes across the United States.
Sharga doesn’t expect to see the pace of acquisitions, heavy in 2013, to continue at the same rate in 2014. Sharga is more skeptical of REO-to-rental as an asset class.
"I’m a little confused how this is becoming an asset class with ratings from agencies that have nothing to rate them on," he said. "Right now we have, at best, maybe a year’s worth of rental activity and I’m curious how you come up with a AAA rating with less than a year’s worth of history. But I’m not expecting we will see rental rates crash anytime soon. Probably it’s a safe bet."
Vincent Fiorillo, global sales manger at Doubleline Group, said his only problem with the Blackstone deal was the pricing. He is not wary of REO-to-rental as a class.
"We didn’t think it was a bad deal but it didn’t strike the right balance," Fiorillo said. He hadn’t seen the numbers on the American Homes 4 Rent at the time Housingwire spoke to him Wednesday.
The American Homes 4 Rent and REO-to-rental securitization did not look so good to at least one lawmaker, who seems to be making this his personal crusade.
"The deal between Goldman Sachs and American Homes 4 Rent further illustrates the need for Congressional hearings and regulation on rental backed securities," says U.S. Rep. Mark Takano, D-Calif. "This second deal shows a clear pattern for investment groups who are looking to gain from these questionable financial instruments and I hope that the House Financial Services Committee will take action on the letter I sent last week calling for oversight."
"The Financial Services Committee can help resolve unanswered questions about these new bonds and the impact they may have on the housing market," Takano said. "Proper oversight of new financial innovations is key to ensuring we don’t go down the same road of the unchecked sub-prime mortgage backed security, and create an unsustainable bubble that will wreak havoc when it bursts."
Takano says rents are partially rising because purchasing a home has become much more difficult for non-investors, who must finance the home and are subjected to tighter credit markets.
"If you’re bidding against a cash rich investor for a property it’s going to be hard to beat them," Sharga said. "That’s just a fact. And I have questions that those on the (economic) margins will qualify for mortgage under the new rules anyway. I saw a report yesterday that says something like 38% of minorities don’t have the 43% debt-to-income required. So they would be renters anyway."
Takano said that he is also concerned about how the asset will perform and what effect a downturn will have on communities.
"It’s unclear how these new financial products could react to a downturn. If vacancy rates rise or renters are unable to pay their rent, Blackstone and others may be forced to sell off vast amounts of property to make their investors whole. Selling a large amount of properties quickly would not only deprive renters of their home, but destabilize the market for homebuyers and send housing prices into a freefall," Takano warned.