A company in Florida wants to change the way REO-to-rental deals are rated.

It's notable considering investors think REO-to-rental will be a big deal in 2014.

Single-family rental properties are houses that are owned by real estate investors and operated for their rental income. These investors can be individuals or companies. The single-family rental market is dominated individual “mom and pop” investors.

But private equity firms started buying single-family rental properties in late 2011. They aggregate properties in to investment pools. 

It’s also a growing asset class for institutional investors.

Right now, a small outfit out of Florida says ratings companies are looking at REO-to-rental using the same standard approach as they use for CMBS evaluation: establish the sustainable net cash flow, asset value, debt service coverage and LTV under a range of stress criteria. Then calculate the probability of default and potential losses for the security during its term and on maturity.  

CMBS backed by single-family assets are difficult to evaluate due to the lack of historical data for individual properties and the asset class in general.  

Enter Visulate.

The company developed a computer-based model to address the lack of historical data.

“What we want to do is offer a new and better way to evaluate REO-to-rental as an asset class,” said Sue Goldthorp, a broker with Visulate.

Most CMBS ratings methodologies start by calculating the NOI and sustainable net cash flow for each property. A cap rate is applied to the NOI to establish the value of each property and then a series of stress tests are applied to determine the sustainable net cash flow, debt service coverage and leverage level under a range of scenarios. These are used to determine the default probability during the term of the security and on its maturity. An estimate of the loss given default is calculated and used to identify the probable loss for each of the scenarios.

“All of these calculations drive off the sustainable net cash flow estimate. This value can be produced with a reasonable degree of accuracy for most types of commercial property. A typical securitization will involve a relatively small number of properties. A detailed analysis can be performed on each one.  Most properties will have historical performance data and any that don’t can be compared to similar properties that do,” she said.

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