“Expanding into geographically diverse markets has challenges, in particular for large, institutional players,” reads the November 2013 feature coverage.
And now in the third dedicated feature to the emerging single-family rental bond market, the next phase of single-family rental financing may have found a way to overcome that lack of breadth in the market.
After successfully introducing the large-loan single-family rental backed bond to the capital market, the next phase of growth will target the backbone of single-family rental investors: the small and medium-sized, local players.
Traditionally, single-family rentals has been a stable, albeit fragmented part of the U.S. housing market, primarily led by small-to-mid-size local operators. But the success of the institutional investor over recent months has opened the capital markets door to small-to-mid-size players.
These smaller level operators, which traditionally didn’t have the scale to access the capital market, today can, for the first time ever, tap non-recourse financing. The loan is secured on collateral cash flow and not the borrower cash flow. The product is driven by a capital markets exit strategy.
Lending programs include both small and middle-market loans ranging from as low as $500K to up to $100 million. Typical terms include 5- to 10-year maturities, 30-year amortization schedules, and up to 75% LTV ratios or higher in some cases. Rates vary depending on sponsorship/borrower.
“These borrowers,” said Beth O’Brien, who leads Colony American Homes’ single-family lending unit Colony American Finance, “are experts in their local markets. What they are not experts at are CMBS.” O’Brien spoke on a panel last spring at a single-family rental conference hosted by Information Management Network.
Colony American Finance offers the non-recourse loans that, for the first time, give these smaller players the ability to build scale. “That level of operator never had access to non-recourse financing before and to the extent that we get it right, it really has the potential to revolutionize the way people can invest in this market,” explained O’Brien in an interview with HousingWire.
B2R Finance set up shop in 2013 to capitalize on the market growth. The company was formed with funds managed by Blackstone Tactical Opportunities. B2R’s products are tailored to serve investors with portfolios of five to 500 homes nationwide. Among its financing products, the company provides non-recourse type rental home financing primarily to small and medium-sized customers looking to buy and renovate portfolios of rental homes.
Although the market for financing on rental homes already existed, either through GSE loans or local private-money capital, these options limited the growth potential of portfolios. The more traditional forms of financing were underwritten on the individual asset and on the individual taking up the loan, very similar to owner-occupied mortgage loans.
“It is not a product that has worked well for operators,” said John Beacham, president of B2R, while speaking at IMN’s spring event. “They have used it because it existed,” he explains, “but having to rely on personal income is difficult and means you’ll be tapped out sooner.”
Local operators have also had the option to borrow from the local, community bank — though these banks are not set up to do large amounts of lending and often don’t have permanent capital allocated for lending in the single-family rental home space.
The non-recourse loan, on the other hand, is underwritten on the cash flow coming off of the assets, like a multifamily loan transaction. Fitch Ratings also outlined some of the refinance risk with the underlying collateral in a report titled: U.S. single-family rental deals face higher refinance risk.
“Unlike traditional RMBS loans, SFR transactions do not fully amortize, exposing issuers to term as well as maturity risk. Term default risk is mitigated by the currently low interest rates and interest rate caps,” the report states.
“However, loans with balloon payments will default at maturity if not refinanced. To refinance, secured lenders expect property cash flow to cover expected principal and interest payments.”
Question of scale
At Colony, the original product that the company offered was a five-year fixed rate loan that was similar to the loans in the single-borrower securitizations, but scaled to an even smaller borrower. The loans don’t go below five homes, but Colony will do as low as $500,000 (as long as there are five homes in the portfolio) and can go up to $100 million. At $100 million, borrowers should be able to access the capital markets directly.
The focus, explained O’Brien, is on the whole market that can’t access institutional money.
B2R offers a similar financing program, which includes loans that target small and medium-sized customers looking to buy and renovate portfolios of rental homes. The product offered includes fixed and floating rate, five-year loans.
The industry has been trying to tailor that even more toward what would be a conduit product in CMBS, and in a short period of two-years, evolved to also offer 10-year products, which mirror the CMBS conduit 10-year products.
“The product addresses all of the protections that you would expect to see in a CMBS loan, such as cash management and property management requirements, adjusted for size. This really is about getting the ultimate bondholder exposure to more than one property management team and multiple geographical locations,” said O’Brien.
Anny Huang, a partner at Sidley Austin who spoke at the IMN Spring event, said the biggest point of tension for operators looking at non-recourse financing is cash management. These players may have been used to getting individual, monthly rent checks in the mail and now, under a non-recourse structure, they have to get used to doing business with cash-control accounts.
This means the large volume of payables and receivables go through one account, audited daily.
By contrast, in a CMBS, there is an expectation that the rental receipts collected are always kept separate from the funds for expenses and payment of operations.
It is one of the factors that allows Colony and B2R to underwrite borrowers on their rental income and not, as the GSEs do, on the borrowers’ personal income.
Rating multifamily
Several of the ratings agencies have looked at the multi-borrower structure and expect it to develop. In May, Morningstar issued a report and stated that the structure introduces new risks that need to be mitigated before Morningstar can rate a securitization. Examples of additional risks include: inconsistent tenant underwriting, strength of data quality/investor reporting, strength of cash management, incentive misalignment/cost basis versus advance rates and ongoing operational oversight.
Moody’s also printed a report in May highlighting similar concerns. “The transaction sponsor’s role in managing the operational issues in multi-borrower SFRs will be critical. A lack of standardization in property maintenance and information reporting among borrowers will increase uncertainty about loan performance and make the credit assessment of the SFR more difficult.”
However, the ratings agency stated in the report that multi-borrower SFR structures are likely to “exhibit less default volatility” than single-loan deals. “Loans in multi- borrower SFRs will be more likely to default than loans in single-borrower transactions because of the larger number of borrowers represented in the pool, but the rate of default will not be 100%, as is the case when the lone borrower in a single-borrower transaction defaults,” the ratings agency noted.
The multi-borrower structure mitigates some of the risks present in large loan deals because it has less geographic concentration and offers buyers exposure to markets nationwide, across many local operators. Buyers get the diversification you would see in a conduit loan vs. a single-borrower loan.
Institutional buyers, those behind the recent single-borrower deal, on the other hand, have a more specific focus. That has limited the markets that they will buy in and therefore limits the geographical diversification of loan pools.
The portfolios backing the eight single-family rental, large loan securitizations come mainly from a relatively small set of metropolitan areas; 27 MSAs account for virtually all of the properties, according to an August Deutsche Bank report.
Just five areas — Atlanta, Chicago, Dallas, Las Vegas and Phoenix — account for an aggregate 44% of the properties.
“These areas were among the hardest-hit areas in terms of price declines and foreclosures, which made them good prospects for higher rental demand and home price appreciation,” stated Deutsche Bank analysts in the report.
The recent Silver Bay 2014-SFR1 transaction stands out from the rest of the securitization portfolios with 73% of the properties located in just three MSAs in contrast to 60% for the American Residential deal, and between 30% and 40% for the other deals.
In three of the most heavily-invested areas — Phoenix, Tampa and Riverside — yields have fallen two percentage points in the last two years while prices have gone up. Yields in Las Vegas — another investor hot spot — have fallen four percentage points. There is some consensus among players in the space that if the multi-borrower structure can work out the risks associated with the asset class and securitization becomes a sustainable form of funding, the market could grow to see $15 billion of issuance per year.
On the large-loan single-family rental securitization side, five firms have completed eight securitizations for $4.4 billion (seven so far in 2014 alone, for $3.9 billion), lowering the financing costs for the issuers. Next year, securitization volume is expected to reach $10 billion, according to Deutsche Bank.
The six largest institutional investment firms have purchased some 115,000 houses for $18 billion (Figure 1), up from 75,000 and $13 billion a year ago. Growth is continuing, but at a slower pace as the stock of distressed properties is lower and foreclosures in the judicial states take longer. Some firms are purchasing nonperforming loans as an alternative source for discounted properties.
Pricing on deals has also been executed incredibly tight. On the early single-loan securitization deals, pricing spreads tighten by 10 to 15 basis points inside of guidance to the point that deals were priced on top of CMBS pricing.
In later deals, spreads have widened on the back of more conservative investment and tighter underwriting criteria. But still, the asset class has been well received in the securitization market because it taps a wide investor base composed of CMBS, RMBS and corporate buyer.
“The theme across the buyer base is consistently they see a housing recovery happening but no real access to the asset class,” said Ryan Stark, managing director of Deutsche Bank, speaking at the IMN conference.
The multi-borrower, single-family rental securitization may become a permanent fixture of American finance, with the potential to issue as much as $20 billion a year, according to Stephen Blevit, a partner at Sidley Austin.
The volume will largely be a reflection of what is available in the non-agency market as it comes back to life because historically, the smaller players have financed through the subprime or alt-markets.
“Either way, the product will find its way to securitization. It’s just a question: does it find its way through a conduit type of deal or blended into some sort of a residential mortgage backed deal?” Stark said.
