Institutional SFR players are stuck in the doldrums

A major lawsuit, a sluggish securitization market and a shortage of housing for-sale are among the woes plaguing a sector that only last year was seen as a Wall Street darling

The largest institutional single-family rental (SFR) operator in the country, Invitation Homes, is in the hot seat over its alleged failure to comply with building-permit requirements for rental properties it owns in California.

Another larger player in the space, Progress Residential, recently postponed a securitization transaction due to difficult market conditions. And yet another big force in the market, FirstKey Homes, is pulling collateral out of a 2021 securitization deal.

These developments—and more—can be seen as cracks in the armor of a housing-industry sector that rose out of the ashes of the Great Recession and grew to become a thriving alternative for individuals locked out the home-purchase market by rapidly rising prices.

The market stresses facing the SFR sector now include decelerating rents, a rising cost of capital and a shortage of homes available to purchase — which has slowed property acquisitions and related securitization deals that help market players regenerate capital.

David Petrosinelli, a New York-based senior trader with InspereX, a tech-driven underwriter and distributor of securities that operates multiple trading desks around the country, said he expects the securitization market for institutional SFR players to “approximate a more normal market by summertime.”

“But the caveat, of course, is that all bets are off if there’s a more meaningful contraction in lending [in the wake of recent bank failures and other economic factors] because then you’re in serious trouble,” Petrosinelli added.

Inviting an SFR lawsuit

Invitation Homes earlier this year failed to convince a judge to dismiss a pending whistleblower lawsuit filed against the company in federal court in San Diego that alleges it made improvements at scores of properties in California without first securing required building permits. 

The lawsuit claims further that the company “ignored permitting laws to avoid fees and increased taxes as well as to get renovated homes on the rental market as soon as possible.” The whistleblower litigation, known as a qui tam action — which allows private parties to sue on behalf of the United States — was filed under seal in state court in California in 2020 and moved last year to federal court — where the judge’s ruling denying dismissal of the case was handed down in January of this year.

The lawsuit is filed as a false-claims action on behalf of some 18 California cities by an entity called Blackbird Special Projects LLC, which discovered the alleged violations based on its examination of public records using artificial intelligence software. If successful in the litigation, Blackbird stands to get a cut of any recoveries for the local governments.

“To support these assertions, [Blackbird] used proprietary software to scour different rental listing websites such as and [Invitation Home’s] website to identify homes owned by defendant,” pleadings in federal court state. “[Blackbird] then used its proprietary ‘lookback’ technology to access pre-renovation images of the homes from a multiple listing service and compare them with post-renovation images from the rental advertisements.”

Invitation Homes declined to comment on specific allegations raised in the lawsuit, but a company spokesman did say the “allegations are without merit, and we intend to vigorously defend the company.”

“Invitation Homes is currently the largest owner of single-family, rental homes in the United States, with most of its homes located in California, Florida, Georgia, Texas and other Sun Belt states,” the federal lawsuit states. “In California, as of December 31, 2019, defendant [Invitation Homes] owned 12,461 single-family homes in over 100 cities. 

“… By its failure to pay or remit inspection, permit fees, penalties and interest, Invitation Homes has defrauded cities and counties in California millions of dollars.”

By “renovating thousands of homes” absent obtaining building permits, pleadings in the case allege, Invitation Homes was able to “avoid revaluations that would have happened if permits were obtained, thus evading increased property taxes on improved properties.”

The Invitation Homes’ case is being watched closely by some players in the secondary market, where large SFR operators like Invitation Homes raise funds through securitization deals backed by their rental properties.

“The reason this matters is they [Invitation Homes] make representations and warranties into their securitization trusts that all work improvements are permitted,” explained Ben Hunsaker, a portfolio manager focused on securitized credit for California-based Beach Point Capital Management. “So, there are points where they may have to refinance securitization debt if this [litigation] goes sideways for them with unsecured corporate debt, and they go from 1% or 2% cost of capital to 7% or 8% cost of capital, and they also have to worry about their ratings then.”

Invitation Homes (IH) spent about $25,000 on renovations per home for its California SFR portfolio, pleadings in the lawsuit state. 

“The vast majority of IH’s renovations required permits — including for demolishing and constructing sections of single-family homes, installing and demolishing pools, and significantly altering the electrical work— but permits were not obtained,” court pleadings allege. “Once the single-family homes were renovated without the required permits, IH rented them to tenants who were unaware of the unpermitted and potentially unsafe renovations.”

The federal judge now overseeing the case earlier this year denied a motion lodged by Invitation Homes seeking to have the case dismissed. As part of that ruling, the judge made clear that he wasn’t going to entertain any arguments by the defendant seeking to shift blame to contractors for failing to secure the building permits.

The judge states in his ruling, essentially, that even if independent contractors are responsible for the alleged failure to obtain building permits, that fact alone doesn’t absolve Invitation Homes of the responsibility to “do the investigating itself” to ensure permits were issued.

Industrywide turbulence

The lawsuit against Invitation Homes is not the only dark cloud hanging over the institutional SFR sector.

The securitization market for institutional SFR companies, which collectively represent some 5% of an SFR market composed of some 17 million properties, is currently in the doldrums. That’s largely due to a lack of housing available to purchase, and consequently a lack of new assets to securitize, according to market expert L.D. Salmanson.

Salmanson is CEO of Cherre, a data-integration and insights platform that works with major players in the real estate market, including insurers, asset managers, lenders and SFR operators. The company serves as a data warehouse and deep analytics platform that integrates client data with other public and private data sources to create powerful market assessment and forecasting tools.

“First of all, there’s been a massive slowdown in the purchase rate for the large [SFR] players,” Salmanson said. “What’s been causing the slowdown is not the [flat to decelerating] rental prices, although that is affecting it.

“Rather, it’s that there are a lot less people selling because they’re not getting the [higher] prices that they’re looking for [as home prices decelerate]. But that’s temporary. That’s not going to last.”

Last year, there were a total of 15 securitization deals involving large institutional SFR players valued in total at $10.3 billion, according to data tracked by Kroll Bond Rating Agency (KBRA). This year, so far, there has been one offering, a $343 million securitization deal by Progress Residential (Progress 2023-SFR1) that closed in late February, KBRA data show.

Yet even Progress, which has a portfolio of some 83,000 SFR properties, appears to be caught up in the SFR securitization stagnation. Hunsaker said one major SFR player a few weeks ago postponed a securitization deal, pulling it off the market prior to pricing due to market conditions. 

That player, according to industry sources, was Pretium Partners-backed Progress Residential, and the deal was Progress 2023-SFR2.

Hunsaker added that another potential drag on the institutional SFR market is the fact that some single-family rental (SFR) operators are backed by investment firms that also invest in the commercial real estate market, which he said also is facing stiff headwinds now — particularly in the office and multifamily sectors. 

For example, Bridge Investment Group Holdings early last year acquired Gorelick Brothers Capital’s estimated 2,700 SFR-property portfolio spread across 14 markets concentrated in the Sunbelt and Midwest. Bridge’s portfolio also includes investments in office and multifamily properties. 

Likewise, SFR operator FirstKey Homes, with a portfolio of some 45,000 SFR properties under management, is an affiliate of Cerberus Capital Management, a global investment firm with approximately $60 billion in assets across credit, private equity as well as residential and commercial real estate interests. 

KBRA reported last month that FirstKey Homes exercised a so-called “excess collateral release” [ECR] feature for a securitization deal dubbed FirstKey Homes 2021-SFR1. It was the first such ECR exercised across the 12 KBRA-rated securitization deals to date that have included such a provision.

“In connection with the subject transaction … the issuer requested release [via the ECR] of 729 properties from the collateral pool of 9,218 properties,” KBRA’s report notes. “Post release, the remaining 8,489 properties will collateralize the same debt of $2.06 billion [due to increased home values]. 

“…The analysis indicated that the [exercise of the] ECR, in and of itself, would not result in a downgrade.”

Hunsaker said for many SFR operators facing uncertainty now, the solution is to stop buying new properties if they believe their cost of capital is rising too much — absent home prices dropping enough in the future to make the numbers work. 

“I think most of these [SFR operators] are capitalized for longer-term [property] holding incentives [and] … I don’t think these structures are set up to be forced sellers,” Hunsaker said.

He added that healthy home-price appreciation to date made it possible for FirstKey Homes to release the excess collateral from the 2021 securitization deal.

“But they weren’t releasing that excess collateral to sell the houses,” he stressed. “They’re releasing that excess collateral to put it on their balance sheet and reduce the amount of encumbered debt they have.”

FirstKey Homes does not share financial details about its operations for competitive reasons, a company spokesman said when asked to comment on the ECR transaction. 

“What’s vital to remember is that across the SFR sector, investors are still active, albeit a bit more selective, with the belief SFR provides durable cash flows and stable occupancies,” the FirstKey spokesman added. “Additionally, with household formations significantly outpacing the decades-long low housing supply, it bodes well for continued strong demand for the high-quality single-family rental homes we provide our family of residents.”

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