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Securitization, Take II: Investment Firms Seek to Securitize Rental Payments

(photo: woodleywonderworks / flickr)

Though this proposal to use eminent domain to buy up underwater homes and refinance them has been getting a lot of publicity in intellectual circles, the unorthodox fix for the housing market is already happening. That would be the REO-to-rental revolution, where investment firms buy up foreclosed properties in mass quantities after repossession, and flip them into the rental market. Entire firms are being built with this business model. We know that over 40% of the city of Oakland’s foreclosed homes have been purchased by investors. This isn’t prospective, it’s already happening.

Setting aside for a moment the potential problems of creating a large swath of hedge fund slumlords, as well as the possibility of razing entire neighborhoods with new development, the theory for the investors is that they can generate a steady stream of rental payments that will eventually dwarf the fire-sale price they paid for the foreclosed property. But there are all kinds of pitfalls to that model, like extended vacancies or troublesome tenants who refuse to pay. I hadn’t figured out how the investors planned to work around that model, until I saw this story in the Wall Street Journal. And then the light bulb went on.

Four years after mortgage-linked deals played a starring role in the worst financial crisis in decades, banks and real-estate investors are at work on a new type of security tied to the housing market.

This time, financial firms are seeking to engineer deals backed by the rental payments of residents living in previously foreclosed homes.

In recent months, firms such as Colony American Homes and Waypoint Homes have snapped up houses in foreclosure and rented them. Backed by investment banks and credit-rating firms, these firms think they have spotted a new opportunity: Packaging thousands of those rental payments into securities and selling them to other investors, a process known as securitization.

Potential issuers, like Colony and Waypoint, are seeking to create and sell these securities to tap outside investors for capital they in turn can use to expand their businesses.

The private securitization market for homes has been broken since 2008, and virtually no deals have gone through. But I could see the same alchemy used to prove to investors that they couldn’t lose on a mortgage-backed security put to work to prove the same thing on a rental-revenue-backed-security. They could slice the pools of rental units up into tranches to cushion the blow of missed monthly payments or vacancies, with more risk for higher return. And who knows, maybe they’ll just securitize that junior tranche into a CDO, just like during the housing bubble, and magically turn a high-risk security into a AAA-rated lock.

In other words, this is just a rerun, and the first movie ended rather badly. It was already going to be a problem for the management companies of these REO-to-rental units to have no community involvement; if they can securitize the payments and get sure revenue no matter what happens at their properties, they have even more of a reason to abandon them and act as absentee slumlords. This could also lead to all sorts of strong-arm tactics to force tenants to pay their rent that we have previously never seen before, well beyond a simple eviction after a grace period. The potential for abuse is high, because now there will be massive amounts of money on the line. And who will service the rental units for the investors? Servicers for loans haven’t exactly covered themselves in glory of late.

I think the key will be if the rating agencies once again abandon their responsibility as neutral arbiters and rate these securities highly. There’s very little data to go on about lengths of vacancies and timely rental payments. And the fact that the same trustees and structured finance experts who created, packaged and sold mortgage-backed securities during the housing bubble are the ones pitching this should act as a big, flashing NO sign. Sadly, I’m not sure it will.

CommunityThe Bullpen

Securitization, Take II: Investment Firms Seek to Securitize Rental Payments

Though this proposal to use eminent domain to buy up underwater homes and refinance them has been getting a lot of publicity in intellectual circles, the unorthodox fix for the housing market is already happening. That would be the REO-to-rental revolution, where investment firms buy up foreclosed properties in mass quantities after repossession, and flip them into the rental market. Entire firms are being built with this business model. We know that over 40% of the city of Oakland’s foreclosed homes have been purchased by investors. This isn’t prospective, it’s already happening.

Setting aside for a moment the potential problems of creating a large swath of hedge fund slumlords, as well as the possibility of razing entire neighborhoods with new development, the theory for the investors is that they can generate a steady stream of rental payments that will eventually dwarf the fire-sale price they paid for the foreclosed property. But there are all kinds of pitfalls to that model, like extended vacancies or troublesome tenants who refuse to pay. I hadn’t figured out how the investors planned to work around that model, until I saw this story in the Wall Street Journal. And then the light bulb went on.

Four years after mortgage-linked deals played a starring role in the worst financial crisis in decades, banks and real-estate investors are at work on a new type of security tied to the housing market.

This time, financial firms are seeking to engineer deals backed by the rental payments of residents living in previously foreclosed homes.

In recent months, firms such as Colony American Homes and Waypoint Homes have snapped up houses in foreclosure and rented them. Backed by investment banks and credit-rating firms, these firms think they have spotted a new opportunity: Packaging thousands of those rental payments into securities and selling them to other investors, a process known as securitization.

Potential issuers, like Colony and Waypoint, are seeking to create and sell these securities to tap outside investors for capital they in turn can use to expand their businesses.

The private securitization market for homes has been broken since 2008, and virtually no deals have gone through. But I could see the same alchemy used to prove to investors that they couldn’t lose on a mortgage-backed security put to work to prove the same thing on a rental-revenue-backed-security. They could slice the pools of rental units up into tranches to cushion the blow of missed monthly payments or vacancies, with more risk for higher return. And who knows, maybe they’ll just securitize that junior tranche into a CDO, just like during the housing bubble, and magically turn a high-risk security into a AAA-rated lock.

In other words, this is just a rerun, and the first movie ended rather badly. It was already going to be a problem for the management companies of these REO-to-rental units to have no community involvement; if they can securitize the payments and get sure revenue no matter what happens at their properties, they have even more of a reason to abandon them and act as absentee slumlords. This could also lead to all sorts of strong-arm tactics to force tenants to pay their rent that we have previously never seen before, well beyond a simple eviction after a grace period. The potential for abuse is high, because now there will be massive amounts of money on the line. And who will service the rental units for the investors? Servicers for loans haven’t exactly covered themselves in glory of late.

I think the key will be if the rating agencies once again abandon their responsibility as neutral arbiters and rate these securities highly. There’s very little data to go on about lengths of vacancies and timely rental payments. And the fact that the same trustees and structured finance experts who created, packaged and sold mortgage-backed securities during the housing bubble are the ones pitching this should act as a big, flashing NO sign. Sadly, I’m not sure it will.

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David Dayen

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