By Shayla Mars  Fri Jan 31, 2014

Rental-Home-Backed Securities? Wall Street’s New Money-Making Strategy

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For those of you who aren’t a housing industry aficionado, you may have missed it when banks, hedge funds and private equity firms bought up 200,000 single-family homes across the nation. Wall Street firms capitalized on the low housing prices and interest rates in order to secure the properties. But being a landlord doesn’t seem to be the end goal for most firms—the real money is in turning those homes into investment properties and then selling them off to investors. While converting homes into bundled investment properties (mortgage-backed securities) is a legal financial practice, the bundling of rental homes hasn’t been done before. The mass buying and selling of mortgage-backed securities played a major part in the last financial crisis. It is uncertain whether rental-home-backed securities would fare better, but some Wall Street firms plan on making a play for it anyway.

Meet your new landlord

Between 2012 and 2013, firms took to buying up foreclosed real estate in distressed markets across the nation—those areas hit hardest by the financial crash. Instead of flipping these properties and transforming them into investments to be sold off, a percentage of homes are being used as rental properties. Firms often contract other companies to maintain their properties, but those companies are sometimes miles away. This could spell potential trouble for renters; be sure you investigate who oversees any rental property you’re interested in and find out what the response time is in emergency situations (e.g., a busted water pipe).

The possibility of rental-home-backed securities

It has been widely accepted that Wall Street fueled the growth of the housing bubble by being the supplier of easily attainable mortgage-backed securities. The securities proved toxic and poisoned the economy, causing the downturn. Investors’ planning to buy up large quantities of property hoping to make a profit from rent is a risky endeavor. Rising housing prices is one concern as supply dwindles, because it will become harder for firms to purchase future housing prospects (large quantities of housing) and to keep pace with paying back lenders.

Blackstone Group LP doesn’t seem to be worried. The world’s largest private equity firm is also the largest owner of housing in America with a total of 41,000 home under its supervision. Blackstone, like other firms, is considering bundling some of its properties and selling them off as rental-home-backed securities—bonds tied to rental income. Economists and rating agencies are both skeptical of this strategy for good reason. There is no precedent of how rental-home-backed securities would fare in a revitalizing market, nor is there knowledge on how they would be regulated. The fear of whether these securities would become unregulated, like the mortgage-backed securities that expedited the bursting of the housing bubble in 2008, adds to the hesitation around accepting them. Before Blackstone Group LP can move forward with this novel idea, rating agencies must approve it.

Firms are looking at the possibility of renter-back securities as a safer bet than mortgage-back securities, because a few tenants not paying their rent won’t cause the same economic upset as defaulting on a mortgage. Bloomberg created an easy to understand infograph of Blackstone’s rental-home-back securities strategy. The graph points out what could potentially happen in the event of rent defaults, evictions and vacant homes. The scenario is very similar to what happened when people defaulted on their mortgages—investors won’t be paid and overall revenue will drop. Of course there are safeguards but there were also safeguards set-up before the housing collapse.

Renters are the wave of the future

The Joint Center for Housing Studies at Harvard University produced a study on rental housing entitled “America’s Rental Housing: Evolving Markets and Needs” in 2013. The study discusses the growth of renting over home ownership. It states that myriad factors, such as displacement of homeowners during the crash of 2008, the recession that followed and the high cost of relocating all contributed to the increase in renters.

Unemployment is down but a vast majority of new jobs are lower-paying full-time positions. Wall Street firms are banking on a continued increase of renters as housing prices rise, pushing more people out of the buying market. The New York Times speculates that the bulk-buying by Wall Street firms may be one of the factors contributing to the rapid decline in supply. Sharp decline in supply leads to a significant jump in housing prices.

The rental market and the housing market are intertwined. Historically, there have been more homeowners than renters in America but as the Joint Center points out, a shift is on the horizon. If home-builders start to cater to the middle and upper class coupled with rising prices of present homes, more and more Americans will slip into the renter category. Rental-home-backed securities could be a great way for Wall Street firms to increase their revenue, but the economy can be unstable. Mass lay-offs or a slight rise in rent could negatively impact both a renter’s ability to pay and a return on the securities. If that happens on a large enough scale, it could cause another financial crisis. It will be interesting to see whether or not rental-home-backed securities come to fruition.

Check out our home mortgage rates page.

 

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