Single Family Home Rental Investments – How to Game the Rental Market
Who hasn’t had a friend, family member, or colleague adversely affected by the 2007 housing bubble?
Though devastating to average Americans who lost their homes, as property values plunged nationally by as much as 35% from the 2006 peaks, the 2007 real estate crisis has been an opportunity in the making for private equity firms and hedge funds with deep pockets.
These firms swooped up thousands of homes at unprecedented rates from foreclosures taking place on courthouse steps across the nation.
The business model was simple: pay cash, buy homes at deeply discounted prices in some of the cities hardest hit by the economic meltdown, and convert them into rental properties targeting the original home owners and average Americans who could no longer afford to buy.
Blackstone Group L.P. — one of the major players in this market, with $248 billion in assets under management and a $3.6 billion real estate line of credit through Deutsche Bank — has now become the largest U.S. landlord of single-family homes.
In the past two years, Blackstone has spent $8.5 billion buying almost 44,000 houses around the country, mainly through its Invitation Homes LP division. Blackstone is, however, not the only player in this lucrative market…
In the past two years alone, institutional investors have spent $20 billion purchasing more than 130,000 homes across the United States, driving up local real estate prices and pushing average homebuyers out of the market.
Securitizing Rentals: Wall Street is the New Landlord
In November of 2013, Blackstone released a rated bond backed by securitized rental payments — the first of its kind.
The bond was backed by 3,207 homes, just a fraction of the rental properties owned by the company’s real estate arm Invitation Homes. Monthly rent checks from the properties were to be used to service the $479.1 million security, and the mortgages on the underlying properties were used as collateral.
Investors couldn’t get enough of the product, and Blackstone’s competitors announced they would be following in the company’s footsteps.
American Homes 4 Rent, the second-largest U.S. landlord for single-family homes, announced this week that it plans to market bonds backed by some of its more than 21,000 rental properties.
The Scottsdale, Arizona-based Colony American Homes, Inc., the third-largest single-family landlord in the U.S., also sold $513 million in bonds tied to rental payments of 3,399 properties in 20 metropolitan areas in seven states this past April.
Other players entering the market include Starwood Waypoint Residential Trust — controlled by Barry Sternlicht — with $1 billion invested in 7,400 rental homes, and American Residential Properties, Inc. — a Scottsdale, Arizona-based landlord with a rental pool of over 4,000 homes.
Though unconfirmed, there have also been reports this week that Blackstone is working with Deutsche Bank AG to sell another $1 billion in securities tied to its properties, about twice the size of its previous offerings.
Residential Mortgage Market the Next Logical Step
Despite the billions of dollars poured into the single-family rental market, the space is still largely dominated by “mom and pop” landlords and small investors with limited borrowing capacity, particularly as Freddie Mac and Fannie May set a maximum limit of 10 mortgages per investor.
Given the higher demand for non-conventional financing for non-owner occupied properties, Blackstone’s announcement that it was going to offer cash to smaller investors looking to play the rental market was hardly surprising.
In November, the company launched B2R Finance with a goal to originate mortgages to landlords that own at least five investment properties and either seek to finance new purchases or wish to refinance.
B2R Finance’s Entrepreneurial Lending Program originates loans from $500,000 to $5 million (minimum five properties), with five- to 10-year fixed-rate terms and up to 30-year amortization, while its Institutional Lending Program offer loans from $3 million to $50 million, five- to 10-year fixed rates or five-year floating rates, with an up to 30-year amortization.
Maximum loan-to-value ratios range from 60-75%, and the minimum DSCR (debt-service coverage ratio) is 1.25x.
Blackstone is not the only institutional investor entering the residential mortgage business — Cerberus Capital Management has also announced the launch of a program offering $1 million to $5 million loans to investors through its affiliate FirstKey Lending.
What the Future Holds for Small Investors in the Rental Market
Given the fact that home prices have risen and foreclosures have leveled off across the country, many large institutional investors have stopped buying single-family homes.
Blackstone’s acquisition pace has declined 70% from its peak last year. American Homes 4 Rent added 2,001 homes to its rental pool in the quarter ending December 31st, down 32% from the previous quarter, and Colony Financial, Inc. — a REIT that invests in Colony American Homes — has also slowed its acquisition of single-family homes in the past quarter.
Considering that significant short-term capital gains from purely flipping homes are no longer realistic, small investors are left with two options: participate in the rental market by buying bonds backed by securitized rental payments, or invest in the rental market for the long term through buying, renovating, and renting out a portfolio of properties and leveraging new lending products offered through institutional investors such as Blackstone.
The jury is still out on this new type of financial product and its underlying risk. Factors such as realistic vacancy rates (where opinions between Wall Street and real estate professionals diverge), combined with how effective the property management policies of institutional investors are in the long run, will determine success or failure.
Small investors with longer investment horizons looking to buy and hold rental properties through leveraging new lending products should use a three-pronged approach: complete a thorough due diligence process, rely on the expertise of local brokers in each investment area, and closely monitor the overall market inventory of new homes competing for the same homebuyers/renters.
Until next time,
Paul Benson for Wealth Daily