Falling Rents Hinder REO Securitization

In yet another roadblock  for future deals, January cashflows reported by Blackstone’s inaugural securitization of single-family rentals fell short of expectations.

Moody’s Investors Service, Standard & Poor’s and Morningstar each published reports relating to the asset class, which Deutsche Bank has estimated could reach $5 billion issuance this year.

In a report published on Wednesday, Moody's said that the trend of rising U.S. home prices have pushed down rental yields in many single-family markets.  “If rental yields are unattractive, fewer investors will purchase homes because their profitability will decline,” the report stated.

Moody’s analyzed a sample of 10 cities to calculate single-family home rents and implied gross rental yields on three- and four-bedroom single-family homes from the fourth quarter of 2011 to the fourth quarter of 2013. The increase in home prices significantly outpaced the increase in rents during this period, with gross rental yields sliding 20.7% on average for three-bedroom homes across the sample from 9.7% to 7.7%, according to Moody’s.  Rental yields for four-bedroom homes on average declined 18.7% from 8.2% to 6.7%.

The trend may explain why Blackstone’s Invitation Homes securitization experienced a reduction in rent. In a report published last Friday, Morningstar, which rated the deal ‘AAA’, said that initial performance data showed that monthly rent collections declined in January 2014 to $3.9 million from $4.0 million. The gross rent collected in January 2014 was 7.6% lower than the gross rent collected as of the cut-off date in October 2013. Moody’s and Kroll Bonds Rating Agency also assigned the Blackstone deal triple-A ratings.

The reduction in rent is primarily due to vacant properties and is consistent with Morningstar’s expected stabilized vacancy rate of 8.0%, but exceeds the issuer’s underwritten vacancy rate of 6.0%.

Along with falling rents, a better housing market could incent some institutional investors to start selling properties in regions where home prices have sharply appreciated, said Moody’s.  “Such sales will generally be credit positive for SFR [single-family rental] securitization because early principal redemptions will help to build credit enhancement faster and cushion against possible losses,” said Moody’s. “However, they may expose some investors to prepayment risk.”

S&P did not rate Blackstone's deal and its view of the sector has not improved. The ratings agency reiterated in a report today that it had “yet to see a transaction with the level of credit enhancement and other risk-mitigating features that warrants the highest investment-grade rating.”

One concern is over the degree of operational risk. Continuity of net cash flows from the underlying properties depends heavily on the ability of their owners to manage large numbers of single-family homes, which are often geographically dispersed and uniquely constructed.

“Skilled property management is necessary to avoid disruptions to the cash flows of a given securitization and to avoid or mitigate future losses,” said analysts in the S&P report. “The largest institutional owners of SFR properties have demonstrated an initial ability to scale their property management across very large pools, but none have a track record of managing such a large pool through an extreme economic downturn.”

S&P concerns are similar to those highlighted by Fitch Ratings in an October 2013 report. Fitch also did not rate the Blackstone deal.