The continued difficulty of acquiring repossessed, single-family homes to rent on a significant scale makes it unlikely that these assets will be securitized this year, as some market participants may have hoped.
Nevertheless, the buzz about real-estate-owned rentals is building, as investors continue to accumulate properties and ratings agencies and various other service providers gear up for potential clients.
When the Federal Housing Finance Agency (FHFA) announced in February that Fannie Mae would sell its real-estate-owned (REO) properties in bulk to investors, there was a lot of talk that the program could provide much-needed collateral for either rated or unrated private mortgage securitization.
Six months later, it's still unclear whether these sales will generate sufficient inventory for a deal. The initial so-called "Fannie trade," on July 3 was for roughly 2,490 single-family REO properties, and the FHFA decided to divide this among three buyers. The FHFA did not disclose who the bidders were. While it's antcipated by market players that Fannie will eventually unload many more of its REOs as part of the FHFA sposored rental initiave, observers say even this larger amount might not be sufficient to stimulate securitization if it is going to be split among multiple buyers.
It's also unclear what kind of financing might be available to potential investors, and whether it would create the leverage necessary to make securitization attractive. Freddie Mac has confirmed that it is exploring a commercial financing program, but would not comment on the timing or specifics.
"There are still some issues that have to be worked out like what level are these financings going to be?" said James Warren, senior vice president at PropertyAccess, an Austin, Texas-based property management services company. "Is it going to come in at $100 million or greater - what is the amount of the facility that they are willing to do," he said
"The [first] choke point in the space is actually assets and the second is leverage," said Warren. "Right now there are so little bulk assets that you can only buy through traditional retail channels and nonperforming notes/loans and that requires servicers and knowledge on how to deal with the loans."
Of course, investors aren't dependent on sales by government sponsored enterprises to build portfolios of scale. While banks still aren't unloading REOs in large bulk, a number of investors have been painstakingly accumulating properties one at a time, with a view toward eventually securitizing them.
According to Warren, there are at least three institutional investors that have acquired well over 1,000 properties each; he said each firm has a $100 million to $200 million portfolio of single family REOs that are being acquired on average at $50 million a month already.
Waypoint Real Estate Group is one of them. Managing Director Gary Beasley said the Oakland, California, based company currently owns more than 2,000 homes worth a total of around $350 million. Since 2009, it has been acquiring distressed single-family houses, one at a time, renovating them, and then leasing them to residents.
Waypoint has recently stepped up the pace of acquisitions, but has no plans to buy in bulk. In July, for example, it acquired 270 homes worth a total of about $45 million, compared with a rate of just 60 homes a month eight months earlier. "We have increased our operating capabilities over four fold since the end of last year," Beasley said. "It's really like building a machine to be able to underwrite, evaluate, renovate, lease and manage. For us, this targeted strategy is preferable to buying large pools, and we have been perfecting this 'rifle shot' vs. 'shotgun' approach over the past three years."
He's confident that the firm can eventually put "multiple billions [of dollars] of capital" to work this way, accumulating enough collateral for deals. "The key is to get to a scale where you could do offerings of a reasonable size such that it makes economic sense to do in light of transaction costs and effort. I think there will be multiple players with portfolios in the $100 million to low billions of assets as we look out into the next few years that will support a market for securitization."
But amassing critical scale by purchasing individual REOs of single-family homes may be too time-consuming for players just getting into the game. So newcomers may be relying on Fannie Mae and others to potentially put a lot of capital to work.
"Rent REOs are a great idea, but a great regional idea, and more of a onesie / twosie transaction," said Rudy Orman, a senior vice president at Residential Credit Solutions, a national mortgage investor, issuer and servicer. "Buying REOs is not a trade and sellers of real estate do it on the [courthouse] steps daily and then through realtors. So you need a huge network of guys chasing one property at a time, daily, before it goes to a realtor."
Colony Capital, which launched in January and is rumored to be one of the winning bidders on the Fannie Mae REO sale, may be pursuing both strategies. The company has not confirmed any purchases of assets from Fannie, But it has said that that it has approximately 3,000 homes owned or in escrow as of late August. It plans to deploy another $1 billion to $1.5 billion over the next 12 months to purchase 10,000 to 15,000 more homes.
Colony declined to comment to ASR on specific purchases, but the company said it expects to reach sufficient scale for a securitization within a year. A spokesperson said it was too soon to speculate on the details of a likely deal, however.
While GSE sales may allow latecomers to the REO-to-rent party to play catch up, potentially speeding up the timeline for securitizing these assets, there's some debate within the industry as to the benefits of buying in bulk.
Waypoint's Beasley said bulk purchases means not always getting the most ideal properties. "We would be more inclined to buy homes [the company buys real estate, not loans] at a larger discount [when purchasing them in bulk] because by definition we would be buying [some] homes that we don't really want," he said.
Making targeted purchases is a safer bet because it allows the firm to take note of the rental yield potential and expenses associated with each purchase. "If you are underwriting a large portfolio, you aren't looking at anything in that granular of a way, and even if you could, it is not possible to be as discerning with your portfolio construction," Beasley said.
Jonathan Spinetto, president at Blackhawk Consulting, which acquires REO properties on behalf of hedge funds and institutional investors, also sees little benefit to buying in bulk. He said that the biggest problem for them is that there is very little opportunity for investors to find properties in bulk from one seller, where all of the assets will meet their invesment criteria. "We have found that the correct strategy to pursue through our methodology is actually single sourcing a lot of these assets and putting them together in packages that makes sense for the hedge funds and the investors based off of their investment criteria," he said.
For these reasons, some industry observers think Colony's timeline for bringing its first deal to market may be too optimistic. One person said it is likely that as much as 20% of the firm's portfolio cannot be securitized, given the loans that will be kicked out due to their financial performance. This person said that it should take the company another year and a half to aggregate any kind of scale, although they are a leader in this space.
Despite the difficulty of accumulating large pools of REO properties, it's an indication of the continued, strong interest in securitizing REO-to-rentals that four credit ratings agencies have recently published reports on the kinds of criteria they would use to rate such deals. Among their chief concerns would be the experience of property managers and the lack of historical data on the single family rental market.
In an Aug. 23 report, Moody's Investors Service identified two categories of risks associated with securitizations of REOs-to-rent: the performance of an operator or manager of the properties and the variability of cash flows from the rental and ultimate sale of the properties." The risk that an operator could fail to perform its duties would be one of the key risks these transactions would present," said Kruti Muni, a Moody's vice president and co-author of the report. "The presence of a manager that actively handles all aspects of the properties would be similar to what is present in cell tower or container lease asset-backed securities."
The report also identified the lack of historical data on the single-family rental market as another concern.
Fitch Ratings raised similar concerns in an Aug. 7 report in which it warned that 'the lack of historical data and ambitious growth strategies by regional operators will make high investment grade ratings on these transactions difficult to attain."
Morningstar Credit Ratings also cited concerns over the lack of historical data on the newly-emerging asset class in a reported published the week of June 4.
And a May 4 report form Standard & Poor's stated that "the property manager's expertise in large-scale residential real estate management and ability to manage subservicing arrangements may also be a credit consideration."
All four ratings agencies indicated that market interest in launching REO-to-rental securitizations has increased over the past several months, driven partly by the sizable inventory of REO properties held by GSEs, RMBS trusts and various financial institutions.
A property manager operator who spoke on condition of anonymity said his company has received multiple inquiries about developing a master property management rule that would function like a master servicer rule, which, he said "shows how serious these companies are in terms of structuring the deal." Master property management rules would ensure that if the operator fails, the master property manager would have the ability to take over the operation of all of these homes and properties nationwide and in a short period of time, this person said.
There are also efforts underway to provide better data on the rental market. In August, Lender Processing Services (LPS) announced a distribution partnership with RentRange that would estimate the monthly rental income a residential property is expected to yield using neighborhood comparables and other factors and provide confidence scores and other market intelligence - such as vacancy rates, market saturation and relative market strength - down to the ZIP code level. The solution also provides rental rate historical trends and rates for specific addresses by ZIP codes and cities.
REOs still tend to suffer from the stigma that they won't get the same price point as they would if that same property were sold by a homeowner. This is less true in the rental space, explained Rob Walker, a managing director at LPS, because consumers don't rent fixer-uppers. "In order for a property to be viable as a rental unit, someone would necessarily have to come in and fix it up first," he said.
RentRange estimates the rental range for a specific property with specific physical characteristics. The data provider has been analyzing rental data for more than five years and has historical data going back approx. 40 months.
In May, CoreLogic launched a tool that provides investors with property-level information on the FHFA's REO-to-rental properties. The product looks at the average potential rent for the subject properties based on relevant market information such as nearby multiple listing service single-family residence rental data; capitalization rate information by geographic area; and the current value of the property using CoreLogic's automated valuation models.
Additional features include an assessment of neighborhood and market trends, a 24-month review of housing price trends, and cash flow projections on similar properties. Investors receive this analysis within one business day, the Santa Ana, Calif.-based analytic provider said.
"Investors are conceptually interested in the notion of rental property securitization, but they want approach it gingerly," Walker said. "They're coming to regard rental property data as a step in the right direction in much the same way AVM data is currently being used to estimate the value of a property in a purchase transaction."
For instance, if buyers know what a three bedroom, two bathroom property typically sells for in a given ZIP code, they can also know what the rental values for those homes are in the same ZIP code. With that information, investors can start to build an income approach to value and estimate capitalization rates, Walker said.
Walter Charnoff, CEO at RentRange, believes that investors do have the necessary empirical data to navigate the market today. RentRange has enough data on single family homes to actually do an apples to apples comparison. "When we are analyzing a single-family home and giving you estimated rent and performance metrics for the surrounding market, we are basing the results on only single-family home data," he explained. "This leads to better results than combining single-family and multifamily data sets."
Charnoff added, that because the single family rental market is heavily leaning towards institutional investors as an exit/solution for single family properties and NPLs, the rent potential of a subject property and the surrounding market have a substantial effect on the potential exit, value and risk of the loan.
Rick Sharga, executive vice president at Carrington Mortgage Services, said that even with this progress, it's still "a little bit premature to be looking at securitizing something that doesn't exist and doing so without a track record on the financial performance of the assets." Nevertheless, Sharga said he wouldn't be surprised to see someone test the waters within the next year.
First up could be a securitization financing vehicle that Freddie Mac is working on along with the Fannie Mae assets. One market source said such a deal had been anticipated for this summer but had been delayed. A Freddie spokesperson confirmed that the GSE is exploring a commercial financing program that would provide liquidity to institutional investors. He said such a program would need to get the green light from the FHFA, but said there was no specific time line.